West Texas Intermediate (WTI), also known as Texas Light
Sweet, is a type of crude oil used as a benchmark in oil pricing. It’s also the
underlying commodity of the New York Mercantile Exchange’s oil futures contracts.
“Although oil prices have risen in recent months, end market demand for distillates (diesel, jet fuel, heating oil, etc.) remains weak,” say Morgan Stanley & Co. Inc. freight transportation analysts William Greene and Adam Longson. “As a result, there is a large disconnect between the price of WTI and diesel. Historically, the relationship between diesel and WTI has stayed within a narrow range, but the price differential is now near an all-time low, which could have unforeseen consequences for a number of freight carriers. While there is precedent for very wide crack spreads (hurricane Katrina, sudden declines in crude prices in fourth-quarter 2008, etc.), this is the first time we have seen such a narrow crack spread.”
As for the effect on railroads, “CSX and Norfolk Southern are most likely to benefit from narrow crack spreads,” say Greene and Longson. “NS and CSX, in particular, still have a number of customers operating under fuel surcharge clauses that are indexed to WTI rather than on-highway diesel. When crack spreads narrow, the effectiveness of these fuel surcharge clauses improves. As long as crack spreads stay below historic norms, both carriers should benefit.”
BNSF, say Greene and Longson, “could post a narrower fuel hedging loss. BNSF has used WTI swaps and collars as part of its fuel hedging strategy. Higher WTI prices will reduce the negative impact from underwater hedges, but BNSF can also incur accounting gains and losses based on the effectiveness of the hedge—the tracking error between WTI and diesel. Remember that BNSF reported a $15 million gain from the ineffectiveness of WTI swaps in second-quarter 2009.”
The narrow crack spread is less positive for intermodal.
“Though higher oil prices are generally bullish for intermodal volume and
pricing, in reality customers are only concerned about the price of diesel,”
say Greene and Longson. “As long as the price of diesel fails to rise,
intermodal’s cost advantage vs. truck will be limited. A narrow crack spread
could weigh on railroad domestic intermodal volumes and pricing as well as J.B.
Hunt’s trucking intermodal volumes, although we'd argue this is mostly in the
price.”
Economic Planning Associates on Tuesday released its
second-quarter 2009 freight car analysis, and, based on production figures
obtained from the Railway Supply Institute American Railway Car Institute
Committee, the freight car market won’t begin to pick up until 2011.
“With some 20% of the various fleets on the sidelines, the
recession in full force, a sharp decline in railcar loadings, and the
constrained financial environment, the outlook for railcar deliveries this year
and next continues to dim,” EPA said. “Our economy will remain under duress for
the next two quarters. Considering the weakened state of the economic and
railroad environments, the second quarter survey results from the ARCI were not
surprising. After 2,374 units were ordered in the first quarter, the latest
survey shows that only 2,165 cars were ordered in the second quarter. As a
result, first-half assemblies of 14,120 cars served to drop net backlogs from
31,921 units at the beginning of the year to 21,558 cars at the end of June.”
EPA added that it remains “deeply concerned” about the
Greenbrier-GE Capital portion of freight car backlogs. Pending litigation
between the two companies over their seven-year deal and the possible
cancellation of remaining railcars in the original order may be affecting
delivery numbers and timing. “Hopefully, recent reports on the prospects of
improving financial health at GE Capital will translate into new car purchases
during the latter part of our forecast horizon.”
There are, however, a few hopeful signs: “Much to the credit
of the railroads, in spite of steep year-over- year declines in haulings and
revenues, reported earnings from companies such as CSX, BNSF, UP, and CN were
at relatively decent levels as the railroads continued to cut costs and improve
efficiency. . . . Should we be correct in an economic rebound later this year
extending into 2010 and beyond, we expect commodity haulings to advance 2.4%
both next year and in 2011. From 2012 through 2014, annual growth in
carloadings will moderate from 1.6% to 1.2%. . . . We expect the weakness in
intermodal traffic to continue into the fourth quarter before a modest recovery
begins in 2010. . . . [S]ome stabilization and a possible modest improvement
will set the stage for an annual rebound of 4.5% in 2010.”
“Based on second-quarter ARCI data, first-half assemblies,
and the extreme caution warranted by the Greenbrier-GE portion of mid-year
backlogs, we have moderately lowered our short term forecasts,” EPA said. “We
currently expect deliveries of 24,800 cars this year and 14,750 cars in 2010.
Beginning in 2011, far stronger economic activities will provide support for
certain railcar assemblies while an improvement in the financial environment
and higher gasoline prices stimulate demand for ethanol and DDG cars. Replacement
pressures and technological advances as well as legislative measures will also
play a role in promoting the demand for a variety of railcars. Construction activities
are expected to return to higher levels, which should support movements of
aggregates and structural steel products. Rising home values and moderate interest
rates after 2010 will stimulate additions and alterations to existing homes
while the do-it-yourself market will continue to expand. Both developments will
rejuvenate growth in haulings of lumber and wood products. Continued expansion
in demand for petroleum products, chemicals, and food and beverages will prop
up the haulings of a variety of liquid products and the demand for tank cars.”
There’s an environmental factor at play, as well: “Stricter
air emission standards will promote the use of lower sulphur western coal,
which is also lower BTU value coal, leading to greater volumes of coal
traveling longer distances. This in turn, will lead to replacements of older,
smaller, steel-bodied coal cars with larger-volume aluminum gondolas and
hoppers. At the same time, eastern coal fleet requirements could stimulate some
demand for technologically advanced steel and hybrid coal cars. Growing
worldwide nutritional needs will pressure the current grain service cars as we proceed
through the longer term while long neglected segments such as equipment to haul
waste, aggregates, and limestone show signs of revival and should add to the
railcar delivery mix in the years to come.”
Over the next five years, “the extremely low levels of
deliveries this year and next will serve to intensify the pressure to replace
aged equipment in various fleets during the longer term forecast horizon,” said
EPA. “After two dismal years, we look for railcar deliveries to rebound
moderately to 27,500 cars in 2011 and then expand annually to the level of 57,000
units in 2014.”