2013 Rail/Intermodal Roundtable: Staying ahead of the pack

Even though rail carload and intermodal volumes have still not caught up to 2006 levels, they’re certainly heading in the right direction. What’s more, those volume levels are on solid footing, with North American Class I railroads upping the ante annually on their respective capital investment plans, setting their sites on building out networks and acquiring new equipment.

While the commodity mix on the carload side has changed in recent years, railroads have shown their versatility in creating high-value services in new and emerging markets, while intermodal—especially on the domestic side—continues to chug along at a healthy clip. Making this all the more impressive is that rail and intermodal are performing well in an uneven economy engulfed in an atmosphere of political uncertainty.

Despite these headwinds, business on the tracks continues to head in a positive direction, and shippers continue to see the benefits of rail, too. But all is not rosy, with some shippers citing an inability to get what they consider to be decent pricing, while others are not always pleased with the service. On top of that looms the constant specter of railroad re-regulation, which has quelled in recent years.

Logistics Management is fortunate to have a trio of the best minds in the railroad and intermodal business explain the real story on the rails and put current market trends and business conditions into perspective for shippers in our 2013 Rail/Intermodal Roundtable. Our panelists include: Brooks Bentz, partner in Accenture’s Supply Chain Practice; Tony Hatch, principal of ABH Consulting; and Bill Rennicke, director of Oliver Wyman, a Boston-based management consultancy.

Logistics Management (LM): What is your take on the current state of the railroad and intermodal markets?
Bill Rennicke: Both markets are on firm footing and demonstrate a solid growth trajectory. While there’s some repositioning of the commodity mix (less coal and more oil), the traffic base has been quite resilient. Intermodal has been very strong in domestic markets, offsetting any soft import volumes.

Brooks Bentz: I would call it “recovering” because growth is there, but it’s not a rocket. I think it’s still to be determined as to whether this will be sustained growth or we’ll have a bit more of a roller coaster ride. As a good friend pointed out once, forecasts are either lucky or lousy, so precision in this regard is always suspect.

Tony Hatch: Overall the rails are in a transition or “bridge” year as their utility coal levels stabilize and we, hopefully, get higher grain levels in the second half. It has been the declines in bulk commodities, for non-cyclical reasons, that held back rail traffic in 2012. And so far in the first quarter of 2013, without steep gains in grain and coal, rail traffic still increased almost 5 percent in the first quarter. 

By 2014, and especially 2015, I expect that CBR [crude-by-rail], frac sand, autos, housing goods, grain, and especially chemicals, steel, and intermodal will all be reaping the benefits of massive capex spending by the rails and by shippers. Intermodal is doing just fine at present as well—that’s surprising on the international front, but it’s still humming on the developing domestic side as well.

LM: While carload volumes are still below pre-recession levels, we do see them beginning to rise. Do you feel things are going in the right direction in carload?
Bentz: The carload business will—as a general rule—continue to thrive. Coal will likely continue to clank along at depressed levels, but the upsurge in alternative fuels is proving a big boost with the related products, like pipe and fracking sand. The main theme, apart from all this, is that rail carload, coupled with intermodal, is a powerful alternative to over-the-road trucking, given the issues of congestion, infrastructure condition, capacity, as well as the cost of fuel.

Hatch: Carload is the tale of two economies: the cyclical merchandise, manufacturing, and housing markets, which are doing better based in rail car loadings than the business press might lead you to believe; and the bulks, which are still running as poorly as last year.

Rennicke: Brooks and Tony are right. The loss of coal volumes is a bit of a cloud over the carload segment, along with poor crop shipments in some regions. Overall, the carload sector is strong and has been able to quickly create high-value services in new and emerging markets, like oil field exploration related commodities. This kind of market response would have been unthinkable 10 years ago. Furthermore, the carload market will increasingly be viewed in terms of revenue generated versus carloads tendered. This is driven by the fact that the loss of low revenue coal loadings is being partially offset by higher revenue energy-based loadings.

LM: Intermodal volumes, particularly domestic containers, continue to outperform carload volumes and have been for a while. That said, how much staying power does intermodal have?
Hatch: Intermodal is in the early-middle innings of a secular shift from truck to rail, as evidenced by domestic containers’ growth performance from the Great Recession through today. And still the rail/intermodal market share is tiny, especially in shorter haul markets (550 miles to 1,000 miles), but not yet at saturation even in super-long-haul markets (2,000+ miles).

Rennicke: Intermodal will continue to play an important growth role. Structural issues in the trucking industry like hours-of-service, driver shortages, and the weakness of some carriers will continue to shift traffic. The aggressive intermodal corridor and terminal expansion by the eastern carriers will continue to see growth in underserved markets. In the international segment, recent announcements suggest that even an enlarged Panama Canal may not necessarily cut down transcontinental container flows, suggesting further strength.

Bentz: Functionally “unlimited.” That’s a big term, and there are some caveats: Railroads must continue investing in line-haul and terminal capacity to accommodate growth—that’s probably the biggest obstacle to growth over the long term. The conversion of highway traffic to rail has a huge upside, not only for shippers, but also for truck lines seeking to reduce operating expenses. 

In the past, labor was the major concern, and it’s still up there, but the fuel cost and consequent savings intermodal affords is hard to ignore.

When you look at intermodal volume as a percentage of intercity ton-miles, it’s still pretty small, which means that the upside is gigantic, particularly as the railroads figure out better ways to attack the shorter-haul market (500 miles–1,000 miles) where a big share of the volume remains.

LM: Is any part of the intermodal growth story related to an increase in container growth as intermodal trailer numbers continue to decline?
Bentz: I’d lay most of this on stack train economics. It just doesn’t make good sense to haul wheel on wheels when you can stack two-high with containers. The high-productivity with the current crop of cranes makes the time to load/unload in terminals variance negligible. On top of that, the aerodynamics of trailers is not a plus either.  Lastly, pilferage is much less likely when a container is either in the well position, or popped up on top. So, mainly, this is a technology shift, not a commercial one.

Hatch: Trailers on rail cars is the ‘gateway drug’ of intermodalism. Once truckload carriers like that level they love the productivity of double-stack container on flatcar [COFC]. COFC requires capital investment on someone’s part, and is therefore ‘sticky’ but the benefits are huge and the service is good. Right now it’s at best-ever levels.

Rennicke: I’ll add that it’s clear that domestic containers are replacing trailers for domestic movement, and that trend should continue.

LM: Where do railroad and intermodal service levels currently stand in light of current market conditions and what can shippers expect in terms of service over the next year?

Rennicke: Over the past 20 years, the North American rail carload and intermodal network has been streamlined, and in some cases simplified, to consistently produce more reliable service. The intermodal network has been consolidated down to high volume hubs that support point-to-point cycles and are served by high frequency train starts to multiple destinations. All of this operating and structural change has greatly improved service. Absent regulatory intrusions like what has been proposed in Ex Parte 711 at the Surface Transportation Board, service should continue to improve.

Hatch: It’s at best-ever levels, and I would anticipate that it will get better as the big capex programs by the rails yield expected benefits in terms of capacity and velocity. Meanwhile, with government “broke” or at least poor, road congestion and infrastructure decline will only be getting worse.

Bentz: I agree with Tony and Bill. Service is probably as good as it has ever been, and networks are still fluid. So I think shippers and their customers can expect that to continue for a while. The industry is continuing to invest significantly.

LM: In what ways are market conditions affecting capacity and rates for rail and intermodal?
Hatch: The slow economy is holding back bi-modal partners’ rate increases, but soon capacity will tighten. The coming hours-of-service changes, long fought over, but coming on line in July, will take out something like 3 percent to 5 percent of driver capacity, which is already stretched. Driver turnover was over 100 percent in the second half of 2012, when unemployment was still high and the housing markets were only just beginning their recovery. It’s a problem that isn’t going away.

Rennicke: One consequence of growth is higher service frequency that leads to more attractive cut off times. As volume grows on existing lanes and new lanes are supported by market growth, service will continue to improve. This is resulting in a much more complete service matrix on core domestic shipping lanes.Further, volumes have reached levels that have allowed regional and short-line railways to participate in the market, expanding the number of hubs.

Bentz: I think we’re on the cusp of a sea change. I believe broader global supply chain issues are at work that will have a long-term effect on transportation in general. These are being driven by larger economic issues in the global economy, as well as the difficulty, challenges, and cost of managing complex global networks. I think this will shift volumes around over time and what was the norm will change.

All of that said, I think rates for both carload and intermodal will rise, but not sensationally, as the need remains to continue feeding the furnace of capacity investment that’s needed to keep up with growth.

LM: Is pricing where it needs to be, given that rails are on the hook for the lionshare of their capex, which is at record levels?
Bentz: I’m not sure pricing is ever really where it needs to be. The buyers want to pay less and the sellers want to charge more. Overall, as a gross generalization, rail rates are not out of line with other modes. If they were, growth would stall and the other modes would benefit at the expense of rail, except for certain specific instances where that’s very difficult. That’s not happening in any meaningful way. I do expect rates will continue rising, but not excessively or rapidly.

Rennicke: Railroads are still not “revenue adequate.” With federal and state budgets strained, the privately financed freight rail network will provide a strong national infrastructure component for decades to come. If the railroads are to finance in the private capital markets, rates must be high enough to support investments at attractive market rates. Higher rail prices and stable margins are essential to maintaining the confidence of the private capital markets.

LM: What is your take on legislative issues related to the industry, such as NITL’s competitive switching proposal and the reappearance of legislation aiming to end the railroad antitrust exemption?
Rennicke: The turnaround of the rail industry since the Staggers Act, and the fact that the U.S. has the lowest freight rates in the world, are solid proof that the regulatory structure as now configured is working well. Railroads use differential and market-based pricing. In any differential pricing model, some customers pay less and some more. The NITL competitive switching proposal is aimed at reducing rail industry revenue from those customers who are paying “more” under current differential pricing practices. The price paid for reducing the rates of a few most likely will be a continuous deterioration of service across the rail industry. The added level of interchange will set the railroads’ streamlining of traffic flows back at least 10 years.

Hatch: Having lost in Congress, the re-regulation folks, backed by some members of the Senate Commerce Committee, have turned their attention to the STB. The switching issue is one that won’t go away. Related to this are two things: the fuel surcharge antritrust case continues out there; and the chemical industry is setting the stages for a coming fight for the really big prize—the benefits of an cheap-energy led reindustrialization. This is like Groundhog Day. There is constant attack on an industry that is raising its cash flow and profits but also its capex and capacity.

LM: How will the rail and intermodal markets look five years from now?
Bentz: Five years is the blink of an eye in this business, so I don’t expect much substantive change. The market will be larger, of course, but not radically so—unless fuel gets up to $8 a gallon.

Hatch: It will be bigger and more important. They will be mature, not in the investment sense, but in the shipper acceptance sense. Coal will have settled down to about a third of utility fuel burn, but CBR, frac, pipe, and new chemical business will more than make up for that. Meanwhile, grain, intermodal, and other cyclicals will be much stronger and bigger. The benefits of a privately financed and fluid transportation network will only be more important.

Rennicke: We will see modest growth in carload with some redistribution of share by commodity from coal to other. Intermodal will be a growth engine with additional train starts, frequencies, and new corridors driving a much more robust network.