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Q4 2017 Rail/Intermodal Roundtable: Improvements apparent; work remains Four of the nation’s foremost experts in the market help shippers better understand the current state of the nation’s ever-complex and competitive rail and intermodal network.


By Jeff Berman, Group News Editor · October 3, 2017 As the economy shows signs of improvement, so too do the rail and intermodal transportation markets. However, it bears repeating that even in the leaner economic times of recent years, these markets did a better than average job of persevering while it appeared that the other major modes were limping along. And all that hard work appears to be paying off, as the current state of the rail and intermodal markets looks promising, considering that volumes are up compared to a year ago at this time. Meanwhile, rail and intermodal players continue to seek pricing gains. In fact, rates are slowly starting to trend up again, while service levels remain below ideal levels—something that has not gone unnoticed by shippers. All of these factors—coupled with the ever-changing regulatory maze of challenges—continue to make these markets complex, competitive, vibrant and challenging all at once. To help put the current state of the nation’s rail and intermodal network into better perspective, Logistics Management is joined by some of the nation’s foremost experts in the market. Our panelists include Larry Gross, senior partner at freight transportation analyst firm FTR; Tony Hatch, rail analyst and principal of ABH Consulting; Bill Rennicke, partner at Oliver Wyman; and Jason Kuehn, vice president at management consultancy Oliver Wyman. Logistics Management (LM): How would you define the current state of the rail carload market? Tony Hatch: Solid? Steady? Better? According to the Association of American Railroads (AAR], U.S. and Canadian carloads are up 6.3% year-to-date through August. Given the big swings in the formerly steady coal volumes, as well as the always volatile grain loads, the cyclical component of that number shows 3.8% growth, which isn’t bad, and certainly better than GDP. Of course, as with coal comparisons, the overall contrasts to the freight recession of 2015-2016 make the numbers look better—and as the AAR’s ‘Rail Time Indicators’ report points out, although U.S. intermodal volume has reached record levels, intermodal plus carloads over the 8-month period this year are more than 8% below the 2006 peak. Larry Gross: Tony is right on, and I’ll add that the current state of the rail carload market is stable, as it has fully recovered from the significant dip that occurred in the first half of 2016. However, the bulk of that recovery was complete by the end of 2016 and activity levels remained quite static throughout the first half of this year. Over the third quarter we saw volume just 1.7% above the same period last year, with gains in coal, metallic ores, crushed stone, sand and gravel—frac sand in particular—slightly more than offsetting losses in grain, petroleum products and automotive. Bill Rennicke: The carload market is doing quite well this year. Coal traffic has rebounded significantly—but keep in mind that coal as an energy source is not back. This is a temporary response to higher natural gas prices and stronger overseas demand. Coal will continue to have its ups and downs, but will slowly trend downward over the longer term. Frac sand is doing well, but crude-by-rail is down. The biggest weak spot in traffic this year is automotive traffic. In fact, finished vehicle sales are down, off peak years in 2015 and 2016, while Grain is currently down, but good harvests are expected this fall. Intermodal traffic has been picking up steam this year and is now growing at a pace of 5% to 6%, which is back to the ‘twice the GDP growth rate’ we like to see after several slow years and following the drop in oil prices. One of the hottest topics for new markets is refined petroleum products and liquid petroleum gas (LPG) to Mexico in response to deregulation of the Mexican petroleum industry. It’s unclear, but possible, that rail transport will be a short-term opportunity. LM: Carload volumes started to see the effect of “easy” comparisons abate in July. How do things look for volumes over the remainder of 2017 and into 2018? Gross: The era of easy comparisons is over, so the annual growth is slowing and could soon disappear entirely. At this moment I foresee no particular catalyst that would fundamentally change the situation. Coal has performed a bit better than I expected, and given the fact that it still accounts for one in four carloads moved by rail, a little improvement here can go a long way. Export coal in particular has been a big contributor, aided by problems experienced by foreign competition and the weaker-than-expected U.S. dollar. But the railroads don’t control either of these factors, and they can’t count on the current export coal strength continuing long-term. There has been discussion of a traffic boost from plastics, but most of the production will be based on the Gulf Coast and used for direct export, so I think the impact on rail carloadings will be muted at best. Jason Kuehn: The North American economy seems to be chugging along at a measured, but consistent pace—and that shows signs of continuing. We expect to see steady growth, but subject to the vagaries of changes in coal markets overseas. Coal is still a big enough commodity on the rails that declines can easily offset steady growth in other commodities. Hatch: Well, we have to see how the overall economy responds, how post-hurricane damages and more importantly re-builds play out—and how the nation’s capital imposes itself on the freight economy. The latter obviously makes an impact on lumber, metals, and grain. Assuming steady state growth, one should expect GDP-like performance, with questions coming from star performers such as frac sand and how long will this export coal mini-boom last. Where will auto sales bottom out? One positive note is that year-end 2017 into 2018 begins the five year or so ramp up in plastics and petrochemicals, some of which will aid the ongoing intermodal growth story. Housing remains behind “normal” levels, with a multi-commodity impact—of course this assumes that rail service, overall and in the southeast, improves. LM: With international shipments starting to track more closely with import volumes, does it stand to reason that international could be the new volume leader for this intermodal segment rather than domestic? Rennicke: There should be some caution on the international intermodal business for two reasons. First, while the closed borders rhetoric in Washington has had a major impact on immigration, so far it has led to few effects on cross-border trade. If some of the “buy American” sentiment does eventually trickle down to international commerce, this could dramatically constrain international traffic growth. Second, the expanded Panama Canal and the ability of East Coast ports to take larger vessels is just starting to have an impact on trade lanes, but volumes at eastern ports are starting to grow. This will be a slow, steady process as glitches with port congestion from larger vessels will impact growth at times, while there is still work being done on deepening harbors in places like Savannah. Overall, we expect to see very gradual, but steady diversion of traffic to the East Coast and slower growth on the West Coast. Hatch: These are all great points. International continues to outperform expectations. I have long assumed that it would be a solid GDP or better performer in the face of market focus on isolationism, trade war potential and near sourcing—all of which have some validity or risk potential, of course. The fact is that consumer goods—from furniture to electronics to clothes and footwear—are made outside of North America, but consumed here. Add to that what looks to be the end of the share loss from the rail-centric West Coast ports to the closer-to-markets East Coast, and you have the re-development of a mild peak season story for international intermodal loads. Gross: When one includes import cargo that is being transloaded into domestic equipment, international has been and continues to account for more than half of all intermodal activity—about 58% in recent months. Right now, the very strong growth in imports is driving international intermodal gains, but to some extent this is masking a current concern. International intermodal’s share of import TEUs dropped significantly in 2016 and has only made a partial recovery thus far this year. The year-to-date gain of 4.9% in international intermodal activity, while certainly good news, does not compare well when contrasted with an 8.2% gain in inbound TEUs via U.S. and Western Canadian ports over the same time frame. LM: With the overall digital economy putting an emphasis on things like smaller shipments and faster, more reliable service, what are the subsequent impacts on railroad and intermodal operations? Gross: From a rail carload perspective, the rail industry is heading in the opposite direction versus the overall economic trends. In response to economic pressures, the railroads are increasing railcar capacity and lengthening trains. In a world of static volume, longer trains translates into fewer departures, which in turn is leading to increased yard dwell as cars await the next departure. Intermodal is the railroads’ best tool for addressing the fast-changing supply chain, but even there, the emphasis of dispersing product more widely in order to get close to the customer and increase responsiveness poses a difficult challenge. Kuehn: It’s likely that there will be some impact on rail traffic from a tightening of the supply chain. Most of the focus to date, however, has been on B2C movements, where direct-to-consumer logistics is growing. There will still be a strong market from factory or port to distribution center and this is really the area where intermodal is used. But the continuing slow, steady movement of manufacturing to smaller scale regional production areas and the slow growth in recycling of materials is creating shorter and more truck competitive supply chains. LM: How do you view the current railroad service levels on a year-to-date basis? Gross: Based on the publicly available statistics, rail service has deteriorated as the organizations have placed more emphasis on economics and reducing cost, but the decline has not been terribly problematic. As of the middle of August, average train speeds were running 4.4% lower than prior year and trains were running about 1.3% slower than average speeds for this timeframe over the past 10 years. More significantly, yard dwell was at elevated levels. Most recently, overall yard dwell time was running 9.5% higher than the average performance over the past 10 years. It was higher even than this time in 2015 when operations were problematic. The key difference this time around is that the elevated yard dwell is by design and reflects fundamental changes in rail operations rather than any acute congestion issues. The exception to this statement recently has been CSX, which has experienced difficulties during the transition to a new operating regimen known as “precision railroading.” Rennicke: With the exception of CSX, overall railroad service levels are on par with or slightly better than they were a year ago. There’s continuing focus by the industry in this area, and there’s once again a focus on asset utilization and the realization that good service can actually be cheaper to provide than poor service. It does seem likely that there will be gradual, steady improvement in railroad service levels, with some irregularities as railroads make changes to account for changing traffic and settle into new operating patterns. Hatch: I’ll flat out say that service is poor, but it seems as if CSX is stabilizing. Overall, rail metrics have declined all year, but I will note that they’re still up over several years ago, and within intermodal they generally remain high. Massive rail capex over the decade combined with better use of IT should mean better service. LM: What is the outlook for rail carload pricing compared to the beginning of the year? Have things changed, or are they within—or meeting—expectations? Kuehn: Rail carload pricing is likely to be increasingly constrained by tighter logistics management and continuing low fuel prices. We also find that truckers are continuing to push fuel and cost efficiency. Programs such as the U.S. Department of Energy’s SuperTruck fuel efficiency program will yield savings to the trucking industry in the near term, and in the longer term we’ll see a strong challenge from autonomous trucks—which will keep a lid on trucking costs and therefore constrain rail rates. Hatch: Rail pricing has bounced off of its near-term lows and is expanding a bit—and can continue to do so as long as service improves. While we’re past the great “Legacy Re-pricing” period, even at its low point last winter the rails were getting ‘above rail inflation pricing.’ Gross: The railroads will continue to work to raise rates as this is one of the key components to their drive for ever-lower operating ratios. This effort will receive some support from the marketplace in the form of rising truck rates due to tighter capacity. LM: How do you view the current state of rail policy as it relates to things like the Surface Transportation Board’s ongoing quest for reciprocal switching, the possibility of railroad re-regulation, and PTC? Hatch: The rail group and its investors continue to rely on the AAR and the RAC to ‘walk on that wall’ to defend the industry because re-regulation would be a death knell of the ‘railroad renaissance.’ Return on invested capital [ROIC] increases, and maintaining a reliable spread over the cost of that capital are integral to the argument for the enormous required capital investment. Play with that formula and you risk everything. Have very public and unresolved service crises and you still risk everything. Gross: Although the Trump administration stands in favor of less regulation, it would be a mistake to infer that this eliminates the possibility of STB action on reciprocal switching. From a political standpoint, many Republican constituencies such as agricultural interests are the same ones behind the push for more open access. So, from a purely political standpoint, I view it as a jump ball. Rennicke: The current anti-regulatory view in Washington will likely minimize the regulatory burden on the rail industry. The mandatory two-person train crew rule-making has been withdrawn, and with a fixed guideway and the implementation of PTC, railroads should be in a strong position to respond in kind to threats, such as autonomous trucks. Railroads are far less labor intensive or fuel intensive than trucks, so efficiency in those two areas will tend to have a stronger impact on truck costs than on railroad costs. Now that the crew size regulatory shackles look to be off, the carriers and their technology suppliers will likely be able to respond to technology-based productivity improvements. LM: What would you say would be on your wish list for the biggest gains and advancement in the railroad and intermodal sectors over the next few years? Gross: My hope is that the industry begins to undertake a thorough reassessment of its approach to single-car railroading, as this, plus intermodal, are the only ways that the industry can reverse its steadily declining share of the transportation pie. The industry’s primary focus currently is internal—on streamlining operations and reducing cost. Ultimately, focus must also be placed on growing the volume base at something greater than the underlying growth rate of the industrial economy. This will require fielding a product with considerably better service consistency than the current single-car network is currently capable of delivering Kuehn: The rail industry needs to adapt to become more competitive in shorter haul markets against a trucking industry that’s poised to become much more fuel efficient and likely to soon start taking advantage of autonomous vehicle and platooning technology. We believe this will require the continuing focus on service and asset utilization and the deployment of new technology to create more fuel-efficient locomotives. Tier 4 emission standards broke the virtuous cycle of increasing fuel economy, and railroads need to start moving in new directions technologically to continue improving on fuel costs Hatch: Railroads must resist “short-termism,” often led by their investor base, and continue to spend the large sums of capital for maintenance and to fuel growth. I note that rails are talking a wide range of ongoing capex plans, from a low of 15% of revenues to a high of 20%, which was close to the average in the big buildup earlier in the decade. Railway management and labor are hard at work on the next contract. And this is a good time to ask: Can work productivity be improved? This is a critical and opportune time, especially with ‘winter coming’ in the form of AV trucking. Can the rails regain their technology mojo, perhaps starting with PTC applications? Many rails have looked to focus on regaining share in carload, so will we see measurable improvements over the next few years?