To say that the freight rail carload and intermodal segments have been on a rocky ride over the last year or so would be an understatement.
The reasons for this vary: service and staffing issues; lower volumes; inflation; and mixed economic indicators. However, there are some reasons for optimism. There are indications that perhaps volumes have bottomed out and could slowly be returning to growth mode, coupled with some visible signs of sorely needed service improvements—although more investment is needed.
On top of that, the freight railroad sector remains squarely in the crosshairs of the Surface Transportation Board (STB), which has been keeping a watchful eye on freight railroads and has been more vocal regarding railroad service and new regulations.
To help bring the current state of the nation’s rail and intermodal network into sharper focus, LM is joined by some of the nation’s foremost experts in the market, including Larry Gross, principal at Gross Transportation Consulting; Anthony Hatch, rail analyst and principal at ABH Consulting; and Adriene Bailey, partner and head of the North American Rail Team at Oliver Wyman.
Logistics Management (LM): How would you define the current state of the rail carload market?
Anthony Hatch: It’s stressed and constrained. Through early September, North American carloads were down 0.3% year-to-date, and that trend is continuing as we enter the fall and easy comparables. Chemicals have been helpful, and autos inflected, but the chip situation remains an issue.
The big questions are: When will we see the full benefits of the hiring and training of the last nine months? When will the expected labor settlement lead to an increase in train and engine attrition? And what is the level of pent-up demand out there—is it enough to compensate for economic uncertainty?
Adrienne Bailey: The carload market is relatively flat right now. Coal exports for eastern coal are higher than last year, a consequence of the Russian invasion of Ukraine, which has led to diminished supply and higher oil and gas prices. Automotive volumes are up compared to last year as well, but still down considerably from historical norms, due to high prices, high interest rates and a persistent chip shortage.
It’s also likely that there’s some consumer hesitation on whether to buy an internal combustible engine now or wait for electric vehicles. Chemicals and plastics are doing well, while demand is expected to increase as a result of the unstable supply situation, with Russia and Ukraine mostly absent from the market. Forest products are relatively good, particularly paper packaging products. Demand for lumber is flat and softening a bit, as prices are going back down, and higher interest rates always hit housing markets the most.
LM: How would you describe the intermodal market from a volume and demand perspective?
Larry Gross: Remember that the intermodal market is actually composed of two sectors—domestic and international. Domestic intermodal has been growing, but the gains have been quite limited. Improvement in the number of loads moving in privately-owned domestic containers has been largely offset by losses in rail box and trailer moves.
In the meantime, international moves remain well behind prior year, although there has been substantial improvement from the first quarter. As a result, total year-to-date intermodal activity through early September remained more than 4% behind 2021.
The international situation reflects capacity limitations as substantial volumes of freight remain floating off our ports awaiting unloading and subsequent inland movement. But the domestic situation appears to be more demand-based, as substantial capacity has been added to the system in the form of new private domestic containers. However, lack of supporting chassis has also been a constraint.
Bailey: Indeed, intermodal volume continues to be depressed, as railroad service performance, congestion, and equipment issues are forcing it onto trucks. Railroads missed the window where a snap back in COVID-19 volume could have provided a market share uplift, as they were caught in the whipsaw of volume roaring back, yet lacking the rail and labor force to handle it.
The result has been warehouses too full to unload, while equipment was tied up, gridlocking the network. Rail service is unlikely to return to more normal levels until labor issues are resolved and the backlog of freight clears.
In the meantime, as shippers seek to restock inventory and get products to market, they’ve shifted to transloading, with much of that moving by truck for speed. Longer-term, share should shift back to intermodal, but a lot depends on the railroads’ ability to establish and maintain acceptable service levels to compete with trucks.
Hatch: It’s not dissimilar to that of carloads, though it’s of a higher profile and even more affected by global events beyond rail management control. Problems at ports, which are actually improving at the Port of Los Angeles and Port of Long Beach, warehouse, shipper inventories and destinations—even at Chinese origins—all play a role, of course.
July’s IANA numbers showing a 3% overall decline sums it up. July continued to show the “green shoot” pattern from the all-important domestic container side, up 2%, but not as green as the year-to-day 4%+ increase. As with carload, the question is how much pent-up demand is there? Or did it all go highway? How much is recapturable?
From the railroad’s perspective, they see very little in terms of expected demand slowdown at this moment in time. However, the questions remain: Are they just wrong? Or is the rail intermodal market different?
LM: How do you view current service levels compared to this time last year?
Bailey: Intermodal involves a complex, multi-party service delivery chain that can quickly go from fluid to congested—if one or more steps in that chain fail. Across the board, labor and equipment shortages, coupled with rapidly rebounding volumes, led to massive congestion in the first two quarters of 2022.
If one considers intermodal train speed as the bellwether of the health of the railroad, we saw train speeds increase as pandemic-related shutdowns lowered rail volumes in 2020, and velocity continued to do well through 2021 coming out of these shutdowns—until post-COVID volumes returned in force.
So, recovery in 2022 thus far has been extremely challenging, with train speeds dropping below 2017-2019 levels. Greater effort on the part of both railroads and shippers is needed to clear bottlenecks, secure adequate labor, and return fluidity to the network.
Hatch: Volumes and metrics year-to-date suggest no real improvement, but more recently we have, just maybe, started to see sequential improvement. Overall, on-time numbers for rails are sitting in the low 70s—and as they would admit, that’s not good enough.
And while this means the rails are behind on their projections from the beginning of the year and they’d be in recovery mode in the second half, it’s still possible, with crews coming on line, that they will be at a 2019 run-rate by the end of the year, as recently stated by Norfolk Southern CEO Alan Shaw.
On the intermodal marketing company side, they all expressed varying degrees of dissatisfaction with rails velocity and turns—but all expressed hope for the near future, and longer term, they’re doubling down by adding significant box capacity. As the old
saying goes: Follow the money.
Gross: Based on both STB reports and user anecdotes, service levels are trending lower this year than last. Intermodal trains are running slower, more trains are being held for lack of crews, power, or other reasons, and a higher number of loaded intermodal cars have not moved in 48 hours or more. However, progress has been made in recent weeks.
A new statistic that’s available from the STB that wasn’t in place last year is the percentage of intermodal trains that are arriving at destination within 24 hours of schedule. Since the STB began collecting this data back in May, we’ve seen on-time arrivals consistently running in the range of 75%.
LM: What can shippers expect in terms of service in the next year or so?
Hatch: Well, it better be better. Until lately, the rail story was the “renaissance” of improving share, returns, and margins backed by price, as well as service, itself backed by massive capex. That seemed to stall in the end of the last decade, bringing in the successful Canadian experiment of precision scheduled railroading (PSR). PSR 2.0 in the ‘textbook’ calls for a ‘pivot to growth,’ and the railroads began talking that pivot in January 2020—and we know what happened then.
And they restated that case in the beginning of this year. I remain adamant that ‘talking the talk’ comes before walking it, but so far, it’s been just that—talk. The rails are under extraordinary pressure—from regulators, politicians, customers—and, yes, shareholders—to solve the immediate train and engine service problems, and they’re hiring, though losing out on experience. I’m hearing more confidence that they are finally seeing that light at the end of the tunnel.
Gross: I expect service to improve. The railroads are working hard to recruit new train crews. While qualifying and training personnel for rail operation is time-consuming, it appears that significant numbers of new workers will be hitting the rails beginning in the fourth quarter.
This, when combined with moderating volumes, should provide the railroads with an opportunity to reset their operations, eliminating some of the congestion currently plaguing the market.
Bailey: Shippers should expect gradually improving service levels over the coming year. This could be accelerated if economic activity slows, allowing the backlog of freight and trapped equipment to be worked off.
Over time, we expect the market will return to equilibrium, but, in the longer term, the railroads must improve on their historical service levels and their ability to maintain those service levels without these types of meltdowns if shippers are going to commit to rail and take trucks off the highway.
LM: Is pricing where it needs to be for railroad and intermodal in light of capital expenditure outlays made by carriers?
Gross: As always, intermodal price levels will be dictated in large part by what’s happening in the truckload space. Truckload spot rates have declined, reflecting a combination of significant supply and waning demand. Contract rates have not fallen as far or fast.
This is typical behavior with contract rates being both less volatile than spot, as well as having a roughly six-month lag—both upward and downward. Intermodal rates will need to remain below truckload rates to attract volume. Hence, we can expect to see downward pressure to the extent that truckload contract rates fall.
Bailey: Yes, pricing has been strong enough to support capital expenditures. Railroads, similar to most businesses, have been reporting healthy earnings, despite other headwinds.
Hatch: Is pricing ever where it needs to be? The rails spend an extraordinary amount on capex, around 18% of revenues, with near-term peaks at more than 25%. Railroad pricing is the key support, and so far, it has held up well. Railroads’ return on invested capital supports the spend as it has surpassed the weighted average cost of capital for the past half-decade, after trailing that benchmark since The Staggers Rail Act of 1980 (deregulation).
One factor to consider: Intermodal has been under quiet attack by some in the financial sector for being ‘not worth the effort,’ given the service requirements, capital outlay—and especially what’s perceived as sub-par returns. This is scary because intermodal is the future. But the comparatively low/lower margins (or higher operating ratio) worry some, and its impact on reported results is an issue. So, in this sector, pricing below truck, but at levels to justify return on invested capital, is critical.
LM: How do you view the emerging presence of technology and automation in freight rail as they relate to the long-term?
Bailey: Oliver Wyman believes slowing adoption of new technology is a major risk for the rail industry going forward. While public policy is encouraging the adoption of autonomous trucking, regulators are blocking rail industry progress in the same direction.
The rail industry is investing in new technology across infrastructure, rolling stock and operations, but is being denied a path to implementation. All constituents should be advocating for railroads to be able to test and deploy technologies that will enhance safety, service quality, and efficiency.
Hatch: This is a big issue. The government is supporting electric vehicles, which can narrow the fuel and emissions gap that trucks have to rail. And, of course, there is great interest around autonomous vehicles, which would narrow the gap in labor—think 300 drivers versus one stack train. But, the rails have a great network in great shape, thanks to that capex. And they have positive train control already installed—and they have money, and lots of it.
So, what’s the holdup? Well, it’s labor (as with the ILWU dockworkers, labor wants to forestall automation) and mostly the government—in this case the Federal Railroad Administration which wants to mandate two-man crews and stop automatic inspection of cars and of track. So, it’s a political issue as much or really more so than a technology one.
Gross: For intermodal to compete effectively with truck, it needs to offer the most ‘truck-like’ service possible. This includes both truck-like levels of reliability, as well as shipment visibility. Intermodal still has a way to go for it to achieve this level of visibility, particularly on the international side. The task is more difficult because of the many participants that play a role in delivering a load via intermodal. Technology can make this process easier.
LM: What are your thoughts on the regulatory front?
Hatch: The regulatory front can be dissected into a few different parts in the United States. First, the Federal Railroad Administration, the safety regulator, using safety as a way to halt technological progress and save jobs. The STB, the main regulator, which had a pre-existing notion that rails were too powerful, too beholden to Wall Street, and spend too much on share buybacks.
Now, the rails self-inflicted service issues have played into the STB’s hands and allowed a conflation of service and price. The hearings on reciprocal switching/forced access best exemplify that. Reciprocal switching, as it will happen, will be rare—and it’s meant as a ‘soft cap’ on rail price, not service. Outside of mergers and acquisitions, the biggest thing the STB can do is shine a big spotlight, though it would like to do more.
While I oppose that, it’s ironic that I think STB issues are in a sense governed by not having enough reach—they look at rails in a vacuum, versus freight movement. While I’m concerned about STB overreach, I’m not panicked. And as an analyst, I actually like seeing more numbers.
Gross: The supply chain crisis has had an effect similar to lowering the water level in a river. The rocks and shoals that were well underwater are now painfully visible and affecting navigation. Customer discontent has been rising and both the STB and the Federal Maritime Commission are responding.
In neither case does the regulatory agency hold the power or capability to address the root causes of the crisis. They can’t “fix the service” or “solve the problem.” However, one area where they can make a difference is in ensuring that the costs stemming from the congestion are fairly apportioned and that supply chain participants are not forced to pay for delays or problems for which the responsibility rightfully belongs elsewhere.
Bailey: It’s imperative that the rail industry build bridges to the public and regulators around the public benefits of rail. Our current economic model undervalues rail and overvalues truck, because the actual costs of congestion, emissions and infrastructure for trucking are not broken out and directly attributed to trucking.
This is easy to explain in the abstract—but much harder to weave into our current approach to modal transportation policy, where each mode is mostly regulated in a vacuum. We would argue that greater collaboration is needed between the regulatory bodies that govern each mode to ensure more consistent logic is applied in valuing cost/benefit tradeoffs, and that decision making in the public interest is more balanced.
LM: How do you think the rail and intermodal markets will look in five years?
Gross: I hope and expect that intermodal will regain the growth track that it was on prior to the onset of precision scheduled railroading and subsequently, the pandemic. Within five years, U.S. intermodal will be effectively 100% containerized, as is already the case in Canada and Mexico. The only trailers moving will be in special circumstances. I also expect that the railroads themselves will have a diminished role in providing equipment, both domestic containers and chassis. The responsibility for this equipment will be assumed by other, non-rail providers.
Bailey: Oliver Wyman projections indicate that if nothing changes, rail likely will keep losing market share to trucks. Regulatory headwinds and a lack of shipper confidence in rail service will make this difficult to reverse. That being said, we believe that two or three times as much intermodal volume could be available to the railroads, if they can establish the right service product and sustain it for multiple years to build shipper trust.
Shippers want the efficiency of rail and its lower carbon emissions, but won’t shift freight without a product that meets their needs. Returning to 2019 service levels will be insufficient. Capturing more volume will require railroads to undergo a real transformation to deliver a customer-centric experience, coupled with much higher service consistency and reliability. If they can do this, railroads could outperform on growth for the next decade or more.
Hatch: I’m encouraged by the marketing experience of the top leadership (five of the seven current CEOs were CMOs), the increased use of available technology, the further developments in rail/IMC partnerships, a new force on the USMCA north-south supply chains (CPKC), and a return of more renaissance-like opportunity.