Recession on rails

Falling carloads and container shipments could be a sign of continued bad times
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RAIL TRAFFIC ANALYSIS

Railroads face tough challenges in 2016 including a contraction in the U.S. industrial sector and competition from truckers operating with low diesel prices.

A strong dollar, low commodity prices and a slumping industrial sector hurt railroads in 2015 and will likely hurt them again in 2016.

Diesel fuel prices in the Midwest hit $2.13 per gallon on Jan. 4, the first business day of the new year, a 31-percent savings from $3.10 per gallon a year ago, according to the U.S Energy Information Agency.

Cheap diesel fuel prices have changed the mathematics for shippers. Spot rates for trucking freight fell significantly in 2015 due to cheap fuel prices and sufficient trucking capacity.

Mark Montague, an analyst with DAT Solutions, said spot van haul rates fell 10.6 percent to $1.51 per mile from $1.69 a year ago, while intermodal rates were even with a year ago at $1.10 per mile.

The intermodal dilemma
Donald Broughton, managing director, senior research analyst, chief market strategist at Avondale Partners, says most rail movements start to become competitive at distances greater than 700 miles. That number used to be around 550 miles when diesel was more expensive. This affects railroads. Look at Union Pacific, which saw its trailer intermodal volumes fall 19 percent in fourth quarter 2015 compared to an 6.77 percent drop in trailers at BNSF Railway in the fourth quarter. Total intermodal volume — trailers and containers combined — were down 5 percent at UP and down 0.81 percent at BNSF Railway in the fourth quarter.

Shippers have re-thought their assumptions about shipping by intermodal, Broughton says. There are a lot of hauls at less than 700 miles. Chicago to St. Louis. Chicago to Kansas City. Dallas to Kansas City. San Francisco to Los Angeles. These are areas where truckers can make a value proposition that excludes rail. This trend will last as long as diesel fuel prices remain near-all-time lows.

CSX trailer intermodal volumes fell 11.3 percent in the fourth quarter 2015 while its main rival Norfolk Southern saw its trailer volume fall 24 percent in the fourth quarter. Total intermodal volumes were up 4 percent at CSX at the end of the year on the strength of growing container traffic. But total intermodal volumes at Norfolk Southern fell 4.6 percent in the fourth quarter on slumping container traffic and lost trailer volume.

Container volumes should grow modestly in Florida with the widening of the Panama Canal. This benefits CSX, the Florida East Coast Railway, and Norfolk Southern. The problem is ports on the East Coast aren’t deep enough to handle the biggest container ships, Montague says.

Slumping industrials and oil and gas sector
Another big factor hurting rail is the slumping industrial sector due to the strong dollar being up 20 percent over the past 18 months, Broughton says.

Rail volumes of coal, steel, iron scrap and metals were down substantially in 2015.

“The U.S. industrial economy is in a recession,” Broughton says.

Power plants are using less coal and more natural gas and wind to generate electricity. Regulations make it expensive to upgrade coal plants to meet tougher clean air laws.

“With power plant regulations, it’s difficult for coal to do anything but decline,” Montague said.

China’s industrial sector also is contracting. As a result, prices for copper, aluminum and steel remain down.


Could the slumping industrial sector drag down the rest of the economy?
It depends on the U.S. consumer, who represents two thirds of the economy, Broughton said.

“Yes, it’s possible, but it’s too early to tell,” Broughton said.

Broughton says declining volumes of freight and commodities have shown the industrial sector has been in a recession since spring 2015, when rail volumes started to decline and never recovered, remaining down for most carriers all year.

“It’s hard to be bearish. This is what the data says,” he says.

He said recent actions by the Federal Reserve to raise interest rates may hurt the industrial sector. The Fed recently raised interest rates for overnight bank loans by 25 basis points.

Everybody in the transportation industry is capital intensive. A higher interest rate makes each decision on capital investment that much more difficult, Broughton said.

When comparing UNP and BNSF Railway, Broughton says BNSF Railway worked hard in 2015 to regain some of the business it lost in 2014 when shale oil was booming and farmers struggled to move wheat through the Dakotas. BNSF, owned by Berkshire Hathaway, spent capital to reduce congestion and improve train speeds. BNSF Railway’s shipments of grain were a bright spot in 2015, up 12.10 percent, compared with UP's 10-percent decline in shipment of grain in 2015 over 2014.

In total volumes, BNSF Railway was the clear winner, with total carload/intermodal volumes down just 0.13 percent in 2015 over 2014. UP’s total volumes were down 6 percent in 2015.

At CSX, total intermodal/carload volume was down 2.4 percent in 2015 while Norfolk Southern’s total intermodal/carload volume was down 2.79 percent.

Railroads will struggle to grow revenues in 2016. The U.S. economy is seeing weakening cracks open up as oil and gas sector lays off employees. BNSF Railway, the largest shipper of oil by rail, saw petroleum volumes fall 24 percent in the fourth quarter. BNSF’s petroleum volumes were down 11.75 percent in 2015 over 2014.

Montague says one positive is railroads improved their service and speeds in 2015. He said Union Pacific achieved 28.4 mph average train velocity compared with 25 mph the previous year, while BNSF achieved 28.7 mph compared with 23.4 mph in the previous year.

Michael Hooper is a freelance writer based in Kansas. He owns shares of Union Pacific and Berkshire Hathaway. This is his first Trains byline.
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