On track for another strong year

Although North American rail carriers had to contend in 2013 with operating challenges that had a worse-than-normal negative impact on service levels, shippers have good reason to remain "bullish" on railroad transportation. In fact, it is a good time for them to reevaluate their transportation portfolios to optimize the use of rail, both carload and intermodal, and to take advantage of the inherent economic and environmental benefits of rail versus truck.

Despite challenges, record profits
The financial performance of the North American Class I rail operators remained strong in 2013. The industry continues to generate record revenues and operating profits, which increased by almost 5 percent (to US $83 billion total) and 10 percent (to over US $26 billion), respectively. The average operating ratio (operating expenses as a percentage of operating revenue—a common financial metric in transportation) for the Class I carriers in 2013 was an impressive 68 percent. In addition, the industry is expected to reinvest approximately US $14 billion—more than 18 percent of annual revenues—into equipment and infrastructure improvements and expansions in 2014.

Article Figures

[Figure 1] Originated carloads of crude oil on U.S. Class 1 railroads Enlarge this image

The big story last year was the service disruptions caused by severe winter weather across the United States and Canada. While rail service in general was good, the heavy snowfalls and extreme cold of late 2013 and early 2014 created severe service issues for both carload and intermodal across the network. Major storms affected every railroad in some way, disrupting the transportation system and supply chains even in parts of the country usually not affected by winter weather.

Most operations are back to normal, although residual effects linger in spots along the system. Intermodal service was hard hit by the winter storms, and it is taking longer than conventional rail service to fully recover. In May, intermodal train speeds were still averaging about two miles per hour slower than they were last fall, adding five hours of travel time from Los Angeles to Chicago.

Another factor contributing to the diminished service performance in 2013 was the energy sector's continued shift from pipeline to rail for transporting crude oil. The resulting increase in rail traffic created bottlenecks in key lanes. The Association of American Railroads (AAR) estimates that last year the sector shipped more than 400,000 carloads of crude by rail—a huge jump compared to 9,500 carloads in 2008 (see Figure 1). This year, crude oil shipments are forecast to reach approximately 650,000 carloads. While this is significant, it still represents only about 11 percent of the total U.S. crude oil moved in 2013—pointing to the railroads' opportunities for new business and to their need to align capital expenditures with those opportunities.

This shift to moving crude by rail has added to the shortage of railcars, including both tank cars for hauling crude and hopper cars for hauling sand and cement used in hydraulic fracturing, or "fracking." Across the board, freight railcar orders in 2013 reached more than 65,500, up from just over 55,000 in 2012. As these orders have grown, backlogs and car lease rates have climbed, too. Railcar shortages will continue beyond 2014 but will eventually be resolved when railroads and car manufacturers align their fleets with the product mix, increase their production, and move needed railcars into the network.

Poised for even better performance
The railroad industry enters the second half of 2014 poised to achieve even greater financial performance and to deliver better service.

The break-even economics of rail versus truck will continue to shift in favor of shipping over steel wheels. Even though U.S. freight rail rates increased last year, rail remains a less expensive option than trucking and a much more environmentally sound shipping policy. In fact, when adjusted for inflation, rail rates (based on revenue per ton-mile) have dropped about 42 percent since 1981, according to the AAR's April 2014 report, "The Cost Effectiveness of America's Freight Railroads." Freight rail rates in the United States also remain the lowest in the world. In general, rates are forecast to rise slightly, but at a slower rate of increase than over the past decade.

Shippers continue to increase their reliance on intermodal. As intermodal attracts more volume, the railroads are putting even more capital into the intermodal network. They are strengthening the infrastructure with more and better gateways and intermodal yards, additional containers and chassis pools, and improved rail equipment. The fastest-growing intermodal lanes are those in the 500- to 750-mile range, suggesting that opportunities for truck-to-rail diversion will increase as more shippers recognize intermodal's favorable service and economics.

The rail industry will continue to reinvest in equipment and infrastructure, as well as in the implementation of Positive Train Control (PTC) technology, which is designed to automatically stop or slow a train to prevent accidents. The continued implementation of PTC should enable the industry to improve network flow and velocity while driving improved asset productivity. These improvements will have a positive impact on both service-level performance and rates.

The "rail renaissance" continues
Railroads will remain in the growth and investment phase of the ongoing "rail renaissance" for some time to come. Since 1980, railroads have gone through restructuring, regulatory, and merger-and-acquisition phases. Now they are focusing on investing, growing, and maintaining an exceptionally strong and efficient freight railroad network. And they are making the majority of this investment with their own money—only a small portion of it is coming from public sources—to improve service for shippers.

Furthermore, the economics of rail versus trucking continue to lean in rail's favor, making now the right time for shippers to revisit their overall transportation strategy and to reconsider the position rail holds in their modal transportation portfolios.