Wednesday, December 28, 2016

2017 Freight Rail Outlook

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If 2016’s wild, throw-predictions-out-the-window runaway freight train of a Presidential election taught us anything, it’s that nothing is ever a given. As the old saw goes, never assume, because it makes an a—well, you get it.

Is a traffic recovery under way? Maybe. Do the railroads have a better chance of clamping the lid shut on onerous rules and regulations like forced access (reciprocal switching), and seeing restrictions lifted on coal-fired electric power plants under a Trump Administration, rather than Clinton II? Probably. A concerted industry effort is under way on Capitol Hill to make those things happen. Does Donald Trump’s purported interest in pouring money into U.S. infrastructure mean that rail transportation will benefit? Unknown.

No one really knows what’s going on beneath the hairspray-hardened flaming orange comb-over topping Trump’s head. Since winning the Electoral College vote on Nov. 8, he at times is appearing more “Presidential”—serious, thoughtful, willing to compromise. He seems to recognize gray areas, in sharp contrast to his campaign persona of talking in extreme black-and-white terms. Some observers think that, deep down, he never believed he’d actually win (perhaps explaining his Looney Tunes Tasmanian Devil-like campaign behavior), and now faces the very somber prospect of actually having to be President of the United States—sort of “Now what do I do?”

What could a Trump Administration mean to the railroads? Plenty. Or perhaps not so much, because market forces will almost always trump politics—pun intended. Following are a few educated observations.

Jason Seidl: Will 2017 Trump 2016?

To paraphrase the Grateful Dead, what a long, strange trip it has been in 2016. I am fairly certain that most railroads would love to close the door on a year that brought the group many challenges. Indeed, the railroads not only saw coal traffic decline yet again but also saw intermodal weakness brought about by a soft truckload environment.

While growth in automotive traffic was solid throughout the year, it was not enough to offset further weakness in metals, chemicals, petroleum and crushed stone and sand. The railroads also saw their core pricing power diminish as we moved through the year due to sluggish overall demand and the aforementioned soft trucking market. The railroads did what they could by reigning in costs through headcount reductions, network streamlining and improved operational productivity. Despite the group’s best efforts, earnings remained under pressure in 2016.

As I write this article, year-over-year carloadings are looking better for the railroad group, with much of it due to easier prior-year comparisons. Growth in agricultural products and less of a coal traffic decline have also helped. Looking out to 2017, we have hopes for volume growth to return to the industry, albeit at a low-single-digit pace.

Indeed, we are forecasting a recovery in intermodal as traffic finds its way back on the rails with rising trucking rates, particularly in the back half of the year. We believe the pending deadline for electronic logging devices (ELDs), coupled with fleet reductions in 2016 by many carriers, will limit capacity as 2017 progresses. This combination should lead to higher spot then contractual pricing for truckload services, which in turn should help the railroads regain some of the transitory business lost to the highways.

Coal traffic, while not expected to show a sharp rebound, should not be nearly the drag it was for the industry in 2016. For some carriers, coal could be up, depending on the combination of winter weather, natural gas prices and exchange rates. Agricultural loadings should be strong to start the year, but a record harvest will likely present very difficult back-half comparisons for the group. Automotive growth should continue to slow considerably, as the law of large numbers takes over while other industrial products should see modest growth. Construction materials and stone may see a surge in the back half of the year as infrastructure projects take hold.

Cowen and Company’s proprietary 3Q Railroad Shipper survey noted pricing expectations slipping to 2.1%, down from the prior two quarters of 2.9% each. We believe this sequential negative pricing trend will begin to correct itself as we move through the course of the year. While overall economic growth should help, so should the anticipated recovery in the truckload market. However, we note that intermodal pricing recovery typically lags truckload pricing.

A discussion of 2017 could not be complete without discussing the political ramifications of the recent election some of you may have heard about. President-Elect Trump’s election night victory caught many people and pundits by surprise. A Trump Presidency will undoubtedly have ramifications on the railroads and the country as a whole.

Trump has been an outspoken critic of the North American Free Trade Agreement (NAFTA) and has vowed to renegotiate or scrap the treaty. He does have the authority to do so as there is a clause in the agreement that allows a party to withdraw six months after it has given notice. Trump has been particularly critical of automotive companies that have moved their plants to Mexico. This is rather important, as some two million vehicles (just over 10% of total vehicles sold) are imported from Mexico each year. Trump has also openly discussed implementing tariffs against Mexico, some of them stiff.

Canada should not be left out of this discussion either, but it appears that relations are far better with Canada especially and has manufacturing associations lobbying their government to prioritize U.S./Canadian trade relations ahead of Mexico.

In addition to NAFTA, potential changes to trade with China and other Asian countries also appear to be on the table. Fears of potential changes go beyond our borders, as the Japanese Prime Minister was the first world leader to meet with the President-Elect Trump in person, altering his schedule to do so.

Washington appointments will also have an impact on the rail industry. The most direct impacts will occur when 2 new members are appointed to the Surface Transportation Board by the new president. While any appointee is subject to Senate confirmation, we doubt any nominee by President Elect Trump will fail to get confirmed given the Republican majority. Such anticipation has led to the Association of American Railroads to call for a complete halt to all major rule making until the STB positions are filled. Trump is very pro-business, especially given his views on reducing corporate tax rates (a potential boost for earnings for most U.S.-based corporations) and proposed infrastructure spending (an area where he can undoubtedly forge alliances across the proverbial aisle). Hence we would be surprised to see any STB appointments that would do damage to the rail industry.

We remain optimistic on the rail group as we head into 2017, and are rooting for the President-Elect to be successful, as we do with every incoming President. Earnings growth should come to the North American rail group far easier in 2017 than 2016. However, given the group’s current pricing power and the state of capacity in the supply chain, any outsized growth will not likely occur until the back half of the year.

Tom Simpson: Innovative Ideas Needed

Despite some bright spots like grain and automobiles, U.S. rail traffic continues its march to historic lows. In October, the Association of American Railroads reported the 20th straight month of traffic declines and more than 350,000 railcars in storage. The Railway Supply Institute American Railway Car Institute (ARCI) Committee railcar orders report, always a leading indicator for our industry, continues the bleak economic news, showing new freight car orders totaling just 5,526 for the third quarter of 2016. While total 2016 railcar deliveries will approach 65,000, the backlog of car orders continues to dwindle. A new “loss of orders” footnote has been added to the report to explain why the numbers do not track from quarter to quarter.

What does all this mean? Paradigm change is a phrase we have heard from Class I railroad executives.

What will help the industry survive the current downturn? Class I executives are looking to technology and an improved, more-focused quality process. When RSI Chairman Tom DeJoseph of Loram Maintenance of Way, Inc. and I were invited to attend the REMSA board meeting this past summer, we heard the call for innovative technology from Class I officials. Those who attended the recent RSI/CMA 2016 Rail Expo and Technical Conference in Omaha and saw Union Pacific Chairman and CEO Lance Fritz’s keynote speech heard a similar refrain.

With more than 800 railroad suppliers listening, Lance described the best ideas that were helping UP weather the downturn. While the railroad likes to look at 10- and 20-year snapshots, Fritz described the company’s goal as “wanting to do better tomorrow with assets we have today.” He spoke of “Machine Vision” car imaging, automated inspection of trains to weed out defective cars before they can lead to a derailment. Using car imaging technology reduces the four hours it would take to inspect a normal train to a few minutes, he said. He also spoke of UP’s movement to longer rail, reducing the number of welds needed in continuous welded rail because welds are a notorious weak point in the rail infrastructure.

In a similar vein, Fritz described how UP has devised an innovated thermite head repair weld that also reduces weak points in the rail infrastructure. From the car and locomotive perspective, he said UP is looking to strengthen the underside of rolling stock and looking for more flexibility and capacity in new railcars.

As an example of next-generation technology, Fritz described the use of drones to inspect tunnels and bridges, reducing the risk to UP employees. Other Class I railroads also are looking for suppliers with innovative ideas on how to bring new technology and innovation to the rail industry.

While RSI was in Omaha, representatives of the RSI Board of Directors and the RSI Quality Committee met with UP Vice President Supply and Continuous Improvement Lynn Kelley, whose background is in the auto and aerospace industries. She described the difficult operating environment she found in those industries and how she applied that knowledge to UP. She described UP’s approach to quality, which goes beyond the M1003 programs adopted by the AAR and Class I railroads. Using what it calls PPAP (Production Part Approval Process), UP is working with its suppliers to identify risks in the manufacturing process to prevent catastrophic events. PPAP is currently focusing only on high-risk areas in the roadbed infrastructure—ballast, rail, frogs, etc. The next high-risk area UP will focus on is rolling stock.

Speaking of quality, the AAR and RSI quality committees are discussing developing an educational effort to again focus the industry on continuous quality improvement. A buzz-phrase in the 1990s, continuous quality improvement seems to lose steam in down economic cycles when it should be most important. As Lynn Kelley and UP have discovered, an emphasis on quality, especially in safety-critical areas, can play a key part in helping the industry face economic downturns.

Lessons here? Suppliers who bring innovative technologies to their customers that will reduce derailments and employee exposure to dangerous situations will be the suppliers that succeed and grow. Companies that adopt a rigorous quality program along the lines of UP’s PPAP will succeed and grow.

Our industry has always bounced back from economic downturns, as in the early 2000s and the early 2010s. We may see a different rebound this time, fueled by technology, innovation and continuous quality improvement.

Freight Cars: Recovery Will Take Some Time

The most recent freight car forecast from Economic Planning Associates calls for deliveries of just under 62,000 units in 2016, as carbuilders work off significant backlogs, followed by a 21,000-car plummet in 2017, a slightly worse 2018, and the beginnings of a small rebound in 2019.

“Due to strength in boxcars, hi-cube covered hoppers, and mid-sized hoppers, our 2016 estimate of total railcar deliveries edged up from 60,300 cars to 61,800 cars,” said EPA principal Peter Toja. “However, weaknesses in tank cars, coal cars, flat cars, and mill gons will serve to lower 2017 assemblies to 41,000 cars. After a further easing to 40,000 deliveries in 2018, demand for railcars will rebound on an annual basis, reaching 51,500 cars in 2021.”

“Railcar demand continues to be relatively weak,” said Toja. “Orders of 18,799 cars through the first three quarters of this year were far outpaced by assemblies of 47,519 cars, sending backlogs down from 111,000 at the beginning of the year to 77,600 units at the end of September. Still, backlogs represent 5.05 quarters of production at current assembly rates.

“However, we anticipate a general softening in deliveries for most car types during the next two years before we see a pickup in assemblies once again in 2019.

“Our weak economy continues to dampen rail traffic. The hardest-hit sections of rail product movements were coal, petroleum, forest products, and metallic ores and metals. Due to a record harvest and strong export markets, grain haulings scored an impressive gain of 5.6% through September.

“Based on significant backlogs, we expect an acceleration in boxcar assemblies that will result in deliveries of 3,250 units this year and 3,500 cars in 2017. We look for deliveries of about 2,000 cars per year during the longer term.

“Due to strength through September and current backlogs, we look for deliveries of 11,500 hi-cube covered hoppers this year and 7,500 units in 2017. From 2018 through 2021, deliveries will be in the range of 4,000-5,000 cars per year.

“Given the assemblies to date and the continuing growth in grain and soda ash demand, we have raised our mid-sized covered hopper deliveries forecast from 8,000 to 10,500 cars this year. Next year, we look for 7,000 cars to be delivered. From 2018 to 2021, deliveries will average 6,000 cars per year.

“Demand for coal carrying equipment has vanished. During the first three quarters of this year, there were no orders for aluminum-bodied hoppers and gondolas.

“The current energy environment is sluggish, at best, and we noted a slowing in tank car orders and assemblies. As a result, we are lowering our 2016 tank car delivery estimate from 20,000 to 18,000, and then to 8,000 cars in 2017. From 2018 to 2021, demand for tank cars will gradually rise from 9,000 units to 15,000.”

From the December 2016 issue of Railway Age.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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