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After a strong performance in 2014, the U.S. rail industry's picture has changed considerably during the first half of 2015. Intermodal has continued on its upward (albeit somewhat bumpy) trajectory. Meanwhile, the carload rail segment has diverged from that path, and volumes are substantially down. The outlook for both segments is fairly complex, involving both secular (longer-term) changes, such as declines in shipments of coal and crude oil by rail, and cyclical changes as the economic recovery continues to sputter.
Carloads down for many commodities
For carload rail, the growth trend that had been well established in 2014 continued during the first quarter of 2015, with overall volume up 1.1 percent year-on-year and 14 of 20 major commodities notching gains in shipment volumes. That's no longer the case, however. At this writing, with one week left in the second quarter, overall volume is down a striking 7.0 percent year-on-year, and 17 of 20 major commodities have posted losses. Figure 1 provides a breakout of the Q2-to-date performance, showing the year-on-year percentage change for each major commodity in yellow, and the same information in terms of the year-on-year number of cars gained (or lost) in blue.
[Figure 1] Year-on-year change in carloads by commodity Enlarge this image
Secular changes in the marketplace account for much of the volume decline. Coal looms largest. Shipment volume has been plunging as both the economics of cheap natural gas as well as environmental issues associated with the burning of coal have led utilities to switch from coal to natural gas. Of the 335,000 fewer carloads handled thus far in Q2 versus last year, the shortfall in coal shipments accounted for 226,000. The troika of 2014 growth stars—grain, crushed stone/sand/gravel, and petroleum products—all have seen declines in Q2. Demand for grain movements this year is not sufficient to clear out last year's bumper crop, and exports have been hurt by the strong U.S. dollar. Crushed stone/sand/gravel shipments have been hampered by reduced drilling activity due to lower oil prices, trimming the need for carloads of sand used in hydraulic fracturing. At the same time, shipments of petroleum products have also been dropping as production from existing wells tapers and fewer new wells are being drilled.
If we exclude coal, grain, petroleum, and crushed stone/sand/gravel, we can look at the balance of rail commodities to get an idea of trends in the industrial side of the U.S. economy. The news is still not very good. During the first quarter of 2015, volume in the remaining 16 major commodities was up 1.8 percent versus the prior year, but so far in the second quarter volume is down by 3.0 percent.
In 2008, North American railroads handled 20.9 million carloads. The next year, volume tumbled to 17.6 million carloads. Five years later, the industry still has not recovered that lost volume, and total carloads in 2014 were still 1.5 percent behind those seen in 2008. It's possible that the former level won't be achieved at all during this economic cycle.
What's going on? In 2014 the rails handled about 322,000 fewer carloads than in 2008, but the composition of those loads changed dramatically during that time frame. Coal volume plunged by almost 1.6 million cars per year. Pulp and paper (down 112,000 cars) was the next biggest loser—another secular story, as digital media continue to replace printed materials. Grain movements were down by 90,000 carloads, and various other commodities added about 237,000 carloads to the deficit, creating a 2.02-million-carload "hole" that had to be filled.
The railroads were able to eliminate most of that deficit for several reasons. For one thing, even as the shift in energy production to hydraulic fracturing and other new methods of extracting oil and gas hurt the rails by reducing coal shipments, it also helped them by increasing movements of petroleum products (+655,000 cars) and boosting demand for crushed stone, sand, and gravel used in energy production (+299,000 cars). For another, cheap energy and economic growth have boosted chemical shipments (+171,000 cars), and the domestic auto business has more than recovered (+217,000 cars). These four commodities made up for two-thirds of the deficit.
These figures tell us that the current "rail renaissance" can be attributed in large part to lower operating costs and stronger pricing rather than to growth. But the changing traffic mix presents some challenges. The 20 percent plunge in coal activity has left the railroads with surplus track in the coal regions. At the same time, unit trains of crude oil, traveling entirely different east-west routes that were often congested, created a need for more capacity at various chokepoints, such as Chicago. Adding permanent capacity—by laying additional track, for example—is expensive and costly to maintain. The railroads are therefore approaching this type of investment with caution.
Intermodal upswing continues
Intermodal has been the railroads' most successful business segment in terms of growth. During the recovery, intermodal shipment growth has exceeded that of both carload and truck. In 2008, according to the Intermodal Association of North America (IANA), the railroads handled 13.6 million containers and trailers. Volume plunged 15 percent the next year but by 2014 had more than fully recovered, reaching 16.3 million, or almost 14 percent above figures for 2008.
Intermodal's story is really a tale of two markets, international and domestic. Each accounts for roughly half of all intermodal activity. International, the carriage of International Standards Organization (ISO) boxes containing import and export cargo, actually peaked in 2006 and has yet to fully regain those heights. Changes in port routing patterns, including less reliance on West Coast ports, has reduced intermodal use. Domestic intermodal, the movement of trailers and 53-foot domestic containers, has been the growth star. While international shipments have grown only 5 percent since 2008, domestic shipments have shot up by 37 percent. FTR estimates that in Q1/2015, intermodal handled a bit less than 18 percent of all U.S. dry-van-type movements of 550 miles or greater, and that intermodal's share of this long-haul truck market has been growing long-term at about 0.1 percent per calendar quarter. This conversion from highway has boosted intermodal growth by between 3 and 4 percent per year.
So far this year the intermodal situation has been turbulent. International loadings were badly affected first by the West Coast port congestion, and then by a big surge of volume when the backlog of containers trapped in ports and intermodal yards broke loose. But the underlying growth in the international segment, powered by consumer spending and a strong dollar, looks relatively robust. Domestic intermodal growth, meanwhile, has been easing for several reasons. One is that truck capacity is relatively abundant—for now. Although capacity is tight by historical standards, we are in a short period when it is more available than it has been; capacity is expected to tighten significantly next year, though. Another is that intermodal service speed and reliability declined markedly in 2014, and that situation has only been partially corrected to date. And finally, lower fuel prices are reducing intermodal's cost advantage over truck.
What is the outlook for the balance of the year? FTR's current forecast calls for a reduction of 3.9 percent in the number of rail carloads moved in 2015 versus 2014, with only a portion of that drop being made up in 2016. Meanwhile, intermodal will continue to grow at about 4.5 percent in 2015, with a slight deceleration going into 2016.
The combination of sagging volume and the shift in traffic mix from higher-margin carload traffic to lower-margin intermodal will put pressure on the railroads' operating ratios. Expect price hikes to continue at a brisk pace in the coming months as the carriers attempt to maintain their profitability.
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