Light at the end of the tunnel?

During the recent economic upheaval, railroading in the United States stayed on track better than most transportation modes. That's not to say that railroads escaped unscathed. All transport sectors were bruised to some degree, and railroads were no exception. When the housing boom fizzled, for example, the need to move rail-oriented commodities such as dimensional lumber, plywood, asphalt shingles, sand, and gravel dropped significantly. Even intermodal freight — long a bastion of sustained growth—suffered drastic drops in import cargo, largely from Asia.

That the rail sector survived at all is a good sign; the industry had a rocky history prior to deregulation under the Staggers Act in 1980. Yet those past troubles may have actually helped it survive the more recent ones. Looking back, the U.S. railroad industry basically reached its peak in 1929, with 229,530 route-miles and a market share of about 80 percent of U.S. intercity freight tonnage. With the exception of traffic spikes occasioned by World War II, railroad's share of tonnage has fallen since then, sinking to 34 percent in 2007, while route-miles shrank to 94,400.

Article Figures

[Figure 1] The impact of fuel-cost increases on a 500-mile truck shipment Enlarge this image

Through those many decades of decline (particularly from the mid-1950s to the early 1980s), railroads worked hard to cut costs and increase efficiency. In fact, railroad executives became quite adept at cost management. This is primarily why the major carriers came through the recent recession in sound financial condition. During the recession, all took major hits in gross revenue and operating margin. However, their reasonably strong efficiencies— and their ability to react quickly and effectively—helped them weather the worst of the storm. So what does this portend for the future as the economy begins to revive?

Railroads invest for the future
For the rail industry, a guardedly upbeat forecast is in order. One reason is rail executives' apparent willingness to invest in their industry. During the 1960s and 1970s, most rail carriers were either in bankruptcy or headed in that direction. Industry return on investment (ROI) fell from an abysmal 1.91 in 1960 to 1.20 in 1975, and many chief executive officers (CEOs) responded by diversifying into related businesses, such as barges and pipelines, as well as unrelated fields like food products and amusement parks. But distinctly different behavior is evident with the current crop of CEOs, who are plowing earnings into physical plant and rolling assets. This is a positive sign that has inspired investors (emblematically Warren Buffet) to ratchet up their interest in the business.

Energy trends may also be working in the industry's favor, in part because world oil production is expected to peak around 2011. Around that time (or even before), oil prices could rise significantly. What's more, the world may run out of conventional (that is, easy to harvest) oil around 2050. Great stores will remain, but they will be sheathed in shale and deepwater deposits, which means that accessing them will be unprecedentedly expensive. The net effect is more pressure to shift to transportation modes that are more fuel efficient—like railroads.

Demographic trends offer further cause for some confidence. In its "Transportation for Tomorrow" report issued in December 2007,1 the National Surface Transportation Policy and Revenue Study Commission predicted that the United States' population will reach 364 million by 2030 and 420 million by 2050. The great majority of these increases will happen where the bulk of the population already lives: on the U.S. East, Gulf, and West Coasts. The report also stated that, "We need to invest at least $225 billion annually from all sources for the next 50 years to upgrade our existing system to a state of good repair and create a more advanced surface transportation system to sustain and ensure strong economic growth."

The bottom line is that a burgeoning population will choke an already congested road infrastructure that is suffering from high fuel prices that are nearly certain to go even higher. For trucking-oriented shippers, that could imply a future where it simply isn't possible to move freight reliably, quickly, or economically. A recent Accenture study shows that a rise in oil prices to US $200 per barrel will add $265 to the cost of a truckload shipment of 500 miles. So if you presently pay $1.80 per mile for that shipment, your $900 cost will rise to $1,165—an increase of almost 30 percent. (See Figure 1.)

All of this could mean that railroading is poised for a major resurgence of traffic. Increases in truckload shipping costs like those noted above—coupled with rising highway-use taxes, tolls, and delays related to congestion—may drive dramatic conversions of highway traffic to intermodal and carload freight.

The U.S. railroads know this. However, they also know that there isn't enough capacity to handle such a large influx of volume. The Class 1 carriers estimate that, between now and 2035, they will need about US $135 billion in capital to improve their infrastructure.

Of this amount, they expect to be able to generate approximately $96 billion, leaving a gap in private capital funding of about $39 billion. (These figures do not include the congressionally mandated—but not yet funded—investment in Positive Train Control, a collision- avoidance system for increased safety.)

In the short run, there should be ample rail capacity, considering the abundance of stored locomotives and cars as well as furloughed employees. But this breathing room may only last for a year or so, as the tide will inevitably shift and the market will become tighter and pricier.

Shippers may need to get on track
Every railroad-industry leadership team will likely be seeking ways to accommodate an uptick in traffic—a boost that the industry is more or less unable to pay for in its entirety. One option would be to improve margins through pricing increases. Shippers may think rail rates are already high enough, but since deregulation in 1980, aggregate rail freight rates have actually declined.

However necessary, price hikes will not be welcome news to shippers, who already face immense pressure to keep their own costs under control. Supply chain executives will need to respond to tomorrow's transportation realities by developing an interdependent, interlocking network of their freight flows and carrier capacity that includes both railroads and other transportation modes. A strong vision and great business savvy—both strategic and operational—are clearly called for.

Endnote:
1. "Transportation for Tomorrow: Report of the National Surface Transportation Policy and Revenue Study Commission—Final Report" (2007)