Freight Rail: Change is the Only Constant
Each year brings a new dynamic to the freight rail industry. Sometimes the shift is subtle while other times black swan events catch many by surprise. One only needs to look back to the end of 2014 to find the most recent example of such a tectonic shift, when oil prices fell nearly 50% to their lowest normalized level since the mid 2000’s.
Other examples include the displacement of coal-burning electricity generation with low-cost natural gas, the rapid expansion of U.S. crude oil production and accompanying sand demand, and looking even further back, the build-out of the ethanol tank car fleet and the expansion of center-partition and cement cars during the U.S. housing boom of the mid 2000’s. These kinds of fluctuations are part of freight rail’s DNA, a testament to complexity and interconnectivity of the industry.
Where will the industry go next? No one can be certain, but below are a few white swan trends that could be worth monitoring in 2016.
Freight Rail Trends to Watch in 2016
Average velocity continues to improve across the network, with 6% year-over-year gains in September. This is both the result of substantial investments by railroads in network efficiency and less congestion on the rails. While velocity is much better than it was last year, it is still well below levels seen in 2012. Velocity is important because, all else being equal, a slower average velocity means that more railcars are needed to move the same amount of freight.
In late 2014, the average price for a barrel of WTI oil fell from over $100 to the mid $40’s. Aside from a brief rally in the spring of 2015, the price of oil hasn’t improved much. While low oil prices are generally good for consumers, they do tend to slow down drilling activity, which holds back demand for sand hoppers and crude tank cars. Predicting the price of oil is notoriously hard to do, so this is one measure to keep a close eye on in 2016.
Crude Export Ban
The U.S. has a long-standing crude export ban that generally prohibits oil exports to most countries. One goal of the ban was to increase energy security by keeping domestic oil supplies in the U.S., however this is less of a concern today with swelling oil production, both in the U.S. and abroad. As such, there appears to be growing momentum to repeal the oil export ban.
While a repeal would ultimately need White House approval, some have made the case that the current administration could find good reason to lift the ban. If this happened, it is likely that crude by rail would lose some share to pipelines for export as oil price spreads narrowed between US and global benchmarks. On the other hand, drilling activity could pick up as a result of higher domestic prices and new markets, a net positive for sand demand on the rails.
According to the Wall Street Journal, 60% of the boxcar fleet is expected to age out of service in the next 15 years. Shippers are unhappy about not having enough boxcars, but, so far have been unwilling to pay high-enough lease rates to make new boxcar acquisitions economically feasible for railroads and lessors. With strong demand for key commodities in the boxcar market, including auto parts for booming auto sales and paper and cardboard packaging products as alternatives to plastic for green packaging options, it will be interesting to watch the supply and demand dynamic play out in this market.
According to the American Chemistry Council, there is nearly $25 billion expected to be invested in new plastic resin capacity in the U.S. in the next decade. Much of this investment is driven by the low price of natural gas, an important feedstock for the plastics production Yearly investments in this sector are expected to grow substantially from today to a peak of more than five billion dollars in 2018. To support this expansion, many plastics producers will need to acquire additional covered hoppers, which are used both to move and store product. With natural gas prices dipping very low in late 2015, it is worth keeping an eye on the pace of resin capacity expansion and the orders of plastics hoppers in 2016.
At an annualized pace of nearly 17 million, auto sales in the U.S. are exceptionally strong right now and are expected to remain so for the next few years. Rail is a primary mode of transportation for new automobiles. They are stacked vertically in pairs of two or sets of three and carried in auto-racks that attach to flat railcars.
Strong auto sales have been a boon for railroads and railcar manufacturers recently, and it will be interesting to see how that trend continues. With low gas prices, consumers could be incentivized to purchase larger vehicles such as trucks and SUV’s rather than sedans and more fuel-efficient compact cars, resulting in increased railcar demand per unit sold.
U.S. Dollar Strength
A strong U.S. dollar can be a double-edged sword. On one hand it makes imported goods cheaper, and on the other hand it can erode international competitiveness for some commodities. This affects rail in export markets such as grain and coal, pushing prices lower, but it also benefits rail with increased automotive and international container imports, for example. Since March of 2015, the U.S. dollar has been especially strong compared to major currencies around the world; this is an area to monitor going forward.
Natural Gas Prices
U.S. natural gas prices are trending near $2.00/MMBTU in late 2015, their lowest level in roughly six years. This is good news for chemical producers that use natural gas as a feedstock and for general consumers that rely on natural gas as an energy source. It isn’t as positive for coal, however, as coal competes with natural gas for electricity generation in the U.S.
EPA Power Plant Regulations
Coupled with the low natural gas prices, the EPA’s regulation of coal-fired power plants to reduce greenhouse gas emissions poses a substantial challenge for U.S. coal producers. The final rules, issued in August 2015, require a 32% reduction in power plant carbon emissions by 2030 from 2005 levels. These regulations face numerous legal challenges and are subject to changes with a new administration in 2016.
The Only Constant is Change
Freight rail is fundamental to our economy, essential to a variety of industries and market segments that contribute to North America’s dynamic economic landscape. With such a diverse industry base, there is rarely a dull moment in the evolution and trajectory of freight rail transportation.
Predicting the direction of the industry is difficult and pointedly not the intention of this article. Rather, these are but a few of the many trends relevant to the industry today, context for the year ahead and examples of why the freight rail industry can be so fascinating and complex.