Tuesday, June 11, 2013

Equipment leasing: The best of times?

Written by  Tony Kruglinski, Financial Editor
Equipment leasing: The best of times? The Greenbrier Companies

The good news is obvious; the bad news is actually hard to find.

Those of you who are regular readers of Railway Age and our Financial Edge column will recall that, over the years, I have made frequent use of Charles Dickens' "It was the best of times, it was the worst of times." It's a favorite of mine because it gives the writer the option of discussing good news and not-so-good news. However, this year it seems that no matter how I bob and weave while applying the quotation to the North American railcar leasing industry, I am left with only: "It was the best of times."

I started this Guide to Equipment Leasing with an understanding that a good part of it had to be about the fracking of hydrocarbons and the rail transportation business that this unbelievable energy phenomenon has occasioned. Frankly, fracking is almost all that anyone in the rail equipment leasing fraternity wants to discuss: The movement of "frac" sand in small-cube covered hoppers.

The movement of crude oil by rail (CBR) drawn from fracked wells in the West and Midwest. The potential for moving vast amounts of LNG by tank car from the production locations in the east to end users around the country and, with some law changes, to ports for export. We are even hearing about the potential for building and leasing natural gas tenders to the nation's railroads to fuel a new generation of natural-gas-powered locomotives. Clearly, for anyone building or leasing or operating cars that serve needs of the fracking industry, it is the best of times.

Surprisingly, however, when I conducted my industry interviews with equipment leasing insiders this year, it was virtually impossible to find the other half of the quotation! No one was complaining that it was the worst of times.

Coal cars

For coal cars, it's not the best of times, but neither the worst. Here is an industry where I was sure I was going to find some way to use my "worst of times" quote. Rocked by the economy and by a national shift in choice of hydrocarbons (coal to gas), I was sure I was going to hear complaints from people leasing coal cars to the industry. And to be honest, these aren't the best of times for this segment of the industry. However, it does not appear that they are the worst of times either:

• Utility stockpiles in the Northeast are down from earlier periods.

• PRB and Illinois Basin coal is being seen as competitive when delivered by rail.

• Coal consumption nationally is reported to be trending upward, tracking the increase in natural gas prices that has already been reported.

• RFPs for new coal car leasing have been reported in the market as lessees who dumped coal cars at lease-ends in the past few years are now apparently considering new leasing to meet increased needs.

Our sources in the leasing industry report that they are operating under the assumption that there will be a long term need for coal cars and that some improvement in their market is expected in the 4th Quarter of 2013 and during 2014.

My partner David Nahass has been representing power generators and their railcar needs for nearly two decades. When repeated queried (by me) on the future of coal car availability and values over the past few years, he has repeatedly predicted that, while the market may seem to be on a downward trend, it would stabilize at some point and run at a level (adjusted from prior years) that it could sustain long-term. I hate it when he is right!

Grain cars

Surely, I thought, it must be some of the worst of times in the market for leasing grain cars, right? Well, while you would think so, there is some reason to think things could be worse. For instance, it was pointed out to me that while there has not been any significant grain car building, the older 4,750 cubic-foot-fleet needs replacing over the long term. (Each time scrap prices go up, more of these cars are scrapped.) The weather situation is also unclear for this year's harvest. Although it has been too wet to plant much of this year's crop (5% of the corn crop is in the ground this year compared to a target of 30%), it is still not as bad as last year's drought.

The closest that we could come to "worst of times" may be reported full-service lease rates as low as $75 per car per month. (More modern 5,150 are reported being quoted at $300 per car per month.)

Centerbeam flats

For centerbeam bulkhead flatcars, I expected to continue to see more of the awful story of massive fleet parkings and losses on top of losses. The reality? Things aren't so bad.

To begin with, an increase in housing starts and in lumber moving to ports for export has reportedly gotten Class I centerbeam fleets out of the weeds and working. Leasing companies with parked fleets have been dribbling these cars into the North American working fleet over the past year or so, and this continues to happen, with more and more cars being leased.

Lessors are reporting inquiries from Class I railroads and shippers for new requirements. Lessees are receiving quotes ranging from $300 to $500 for full-service operating leases for terms of up to one year. (Multi-year commitments achieve better pricing.) So, it's clearly no longer the worst of times.

Autoracks and intermodal

In our interviews for this guide, we have received reports of Class I's purchasing autoracks to be attached to TTX flatcars for service in the North American fleet. Unfortunately, we have been told that the railroads in question have been buying these racks for cash and that leasing (other than the TTX operating leases on the flatcars) has not been involved.

We have also received almost universal reports that the market for leasing intermodal equipment is in excellent shape.

Small-cube covered hoppers

At this point in time, we have to shift back to the "best of times" side of the ledger and talk about a rebound in the building of small-cube covered hoppers for sand and cement service. According to our sources, this market has rebounded big time:

• Higher gas and oil prices have renewed active drilling of wells that require the frac sand that is carried in these types of hoppers.

• Older cars are garnering lease rates of $500-plus per car per month, full-service for as long as three to five years. Newer 3,250 cars are doing even better.

• We are told that there are virtually no sand cars sitting unutilized. The "overbuilt" situation with OEMs and sand cars that was existent for some months last year apparently has been broken by new orders for some new cars, 1,000 or so.

We have also received reports that the market for cement cars is tighter than it has been for some time, perhaps reflecting growing commitments to invest in the nation's infrastructure.

Fracking

As I said at the beginning of this Guide, the "best of times" are clearly being had by anyone in our industry who has anything to do with the movement of anything that is required for the extraction of hydrocarbons using the latest fracking techniques. As we said above, this certainly includes the provision of leased sand cars to bring sand into the wells at which fracking plays a role in extracting oil and/or gas. We're probably also shipping pipe and machinery by rail to these sites.

It also includes the tank cars that are being built and leased by a variety of parties to end-users that need to move the extracted oil and gas to wherever it wants to go.

But before we go into the leasing industry report we've compiled, we thought we would give you some "50,000-foot" views on just why rail is such an important component to the fracking story.

We have been told by more than one source that one of the profound impressions that they have taken away from discussions with end-users of tank cars for CBR and natural gas is that the costs of buying or renting the cars to transport these products seem minor compared with the amount of profit that can be made in moving the products themselves.

"I almost get the impression that someone needing these cars will pay anything to get them," said one source. I haven't been privy to similar discussions regarding rail shipping rates, but it would seem that the same rule may apply.

Experience with CBR is teaching shippers that the old rules for moving oil by pipeline (the oil goes where the pipeline goes) don't apply to CBR. If a better price can be had at a refinery on the East Coast than the Gulf Coast, rail can deliver that extra profit. The advent of 100-car unit trains of CBR just makes things more efficient.

The efficient transit times that our rail system has achieved for various kinds of freight are adding to the attractiveness of CBR. In fact, the only reason the fracking industry has been as successful as it has been (other than extracting the oil and gas) is the existence of a rail system that (via Class I, II and III railroads) can pick up loads almost anywhere and deliver them almost anywhere. If you read reports of fracking opportunities in Europe (where the rails are crowded with passengers) or Africa (where there are few railroads), read them with the knowledge that the fracking will most likely have to be accompanied by a multi-billion-dollar pipeline.

The tank car report

Conversations with a number of sources in the leasing industry resulted in reports indicating that, while there may be some "spot" availability to build some cars in 2014, the bulk of the railcar builders are "built out" until 2015. This appears to be the case for the full range of tank car types including jumbo LPG cars as well as 30,000-plus-gallon general purpose tank cars and insulated-coil cars.

What about leasing? If you can find the cars you need, even older ones, expect to pay $1,200 per car per month, full service, to the operating lessor that has the cars.

What about putting in your order now and arranging the leasing (finance or operating) later? That makes sense if you can decide what you want to buy.

What are we talking about? We spoke to one lessor that already has a wide variety of tank car types in its fleet and that has chosen for now to acquire "only" 29,000 insulated-coil cars. There appear to be at least two reasons for this decision:

• Investing in a slightly smaller, but insulated and heated tank car opens up the option of putting the cars into either Canadian oil sand service or service in the U.S. moving lighter density oil.

• The regulatory process has already begun to assess the need for new safety rules for CBR. It seems likely to some observers that ultimately a rule will be put in place requiring jacketing of the kind already present on insulated cars. Better to have cars which are already jacketed than the need to shop the cars for an aftermarket retrofit that could cost as much as $60,000 to $65,000 per car.

What do new cars cost? Assume $110,000 to $120,000 for general purpose 30,000-plus-gallon cars and $130,000 to $135,000 for the insulated coil-variety.

What kind of experience are operating lessors having with their tank car fleets? One lessor told us that his overall "retention" rate (leased cars renewed by the lessee) for his fleet was approximately 80%. The retention rate for this tank car fleet was 97%+.

What are the issues faced by operating lessors of CBR and LNG tank cars? Not surprisingly, one of the issues for full service lessors of CBR tank cars is the amount of mileage that is incurred on their cars during a given year and the cost of maintaining the cars. For instance, a 100-car unit train could (we are told) travel 100,000 or miles a year in CBR service where normal tank car mileage for the rest of the fleet could be just 15,000 to 17,000 on average per year.

The solution to the problem? Mileage limits/surcharges on the full-service CBR leases.

Plastic pellet cars

The plastic pellet car marketplace is also extremely strong in light of the relatively cheap natural gas that is available to the pellet producers. A closer look, however, would show that there has been some retrenchment in this market due to the edging up of gas prices as well as the apparent need to digest earlier large builds of new equipment.

My company, Railroad Financial Corporation, has advised end-users on more than 3,000 plastic pellet car acquisitions during the past two calendar years. From this activity we have observed the following:

• New plastic pellet cars (5,800 to 6,200 cubic-foot-capacity) are being priced by builders at approximately $100,000-plus.

• Operating lessors are renting similar sized, but older, cars for $400 to $650 per car per month, full-service for terms of five to seven years. Shorter terms are available at a higher cost. (Operating lessors in this market are trying to capture premium rents for as long as possible.)

It has been reported that $30 billion woth of petrochemical facility expansions or greenfield building is expected in the Gulf Coast area over the next five years. New railcar building will be required to support this additional production capacity.

We expect significant opportunities to replace older, suboptimal equipment in the near future.

Conclusions

In the 30 or so years I have been involved in this industry, there have been other periods of relative euphoria. However, these earlier periods of "good times" were almost always followed by a significant market drop lasting for years, during which time excess railcar building was digested. For instance, there were overbuilt boxcars and grain cars in the late 1970s that polluted the market until the late 1980s. Often, these periods of adjustment resulted in some significant distress for the players involved.

Even with this historical perspective as a warning flag, I have been hard pressed to see any near-term discernable downside to the railcar building that has been going on to service the hydrocarbon industry. The estimates of available to-be-fracked oil reserves continue to rise. So do the new railcar orders that are tied to them.

Will there be a market crash? It's not easy to predict, but if these CBR and LNG railcars are briskly amortized by the profits they have the capacity to earn, no one—neither lessor nor lessee—should get hurt.

—Anthony Kruglinski is President of Railroad Financial Corporation and the Chairman of Rail Equipment Finance 2014, March 2-5, 2014, in Palm Springs, Calif.