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December 2012



Class Is Article
Class I railroads' outlook for 2013 is a smidgen on the optimistic side



Class Is

— by Jeff Stagl, Managing Editor

Steady, albeit slow business growth. A U.S. economy that continues to expand, but at a moderate rate. Weak fundamentals in most markets in the first half.

Those are some of the comments provided by Class I chief executive officers last month on their outlook for 2013. Similar to the past few years, Progressive Railroading emailed questions to each CEO seeking their take on economic- and traffic-growth prospects for the coming year. All seven top execs provided emailed responses, which also included a few key goals and issues pegged for 2013.

Union Pacific Railroad President and CEO Jack Koraleski best summed up the execs' take on next year: Remain slightly upbeat — and yet cautious — about increasing volume. He also summarized a growth strategy echoed by his counterparts: Stay focused on business fundamentals, market diversity, service performance, productivity and innovation to drive financial results and lower the operating ratio.

"Ever-changing markets, regulatory uncertainty, tax issues and other financial challenges weigh heavily on business leaders and consumer confidence, impacting hiring and capital investment decisions by companies across many industries," said Koraleski. "Regardless of how the economy takes shape, we will remain disciplined and focused on providing excellent service to our customers and strong returns to our shareholders."

For Kansas City Southern, 2013 likely will bring "impressive growth" in revenue and volume, said President and CEO David Starling. But it will be a bridge year to what he projects to be even stronger business growth in subsequent years.

"KCS' task will be to capitalize on the growth opportunities that we project for 2013 and beyond, while maintaining strong operational metrics and continued margin improvement," said Starling.

BNSF Railway Co. Chairman and CEO Matt Rose concurs. He projects more of a traffic bump well beyond next year.

"Although there is much uncertainty in the marketplace, the economy seems to be continuing on a modest growth track. While we do not think we will hit overall peak volumes until late 2014 or 2015, we do see the business continuing to grow," he said.

But for CN President and CEO Claude Mongeau, last month wasn't yet the proper time to read any tea leaves. It was too early to characterize CN's prospects for 2013, he said, adding that the Class I plans to provide guidance in January.

Nonetheless, the railroad generally will continue growing faster than the overall economy or base markets, said Mongeau.

From Containers To Crude Oil

He believes growth will be driven next year by a range of initiatives, namely expanding overseas and domestic container markets; taking advantage of bulk commodity exports, including coal, grain and potash; capitalizing on crude oil, frac sand and other energy-related opportunities; and leveraging the U.S. housing industry's recovery, particularly in forest product shipments.

"Crude oil shipments, which were just 5,000 carloads in 2011, are expected to exceed 30,000 carloads in 2012, and we believe we have the capacity to reach 60,000 carloads of crude in 2013, said Mongeau.

In addition, CN's frac sand market has grown nearly 70 percent over the past three years, reaching $100 million in revenue in 2011.

"We hope that our end-to-end service focus will help us grow this market to become a $300 million business for CN in the next three- to five-year horizon," said Mongeau.

Norfolk Southern Corp. also is counting on the energy and intermodal sectors since competition from low natural gas prices and reduced electricity demand will keep impacting utility coal volumes, and weaker metallurgical and steam coal demand in Europe and Asia will continue to challenge export coal traffic, said Chairman, President and CEO Wick Moorman.

"One of the great strengths of Norfolk Southern's network is the diversity of our business portfolio and the opportunities to participate in emerging markets. A great example is the transportation of inbound sand, pipe, chemicals and drilling machinery into the Marcellus and Utica shale regions of Pennsylvania, Ohio and New York to support natural gas drilling," he said.

Another market offering considerable potential: unit trains of crude oil moving from Bakken Shale oil fields in North Dakota and western Canada over the Chicago gateway to Northeast refineries, said Moorman.

"Together with our western rail partners, we become a rolling pipeline to supply lower-cost crude oil to these refineries," he said.

In terms of intermodal, NS will increase capacity to handle additional highway conversions and East Coast imports by establishing new Crescent Corridor terminals in Memphis, Tenn., Birmingham, Ala., and Greencastle, Pa., said Moorman.

In January and through the first half, NS also will introduce new long-haul service lanes through Birmingham to the West, Mexico and the Northeast via terminals in Greencastle and Harrisburg, Pa., he said.

Seeking More Converts

Although automotive volume appears to be sustainable — after increasing 18 percent in the third quarter — and shales will continue to present opportunities, intermodal will remain a vital part of any economic expansion, said CSX Corp. Chairman, President and CEO Michael Ward.

"Our strategic network investments and strong service delivery will support highway-to-rail conversions. We also will continue to leverage our connections with more than 70 ocean, river and lake ports through which intermodal and other global freight is channeled," he said.

This year, CSX continued to devote dollars to work on the National Gateway double-stack intermodal corridor from Mid-Atlantic ports to the Midwest. New or expanded intermodal terminals are under way in Columbus, Ohio; Charlotte, N.C.; Cincinnati; and Worcester, Mass., while CSX affiliate Evansville Western Railway is building an intermodal terminal in Winter Haven, Fla.

"This expanded intermodal capacity will be an important part of competing for an estimated 9 million truckloads that currently [have] a length of haul of more than 550 miles in CSX-served markets," said Ward.

Canadian Pacific already is reaping benefits from an intermodal network change. In September, the Class I launched new, faster intermodal services connecting Vancouver, British Columbia, to Toronto and Chicago.

"We've cut a day off transit times, [which] has produced a great response from customers," said CP President and CEO E. Hunter Harrison.

Encouraging responses are anticipated from more energy sector shippers, as well.

"Early in 2013, we expect to hit 70,000 annualized energy carloads. That's up from the 13,000 we handled in 2011," said Harrison. "We'll be expanding our crude-by-rail model in Saskatchewan and Alberta, and we expect heavier grades of oil to begin moving this way in addition to the current sweet, light crudes we're now hauling."

Shale Plays In Play

BNSF is high on crude-by-rail traffic, too.

"There is no indication that production from the Bakken and other oil shale formations in the Williston Basin will slow next year, and we anticipate growth coming from the other emerging shale plays throughout the central and western U.S.," said Rose.

Likewise, intermodal will provide a boost, as over-the-road conversions continue in long-haul lanes because of trucking companies' ever-present challenges and shippers' savviness about their transportation options, he said.

A Next Generation Intermodal (NGI) initiative should help propel volume, Rose believes. Launched several years ago, NGI offers different transit speeds and multi-modal rail options in the same shipping lane that can be tailored to a shipper's needs.

Through NGI, "we will continue to collaborate with our trucking partners to help identify new ways in which intermodal can be incorporated into shippers' supply chains," said Rose.

While additional highway conversions and busy shales factor heavily into UP's prospects, volume also will be buoyed by strong automotive and Mexican markets, said Koraleski.

"Over the next five years, finished vehicle sales are projected to return to near pre-recession levels, "he said. "And increased manufacturing fueled in part by significant foreign direct investment in Mexico presents significant opportunities."

Ditto for KCS. A near-sourcing phenomenon will continue to gain traction as many companies locate production facilities in Mexico near the Class I's network, said Starling. In addition, favorable credit conditions will prompt more consumers to make auto purchases that might have been deferred during the recession.

As of mid-November, KCS' auto volume was up 21 percent year over year, and much of that growth came from Mexican auto production, said Starling.

"We expect that growth to continue in the first part of 2013 and to accelerate into the first quarter of 2014, when new Honda and Mazda plants, and an expanded Nissan plant come online," he said.

KCS' strong container growth at the Port of Lázaro Cárdenas in Mexico and solid cross-border intermodal volume — which ballooned 98 percent in the third quarter — also figure to keep mounting, said Starling.

"We believe that the entire addressable market for cross-border truckloads is 2.9 million. Of that total, we have less than a 2 percent market share," he said.

It's All Cyclical

Just as the CEOs are approaching volume growth from several angles, they're addressing cost control from a number of slants. Controlling expenses — which is essential for CP to reduce its operating ratio to the low 70s or high 60s — comes down to a "virtuous cycle," said Harrison.

"When you provide better service, you turn assets [and] you lower your costs," he said. "In 2012, we returned more than 5,400 leased freight cars simply by making the most of our assets."

CP also redesigned how trains are assembled and car blocks connect, which enabled the railroad to close four hump yards and alter flat-switching operations. In addition, the Class I improved train scheduling, resulting in a need for fewer locomotives, said Harrison.

"When you add it all up, you've got more efficient trains running on time, you're maximizing assets and providing better service for the customer, and [you've got] a falling operating ratio," he said.

To reduce its ratio, KCS plans to scale costs well below volume- and revenue-growth projections, and use latent capacity to absorb new growth, said Starling.

"We will also continue to expand our overall network capacity in both the U.S. and Mexico in order to efficiently handle the business growth we anticipate during the rest of this decade," he said.

Reformation Act

BNSF plans to continue pursuing robust capital investment programs — a la 2012's $3.9 billion budget — to expand and maintain its network.

But regulatory reform on the permitting of new projects is necessary to make it easier and more attractive for private companies to invest in infrastructure, said Rose.

"Large highway projects can take 12 years to get permitted. Our own projects — which don't include public funding — take too long," he said.

For example, BNSF is in the eighth year of the permitting process in the Los Angeles area for its proposed Southern California International Gateway intermodal terminal.

"The project will remove 1.5 million trucks from a major local freeway in southern California and provide good-paying jobs," said Rose, adding that BNSF plans to invest $500 million in the terminal.

Jobs are a top-of-mind issue for CN's Mongeau. The Class I plans to hire more than 5,000 workers over the next two years, assuming business trends hold, he said.

Federal regulations are on his mind, as well. The Canadian government should stay the course with a commercial approach to rail service, and avoid additional regulation that could stifle innovation and "chill the positive momentum we've developed," said Mongeau.

In the United States, Congress needs to carefully weigh any moves to modify the economic regulation of the rail industry or eliminate roads' limited immunity from antitrust laws, he said.

The other Class Is also support a balanced regulatory environment.

"We continue to hear from federal, state and local governments, and from the customers and communities we serve that there is a real need to get more freight off the highways and onto the rail system," said Ward. "Any actions to limit long-haul freight-rail movements and force the opening of our private networks would artificially constrain profits and scale down our investment plans and job creation."

Safer Situations

Another issue that warrants stronger consideration next year is safety. UP expects to focus more on it because the No. 1 goal is always zero incidents, said Koraleski.

"To run an incident-free network, we focus on activities such as risk reduction, standard processes and our peer-to-peer, behavior-based Total Safety Culture initiative," he said. "First and foremost, we want and need engaged employees who have each other's backs and are committed to making sure each of us goes home safely every day."

Employee engagement is one of the main reasons NS began to change its safety culture this year — an effort that will continue in 2013 (see the cover story in Progressive Railroading's November issue for more details on the cultural shift).

"We're focusing on positive recognition to reinforce safe work habits and constructive coaching to address unsafe situations," said Moorman.

The culture change also incorporates efforts to improve the Class I's service performance.

"One big change has been to expand the role of local safety committees to include service," said Moorman. "All across the railroad, teams of employees are helping us to improve operations, provide better service to our customers and win new business."

An Opportunistic Bent

Better service also will help CSX earn more business by not only meeting, but exceeding customers' expectations, said Ward.

"We have visited all 5,000 of our customers to discuss growth opportunities and to view first-hand the potential infrastructure changes that could improve efficiencies for both our customers and CSX," said Ward. "We're now concluding a second wave of customer visits to further explore those possibilities."

Exploring — and seizing — opportunities will be key to volume and revenue growth for all Class Is next year. Although the economy isn't anywhere near full health, opportunities should abound in 2013, CEOs believe.

And UP, for one, is potentially in its best position to capitalize, said Koraleski.

"In my 40-year career, the future has never been more promising for Union Pacific than it is today," he said. "We are creating great value for our customers, engaging employees to provide the safest work environment in company history, making positive contributions to our more than 7,000 communities and generating record shareholder returns."



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