After an extremely difficult 2016, things have improved significantly thus far in 2017 for the nation's railroads. But the popular perception of the strength of the current carload recovery may be overstated, and caution is indicated. Now the question is, where to from here? And what are the implications of the new Trump administration and its policies? Will they help Make Carload Great Again?
Carload: Steady but stagnant
The rail headlines certainly look favorable. According to Association of American Railroads (AAR) data, North American carloads excluding intermodal units were up a very solid 7.6 percent in the first half of 2017 versus the same period in the prior year. But that doesn't necessarily indicate that we're seeing current growth.
Figure 1 displays the four-week rolling average North American carloads for all commodities over the past two years. The chart shows clearly the savage drop in carload activity that occurred during the early part of 2016 as well as the relative strength displayed during the first half of this year. The year-over-year comparison shows strong growth. But in fact, the recovery occurred quite some time ago—during the second and third quarters of 2016. Since the beginning of this year (and discounting the normal holiday-season lull), volume has been unusually flat, although there was a small uptick toward the very end of the second quarter. Rather than showing a recovery currently underway, the data indicate that carload activity has been largely stagnant over the past three calendar quarters. A comparison of Q2 carloads to Q1 shows that volume grew only 0.1 percent, or 9,000 units. The bright spots were increased movements of nonmetallic minerals, principally hydraulic fracturing (fracking) sand; metallic ores and metals; and chemicals. These were offset by quarter-on-quarter declines in shipments of coal and agricultural products.
In the near term, we see little catalyst for improvement. Despite its recent losses, coal still remains the single most important commodity in terms of carloads, accounting for one in four originations in the second quarter. The Trump administration has made rejuvenating the coal industry a top priority and has rolled back some federal regulations affecting that industry. Our view is that such actions will have only a very limited effect, because the problem with coal is primarily economic, not regulatory. Well-priced natural gas is displacing coal as the primary fuel for electric-power generation. With the Trump administration also rolling back regulations on fossil fuels in general and fracking in particular, we don't see the fundamental problem for coal changing much. The decline in coal shipments may slow for a while, but any rebound will be short-lived, in our view.
One positive for rail is the elevated demand for the movement of frack sand. More wells are being drilled and more frack sand is being used per well, causing shipments to rise. This dynamic should continue, although a threat is posed by drillers who continue to experiment with the use of cheaper, locally sourced "brown sand" as a lower-cost replacement for the prized, sharp-edged "white sand" that currently is often moved long distances by rail to reach the wellheads.
Another potential plus is the downstream petrochemical activity that is being spurred by the continuing availability of cheap natural gas feedstock. Substantial plastics capacity is beginning to come on stream, mostly on the U.S. Gulf Coast. This presents some opportunities for increased carload volume, but the bulk of this activity will take the form of containerized exports. To the extent that these exports flow out of Gulf Coast ports like Houston, the rail carload benefits will be limited.
Intermodal: Volume on the upswing
Last year was also a tough one for intermodal, with total North American volume declining 2.1 percent versus the prior year, according to data from the Intermodal Association of North America (IANA)—the first such decline since the Great Recession. But the current intermodal picture is brighter.
While reported as one commodity by the railroads, intermodal is actually composed of two segments of roughly equal size: international and domestic. International intermodal, which consists of the movement of ISO international containers that are largely involved in the movement of import and export commodities, declined 3.3 percent in 2016. Domestic intermodal, which moves in 53-foot domestic containers and trailers, also lost ground, but to a lesser degree, registering a small volume decline of 0.7 percent for the year.
The international and domestic intermodal sectors are subject to distinct market influences and don't always move in parallel. While both sectors were weak in 2016, it was for largely different reasons. Normally, international intermodal volume moves in concert with U.S. containerized trade activity, with imports dominating. But in 2016 a disconnect occurred. International intermodal fell even though North American (U.S. plus Western Canada) import 20-foot equivalent units (TEUs) rose by 2.5 percent for the year. The reasons for this change are not completely clear, but in our opinion include alterations in port routing, more intense truck competition, and increased use of transloading at or near seaports.
The small decline in domestic intermodal was actually the product of two opposing forces. Domestic container activity moved up 4.1 percent in 2016, while trailer activity plunged 22.1 percent. Much of the trailer decline was due to a one-time event, specifically the decision by Norfolk Southern to terminate most routes operated by its Triple Crown RoadRailer trailer intermodal subsidiary, dropping their reported trailer volumes dramatically. But more generally, domestic intermodal suffered from more intense truck competition as ample trucking capacity led to lower highway rates and created competitive headwinds, particularly on shorter-haul intermodal lanes. Lower diesel prices also made motor carriers more competitive with intermodal.
So far, the intermodal picture looks far better in 2017. Through mid-year, total intermodal volume tracked by AAR was up 3.8 percent, and growth looks to be accelerating. Activity in the second quarter of 2017 was 5.4 percent higher than in the prior year. The IANA data (through June) permits parsing the intermodal market by sector. Most of the strength thus far this year has come on the international side of the house (+4.3 percent year-to-date and +5.6 percent for Q2). The disconnect between intermodal and containerized imports appears to have abated. Inbound container shipments have also been relatively strong, as the consumer appears to be in a buying mood. Inbound U.S. TEUs were up 6.4 percent year-on-year in the first half of this year.
After a very slow start, domestic intermodal activity has also resumed growing. Overall domestic activity was up 2.2 percent year-to-date through June. Domestic container moves were 2.3 percent higher than last year, a bit slower growth than was seen in 2016. But trailer activity was much less of a drag, easing just 1.0 percent year-to-date. Q2 volume showed year-on-year growth of 3.2 percent for domestic containers and (unusually) trailers rose even faster at +3.9 percent, resulting in overall domestic volume growth of 3.3% for the second quarter.
FTR Transportation Intelligence is forecasting a continuing acceleration for domestic intermodal over the balance of 2017. While we don't expect an increase in the pace of growth in the economy, we are projecting that truck capacity will tighten as the implementation date for the electronic logging device mandate in December approaches. How tight things will get and how fast the process will unfold are difficult questions to answer. We believe that capacity will get quite tight but not critically so, with the biggest effects to be felt in 2018. But intermodal should stand to benefit as we roll into the 2017 peak season, as shippers will use the intermodal option to ensure access to well-priced capacity.
The growth dilemma
In the long run, challenges await both rail carload and intermodal. While fully autonomous trucks able to drive themselves all the way from origin to destination are still perhaps decades away, it would be a mistake for the rails to be complacent. Semi-autonomous trucks will bring cost reductions to trucking in the coming years, perhaps in the form of multivehicle platoons with only the lead truck fully manned. The competitive landscape will therefore get more difficult for rail.
In the end, there are only three ways for rail volume to grow. The first is basic growth in the industrial economy. The second is when a new rail-compatible, unit-train-oriented commodity springs forth. A few years ago it was crude-by-rail; today it is frack sand. Neither of these growth factors are within the control of the railroad industry. The only way to ensure that industry activity grows faster than industrial gross domestic product (GDP) is to gain market share—in other words, to take volume off the highway. Intermodal is one tool to accomplish this goal but can't do it alone, because each intermodal unit packs only about one-third the revenue punch of a typical carload. The industry's health in the long run will rest on its ability to address the fundamental dilemma of how to grow the carload franchise.