Our railroads are a MESS

I don’t recall ever seeing so much of the railroad industry in such disarray. Examples are everywhere you look. Tens of thousands of new vehicles sit on lots in Detroit and Toledo, waiting for rail cars to take them to dealers. Canadian National and Canadian Pacific strain under their government’s edict to move grain to ports faster. BNSF Railway is so far behind delivering Powder River Basin coal to its customers that stockpiles at some locations are down to a few days. Chicago is as plugged up as ever, and you can no longer blame winter weather; everywhere you look around the city’s outer perimeter, expect to see parked trains. BNSF and CP are under U.S. government notice to do a better job of clearing last year’s grain crops out of country elevators. Amtrak’s long-distance trains are now hours rather than minutes late, due primarily to freight railroad congestion. Terminal dwell times for freight cars are way up at most railroads versus this time a year ago, and average train speeds are way down.

You can explain this any number of ways, but to my way of thinking, railroads have become victims of their own success. They are running out of capacity. Intermodal shipments reach all-time records each week lately, and intermodal trains having priority, capacity gets sucked up like a sponge. Many other commodities are above their 2006 highs, the big exception being coal (eastern coal, specifically). With so little wiggle room, it’s hard if not almost impossible for railroads to get their mojo back when huge events like an abnormally bitter winter occur. (Climate change could bring us more such winters, too.)

Financially, the railroads don’t appear to be suffering from their troubles. But railroad customers must be beside themselves. Every parked train means heartbreak for 100 shippers.

Against this backdrop, let’s turn and look ahead. The view of the near future is no prettier. Nobody has a plan to debottleneck Chicago, that is, unless carriers begin interchanging traffic in places like St. Louis or Memphis, and only a limited amount of that is feasible. There is today a desperate shortage of high-horsepower locomotives. But according to reports I have read, as of January 1, Caterpillar’s Electro-Motive Diesel will cease domestic production until at least 2017 because it will not have a product that meets the Environmental Protection Agency’s Tier 4 emission limits. General Electric is testing a couple of Tier 4 locomotives, but it is not assured that GE’s emissions technology will be certified in time, either. Remanufacturing of older locomotives may all but cease, for the same reason -- there is a lot of uncertainty on this last point.

Locomotives, or rather the lack of them, will be a dire problem by next year, yet nobody talks about it publicly. But soon enough, they will. A business cannot grow without the prime ingredients.

Meanwhile, highway truckers are quickly building infrastructure that will allow them to convert their tractors from diesel fuel to liquefied natural gas. Their costs will go down significantly, by roughly 15%, putting rail intermodal at a distinct disadvantage. Jason Kuehn, of transportation consultant Oliver Wyman, told clients of brokerage Stifel Nicolaus last month that once truckers get LNG, the distance for rail intermodal to be competitive with the highway will jump from 500-600 miles to as many as 750 miles. True, railroads are testing LNG locomotives but only in a very limited manner so far, because the Federal Railroad Administration won’t revise its ban against putting an LNG fuel car in a locomotive consist.

Kuehn, by the way, had some observations about the intermodal business that you may find interesting. He says intermodal is now 50-50 between international and domestic shipments, versus 60% international before the 2008-2009 recession. The intermodal network in the west is becoming mature, with growth the past four years at a 5% annual rate at BNSF and a 4% rate at Union Pacific. In contrast, he notes that eastern railroads CSX and Norfolk Southern are expanding their intermodal lanes aggressively as they become more adept at competing over shorter distances. The intermodal growth rates are 6% for CSX and 7% for NS. The real battleground between highway and railroad, he says, is in the 500-1,000 mile markets, and those are primarily in the east.

The intermodal franchise has been growing a percentage point or two faster than gross domestic product (GDP). Kuehn says that for even this pace to continue will require two to three new intermodal terminals to open per year. That’s been occurring, but just barely. He also says a growth rate that is twice that of GDP, or 7% annually, is commercially feasible, but it would require not only roadway capacity expansion but also at least four new terminals a year at a total cost of as much as $600 million. Kuehn characterizes the railroad intermodal network today as very near its capacity.

That 7% growth rate would also require a lot more locomotives, and this gets us back to our starting point. Yes, our railroads are a mess, congested as all get-out. BNSF at least admits it got behind the growth curve. Meanwhile, Wall Street remains adamantly enamored of low operating ratios. To some degree, spending to expand capacity and achieving low operating ratios are incompatible. Not every railroad may need expanding as much as BNSF. But as I’ve tried to explain, there will be consequences for standing still. Long term, pissing off your customers is not a viable business strategy. — Fred W. Frailey