Commentary: Missed Signs Of Freight Rail Slowdown?

Here is a different perspective regarding the decline in U.S. rail carloads, and how long ago it may have started. The idea was originally authored by Lee A. Clair at Transportation and Logistics Advisors, known as T&LA.

Who?

Mr. Clair is the Managing Partner at Transportation and Logistics Advisors in Highland Park, Illinois.  

His assessment of rail freight is interesting since his point of view is based on a cross-functional education with elements of logistics, law, business administration and transportation.

The ideas he has presented resurfaced in a library stacks research project this journalist conducted over the past two years.  

It's offered in parts here as the year 2019 closes with U.S. railroads trying to rebalance their strategy for growth and market share heading into the decade 2020-2030. This is being done with a backdrop of declining demand for freight rail.

Let's start with positive information. Yes, there clearly was a freight rail renaissance period prior to 2007 when there was traffic unit growth.

When did that occur? The Federal Reserve Bank of St. Louis (FRED) charts show that growth period. U.S. government transport records show that customer business tendered to railroads as carload units. 

Note – Intermodal is excluded from both Figure 1 and Figure 2.

Figure 1: U. S. Rail Carloads 2000 to 2018

There was carload unit growth going into 2006. Then the pattern began to fall – into the Great Recession.  

Since then, there have been only two brief upward growth periods – between 2009-2012 and again between 2014 and 2016.

(Note – GDP Recession periods are shown in gray shade on the FRED graph)

Figure 2 refocuses our eyes on the shorter-term carload pattern between 2014 into early 2019. (Note – GDP recession periods are shown in gray shade on the FRED graph.)

Figure 2: U. S. Rail Carloads – 2014 towards 2018

The biggest single decline in carloads took place in the coal sector.

Conversely, rail intermodal volume has grown since 2006. Intermodal has been a success story. But that growth stalled in 2019.   The reasons are complicated. The message is that entering 2020, the railway view of intermodal growth is not clear. No one seems to be ordering more intermodal railway cars. There are multiple signs of unused intermodal capacity in 2019. One sign is the lower rail intermodal spot prices in selected cross-country corridors than the competition corridor spot intermodal prices.    

Figure 3: Intermodal spot rates significantly below year-ago levels, indicating capacity availability.
Source: FreightWaves SONAR

Sticking with the carloads, what is that segment's message?

How much market position does carload freight have and how much relevance for growth?

Answers are tough to come by.  

Railroad corporate profits have improved despite the decline in coal carloads and the overall flattening patterns of other types of carloads. 

Railroad company executives "expect" volume to return in the future as they ratchet their internal costs down further and increase their corporate net cash flow.

However, a due diligence review finds very few instances historically whereby a significant lowering of railroad company internal costs automatically translated into a larger customer traffic volume growth.

There is, however, evidence of customers using more railroad service when the railroads shared part of their internal rail company savings by lowering shipping rates.

Is that happening in 2019? Are the U.S. railroads splitting the cost savings from their internal cost restructuring (sometimes under the guise of so-called precision scheduled railroading changes)?

A survey of logistics literature suggests that rail freight carload rate-cutting is not being reported.

Might rail managers adopt selective rate cutting to increase both overall reported future net cash flow and market share volume into the next decade? There are not yet many signals of a pricing strategy. Are there?

How serious has the carload traffic erosion and slowing of growth been? One way to answer is to use a series of classic "what-ifs" to consider the relative market size position of rail carload traffic that "might have been."

This is where Lee Clair's insight comes in.

He observes that four years ago, the 2015 U.S. economy was about 75% larger than it had been in the base year 2000. If we mentally adjust that downward for inflation, we might moderate this to a calculated 30% to 40% growth in the economy.

On a carload basis, railroads didn't keep pace. 

Where have railroads been succeeding? It is in the financial area.

U.S. railroad management success between about 2004 and 2014 was in pricing leverage. In that recent decade, nominal rail prices increased significantly.

Analysis by T&LA shows that between 2004 and 2014, rail prices stated in average price per ton-mile increased by about 5%. That was despite the Great Recession period shown in Figure 4.

Figure 4: Long-term Purchasing Managers Index chart. Data from the Association of American Railroads.

That is in marked contrast to the public relations aspects surrounding the lowering of railroad rates after the passage of regulatory freedoms under the Staggers Act, which was passed by Congress in 1980.

During the immediate post-Staggers Act (that deregulated much of the railroad industry), rail freight prices declined by about 1% per year. The Staggers Act lower prices story line – a very good one – has apparently run its nearly four decade-long course. 

A continued pattern of lower rates is not the signal shippers are seeing out towards 2030. Is it?

Here is the railroad overall traffic financial success story in a graph.

Figure 5: Outstanding 10-year financial performance – continuing into 2019

U.S. railroads' reported net income saw a worldwide superior performance in earnings between 2004 and 2014. Higher reported quarterly earnings continued into the third quarter of 2019.  Overall freight profitability retains its luster – even as volume drops. You don't see that elsewhere in the global railway sector (Canada being an exception), or in most competing freight modes.

The core message is that in the 25-year period between 1990 and 2015, overall carloads (excluding intermodal) increased at a negative rate of minus 0.2% compound annual growth rate (CAGR). Yes, that includes the coal decline. Technically, this suggests that plenty of network capacity exist out there – if they want to gain traffic volume.

The contrasting statistics are that the economy to be served grew in the same period. Industrial production grew at a 1.6% CAGR for 25 years.

Figure 6: U.S. rail carloads under-performed U.S. industrial production in the past decade
Source: FreightWaves SONAR

While the U.S. overall growth rate may be much slower than that following the end of World War II, it is nevertheless growing.

Figure 7 is a FreightWaves SONAR graph showing the current carload rail freight volume as we approached December 2019. Important to note is that volumes now are below that of both 2018 and 2017 as the year ends. The pace remains overall negative for rail carloads.

Figure 7: Total USA rail carloads volume – year-to-date into November each year
Source: FreightWaves SONAR

Without some type of trade resolution between China and the United States, it is difficult to assert a forecast of strong carload growth during 2020. With a trade deal of substance, there could be a surge in grain, fertilizer, and petrochemical carload commodities into 2020 and 2021.

Here Is A Closing Upside Message

The prospects for rail freight are not inevitably bleak.

Once rail managers admit to the market risks, adjustment can be made. An aggressive return to volume growth across their much higher productivity rail routes could be targeted.

An increase in petrochemical shipments is very promising for rail volume growth – and is still a highly valued service by customers who own or lease private tank car fleets.

In some lanes, liquified natural gas (LNG) could replace crude oil by rail volume that might be lost in the coming years as pipelines come on-line.

Movement of high-and-wide industrial products on selected corridors has significant upside. These products include wind turbines, generators and transformers. In addition, both planned as well as emergency logistics response efforts could move by rail. 

Doom and gloom need not be the takeaway message.

What's your outlook? Care to share it?

References For Additional Perspective

It is always recommended that readers seek alternative counsel and insight.

For revealing rail freight financial insight, material published by Anthony B. Hatch (Senior Transportation Analyst at ABH Consulting) is a recommended source. Hatch was named the 2019 North American Rail Shippers Association (NARS) "Person of the Year." Hatch has been a senior transportation analyst on Wall Street for over 30 years at major financial institutions such as Solomon Brothers, Argus, PaineWebber, and Natwest Markets.

Original remarks from Mr. Clair are found on an internet posting of a STIFEL conference dated November 2017: http://www.tandla.net/sites/default/files/Stifel%20-%20Rail%20Growth%20Strategy%20Slides.pdf

Image Sourced from Pixabay