Thursday, November 17, 2011

What gives with these full order books?

Written by  Tony Kruglinski, Financial Editor

A good friend of mine who practices transportation finance in London, Jacqui Nelson, recently asked me about the condition of the U.S. economy. She reported that the “City” of London (the U.K.’s Wall Street) was truly rattled by the Greek financial crisis and its likely meaning for the European economy.

I told her that the U.S. economy is in similarly awful shape, with people talking about “lost” generations of workers who might never work again. But I also told her that the freight rail equipment business is, despite the appalling state of the overall economy, “robust.”

(“Robust” is a particularly British term, but I think it is well applied to the situation of our railcar manufacturers and suppliers who have all the business they might want, or be able to handle, at this point in time.)

Reports suggest that the North American railcar build for 2011 might top out in the high-30,000 range, with 2012 predicted to be as much as 55,000. The only thing keeping our builders from building more might be their desire to manage their ramp-up of construction and, perhaps, the availability of components, particularly castings. No one (it seems) particularly wants a return to the boom or bust days of 17,000 new builds one year and 60,000-plus in another.

But with the economy in the toilet, what gives with these full order books?

To begin with, this writer has often preached that the North American rail industry needs to build an average of 50,000 cars a year just to keep up with a reasonable level of fleet retirements due to age. The predictions I quoted above are generally in line with that average.

If you look at what is being built, you can see some pretty dramatic reflections of some of the hot spots in our otherwise lousy economy: Small-cube covered hoppers for frac sand; 30,000-gallon general purpose tank cars for, among other things, western oil being moved from locations that don’t have pipeline access; a variety of other car types, including cars to supply a robust (there’s that Brit word again) North American chemical industry.

Some of this carbuilding is not only taking place during a sour economy, but is being accomplished in the face of issues with the car types themselves. Readers of last month’s “Railroad Financial Desk Book” learned about the safety issues surrounding the design of the generic 30,000-gallon tank car, but they bear repeating here: The possibility that regulators may require head shields, insulation, and additional armor on tank cars that may be moving, among other things, the lighter crude oil being produced by western frac sand operations. If you are about to place an order for new generic 30,000-gallon tank cars and you are told that you might need $10,000 or $15,000 in after-market add-ons down the road and you still place the order, that is a hot car type. (Perhaps it is the $1,000 per car per month rental rates that this car is commanding in this hot market that are helping to convince buyers to place these orders!)

So where is all of this building leading us? First of all, it could be leading to a fall. Remember that a good number of those already-constructed 30,000-gallon general purpose tank cars that are in western oil service have been diverted from a deflated ethanol marketplace. The bloom could come off the rose just as quickly for the new markets for which these new cars are being built if, perhaps, some kind of environmental issue or issues crop up.

If something does happen to the new markets for which these cars are being built, all would not necessarily be lost. A sand car is more or less a sand car and a deflation in the frac sand business could just mean that older, less efficient covered hoppers in other sand services may just end up being cut up earlier than would otherwise be the case. Or our crumbling infrastructure needs might end up sucking up some unused equipment if stimulus funds are used for those purposes. Hey, it could happen!

The same thing might be said for the 30,000-gallon general-purpose tank cars. If they come into surplus, older, less efficient equipment might be parked or cut up.

There is a problem with these alternative scenarios, however. The cars being built today are at the very top of the price points for new railcars. These robust builds are taking place despite the fact that the prices for new cars are easily $10,000 to $15,000 more than the price for similar equipment just a couple of years ago.

Why are these prices holding up in a poor economy? One good friend of ours has suggested that a fear of being unable to get cars built near-term has caused the price sensitivity that might otherwise kick in to be AWOL.

In any case, when you increase the price of a piece of rail equipment, you run the risk of either raising operating costs (or rental rates) or adding years to the cars’ payback statistics.

Or everything could turn out just fine.