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December 2013



Rail News: Rail Industry Trends

RailTrends 2013 recap: Innovation and risk to yield growth



By Tony Hatch



RailTrends 2013, held Nov. 21-22 at the W New York Hotel in New York City, provided support for the thesis of the coming second phase of the rail renaissance that we have been predicting. And, of course, RailTrends 2013 was thoroughly entertaining, as well — this summit will be hard to top (although of course we'll try), with a record crowd, almost all CEO-level speakers, and an audience almost as varied, experienced and accomplished as the speaker roster. Oh, and Hunter Harrison ('nuff said).


Beyond the obvious star wattage, some clear trends emerged. A few obstacles remain, with more coming (and sooner) from D.C. than some foresee. And there's much work to do, with not all outcomes certain, including in the crude by rail (CBR) arena.

But what really came out of all of the RailTrends 2013 presentations and chat was the real, shared sense of confidence in the industry's continued potential, and the transferability of skills and accomplishment to new or developing markets — from intermodal to Australia.

Here's a recap, in six parts:

1. 2014 will feature more D.C. rail battles than previously anticipated. Just as much of the financial community began to get complacent about the possible threat from D.C. and its near-term impact on the rails, it became clear over the course of RT13 that a confluence of events or due dates make next year perhaps more important than anticipated. The stage was well set by the national rail association leaders — Association of American Railroads President and CEO Ed Hamberger and Railway Association of Canada President and CEO Michael Bourque — both of whom will be busy next year! In 2014, we expect:



• Sen. John "Jay" Rockefeller, chairman of the Senate Committee on Commerce, Science and Transportation, will retire when his term ends in 2014, taking decades of hostility to rail no matter what topic with him — either possible successor (Sen. Bill Nelson (D-Fla.) or Sen. John Thune (R-S. Dak.), at this point — is essentially pro-rail. We don't expect much of a final roar from the old lion. But it is Rockefeller's last chance.


Surface Transportation Board Chair Dan Elliott provided an update from the STB perspective. The STB (under the Senate Commerce Committee budget) will finally hold its hearing sometime in the spring on the National Industrial Transportation League (NITL) proposals on "reciprocal switching" (i.e., access) following the expected approval of its third member (Deb Miller for Frank Mulvey); a date could be released soon for February. This is the biggest threat and also one that few outside of the NITL want to see happen. 


• As American Short Line and Regional Railroad Association President Rich Timmons pointed out, even the small regs are "cumbersome and expensive," with increased reporting, whistle blowing etc. causing headaches for rails small and large — almost to the "death by a 1000 cuts" level as the Federal Railroad Administration (FRA) appears to be on a mission. (Note: FRA Administrator Joe Szabo also presented at RT13, touting rail as "the mode of opportunity" while stating that an aim for the industry is to "evolve into driving continuing safety improvement.") Meanwhile, there was no news on the short-line tax credit, universally supported but doomed to always being a "game time" resolution.


• On the other hand, it is clear that positive train control (PTC) will not make the 2015
 deadline — a delay is all but certain (and was in fact inadvertently "announced" at RT13 by virtue of a mis-speak that went very noticed. One emerging reason straight out of Ripley's is the emergence of the Federal Communications Commission on bandwidth capacity, reservation (and railway) land and Native American rights.


• Tank car changes: The government and the various stakeholders almost assuredly will enact some change in regulations on the older ("111") tank cars, after a sort of split in the chemical/crude supply chain stakeholder base when the AAR came out for retrofitting (at ~$30,000 per for some 70,000 cars) — enough to make the backlogs more than justifiable? We heard from two rail-car experts along with the Railway Supply Institute's Tom Simpson: Avondale Partners L.L.C.'s Kristine Kubacki, who noted that normal replacement orders were beginning to diversify the backlog away from "just" CBR; and Rail Theory Forecasts L.L.C. President (and Progressive Railroading columnist) Toby Kolstad, who saw that a bubble was looking imminent in 2015 before the new regs scenario, and that while rail volumes remain healthy there is room for improvement in utilization.


• As several panelists noted, the House study on truck size and weight (TSW) is due next year — it is non-binding but could help sway arguments that will likely climax around
the ...


• Here we go again? Expiration of the Transportation (formerly "Highway") Bill on Sept. 20, 2014, will be newsworthy and partisan — and hard to determine. Still unresolved is the nature of how to pay for the restoration, even partial, of the crumbling infrastructure without raising taxes in any way and in any amount. 


• Meanwhile on the positive side (though not all will see it this way!) National Railroad Construction & Maintenance Association President Chuck Baker — and others via conversations throughout RT13 — suggested that rail capex will increase YOY in 2014 (in gross dollars even if, "as a percent of revenue," it may actually flatten or drop as much as a percentage point); BNSF Railway Inc. already announced an increase for 2014 after a mega $4.6 billion spend this year!


• Whew — and that is just D.C. (and just a summary)! In short: 2014 could present "buy on the bad news" opportunities as issues (rereg, TSW, car regs, etc.) gain public focus and thereby create risk for rails that they should be able to continue to overcome.



2. Two CEOs — Hunter Harrison and Wick Moorman — showed differing approaches to the need for constant improvement. Elvis! Fresh off Q3 results that showed him some two full years ahead of schedule (in terms of OR targets, etc.), Canadian Pacific's Hunter Harrison spoke with his usual spirit and challenge. Hunter explained his success as part past accomplishments (creating faster buy-in this go-round) and part data-driven Plan (with a capital "P," the very one so many folks have clamored over) — and a large measure coming from rapid decision-making (such as with the four hump yard closings announced days after his formal succession as opposed to months or years and a "traditional Class I"). Although the key to his RT13 talk can be — and was — summed up in "The CP story is far from over," it wouldn't be an EHH event without some dead-honest bombshells thrown about. To wit:



• Intermodal is a mixed bag for HH & CP — international, with its new focus on "slow steaming" etc., "doesn't fit well with CP (domestic does, however).


• The DM&E West railway segment sale is progressing, with a hard "no deal" below the number in the mind of the seller (CP); the D&H will be the focus of H1/2014.


• Meanwhile, further acquisitions are always possible (HH had the same conviction that his plan could accommodate all rails while at CN), and the congestion situation in Chicago — today and if it continues to "worsen" on trendline, tomorrow — could lead to full transcon consolidation in part since CREATE has been unable to ever get full funding (Note: This was much discussed, of course, after HH's town-hall-like speech, and other carriers continued to come out against the likelihood.)


• "Crude is an overhyped story" for rails — yes, the CEO of one of only TWO rails that go into the Bakken and into the Alberta fields (and the only one to do both) said CBR is over-hyped. "It's only 5-6 percent of our overall business (at CP)," he said.


• The story is and will always be a ruthless fight for efficiency that will drive asset turn, on-time percentage, etc., etc. 

And then there was Norfolk Southern's Wick Moorman, who most deservedly won the annual Progressive Railroading and RailTrends 2013 "Railroad Innovator Award" (given to HH in 2009 on his first "retirement," BTW). As such, in his acceptance speech, he was able to spotlight what NS has either initiated or advanced under his tenure:



• Technology — NS has long been a real factor here, and Wick (as a former CIO) is as tech-capable as any in the industry and helped The Thoroughbred claim leadership in real software driven planning tools with real fame in the industry such as LEADER, UTCS, RailEdge, TYES, etc.


• Re-creating old technologies — such as NS' locomotive Juniata repair shop, which repairs and even rebuilds locos and switchers etc.


• Creating new ways to develop public-private partnerships and to create joint-venture
marketing opportunities in NS' corridor programs, with other rails large (Mid-American Corridor and the Meridian Speedway) and small (Patriot) and with intermodal marketing companies and carriers both international (Heartland) and domestic (Crescent).


• Safety — Not only to win the Harriman Award every year but to begin to look beyond the benefits of the contest to a more non-confrontational future based on real innovations in behavioral science.


• Not done yet: Meanwhile, Wick's successor (at some later date), NS President Jim Squires, was with us at RT13, and he was electric in outlining the Class I's re-focused marketing and industrial development efforts, away from coal and towards emerging growth opportunities in CBR etc. (the "Crude Corridor"), and in the related industrial growth in the second half of the decade as new U.S. gas-fired competitiveness (and NS abuts the Marcellus) takes root in chemicals, metals, paper, glass, etc. — a developing thesis of mine and a discussion 
we will come back to in early 2014.



3. Intermodal growth — volume, share, price and ROI — will be the driver of
the second phase of the rail renaissance. And since that can confuse the "Cult of the OR," confusion will ensue before euphoria. I personally announced the creation of my white paper on "Intermodal - 10 Years After" at both the Intermodal Association of North America's (IANA) annual expo in Houston right before RT13 and at RT13 proper — the critical thesis simplified being that the ROI explosion that drove international intermodal in the first decade of the renaissance will be replicated by a domestic boom already underway. Supporting my thesis were top-flight presentations, notably by: 



Kansas City Southern's Senior Vice President of Intermodal and Automotive Brian Bowers, the point man on the Class I's growth drive. KSU's great growth in intermodal and cross-border intermodal, aided by southbound auto parts expansion supporting the big auto plant ramp up in central Mexico, still leaves cross-border share ("the last
frontier") at low-to-mid single digit!


• The "Current Truck Loads" panel featured Avondale Partners' Donald Broughton, who noted the (ahem) "shrinkage" of truck-load length of haul and share to intermodal, especially in the developing Midwest-to-eastern markets (overlaying the capex of NS and CSX); and FTR Associates Senior Consultant Larry Gross, who stated that domestic intermodal was growing around 0.1 percent in share every quarter YOY and would fuel continued mid-single digit overall intermodal growth. In fact, I think Larry may be
overly conservative; stay tuned.


• CSX Chief Transportation Officer Cindy Sanborn, a rising star at her railroad and within the industry, who noted her company's need to (and success so far in) adjusting away from a coal focus, by variablizing coal resources and re-emphasizing service-sensitive growth areas (i.e., intermodal). At the same time as that beyond-significant challenge, CSX is producing efficiencies on about a $153 million/year average since 2006 and is on target for roughly that amount this year. At IANA, we learned that CSX was going forward with "clearing" (for double stack) the vaunted Virginia Avenue Tunnel in D.C., and looking for at least one more hub terminal to go with North Baltimore, the most modern domestic terminal in the world, in the southeast for its H/S intermodal strategy. Cindy also talked about CSX's first/last mile efforts and how customer surveys showed improvements — and how CSX was committed to being the safest (they would have won the Harriman last year had it not been discontinued) and, interestingly, the most progressive railroad.



4. International and short-line growth, mate. RT13 featured an under-theme
of down-under because at long last, I was able to get Lance Hockridge, Managing Director and CEO of Aussie rail giant Aurizon, to speak — followed by the CEOs of two short lines with significant and growing Aussie exposure: Genesee & Wyoming Inc.'s (GWI) Jack Hellmann and Watco Cos. L.L.C.'s Rick Webb. The Indiana Rail Road Co., meanwhile, for now is content to make money in old-fashioned Midwestern railroading.

• Burdened by open access, multiple grades and government ownership until 2010, Aurizon, nee QR National out of Queensland Australia, would seem to have three strikes against it at the outset. They play by different rules down under, and a vigorous management restructuring has led to Aurizon beating IPO goals — despite flooding that massively curtailed the output of coal and iron ore that is the origin commodity and caused big misses in revenue targets. How did they do it? By benchmarking with world-class railroading here in North America, focusing on safety (lost time down 60 percent YOY, for example), asset utilization, OR (started new life over 90 percent; now, it's in the mid-80s with a 75 percent target for FY2015 and a long-term goal of 65 percent  world class!) and ROIC. Growth opportunities exist in coal and ore (belying the "China-slows" thesis), intermodal and ag. This is a very interesting story and the RT13 presentation served as a terrific introduction.


• While benchmarking with North American rails makes excellent and evident sense, in some measures — train intensity — we here could learn from the former Soviet Union. Oliver Wyman's Rod Case gave an eye opening talk about running high-intensity, train-path driven railroading with bulk, intermodal and a Euro-style passenger operation in a small dense network. Room for improvement and perhaps even for reduced arrogance?


• GWI has become a $5 billion market cap holding company due to maintaining decentralized entrepreneurial spirit, rigorous safety culture (GWI's injury frequency rate of 0.7 compares so well with the short line average of about 3, and even the Class I average of 1.1 percent), aggressive yet sane M&A strategy. GWI's new size leads to challenges, in pushing their culture to the former RailAmerica lines (site of the accident in Alabama), in centralizing some operations and costs/capex functions without ceding local control, in finding growth opportunities that can move their needle. One such spot is Australia — 20 percent of the revenue base at present (~$320mm LTM) supported by over $620 million of capex over the past four years.


• Watco is one of the most interesting companies in any industry (and my partner in the Bakken Blitzes!). Watco is diversified geographically in North American and with its developing above-rail contract in the ag business in Western Australia. It's also diversified in terms of business — 66 percent rail transport, 22 percent mechanical (rail- car repair) and 12 percent and growing rail switching and terminals, including the CBR facilities we visited in North Dakota. Watco has a partner in Kinder Morgan, a $100mm investor and energy transport giant. It also has a 10-year CAGR in revenue growth of 20 percent and in EBITDA of 22 percent.


• The Indiana Rail Road (IRR) is a great story — essentially a major railroad with big (and growing!) coal ops and a high horsepower locomotive fleet, big capex commitments, all on a 500 mile platform. But as President and CEO Tom Hoback noted, IRR is also transforming toward intermodal, having partnered with the state of Indiana to develop a long-sought-after Indianapolis hub — and with CN — for easy and fast (saving a week) connections to/from Asia via Prince Rupert.

• Overall, short lines may be about to be a real hot topic in D.C. and Ottawa (risk assessment, capex and track conditions), but GWI, Watco and IRR — with records and data similar to Class I standards — may be immune to any small railway backlash.



5. CBR is still the move of the moment. Crude-by-rail was discussed in every presentation — from Harrison's "over-hyped" characterization to being called under-developed at NS, from the underlying commodity behind the tank-car surge and retrofit
maelstrom to the growth engine in terminals or in industrial development. At RT13, CBR was everywhere. It even had its own panel, a reminder that commodity booms always get hyped.



• Stuart Nance, vice president of marketing for North American oil and natural gas exploration and production company Bill Barrett Corp., talked about developments outside of the Bakken, in Colorado's Niobrara (where OmniTRAX is a big player), worried about oil price swings and the cost of fracking — and generally felt that forecasts (oil production, not CBR share) were generally too optimistic.


• Old friend Graham Brisben of PLG Consulting did seem to think that rail share was also over-hyped. It is a matter of perspective. Two years ago, CBR was virtually unheard of; so to some, looking to retain a 50 percent or so share in the Bakken (mostly the east and west moves) is pretty good, even if it is not, say, May's 73 percent-plus share position. Graham's position is that rail has emerged as an arbitrage tool, with inherent risks in volume and location. St. James, Louisiana, is losing luster; the Eagle Ford — with plenty of pipe capacity, is about to pass the Bakken in growth. On the other hand, spreads are widening again. Price, moreover, was described as a "floor," sand percent per well is about to increase rather sharply (and new frack sites far from sand mines are developing) and the big Canadian oil sands opportunity is some two years behind the U.S. opportunity.



6. LNG power is coming — a diesel moment? We closed RT13 with something we'll likely need to revisit in 2014: liquefied natural gas (LNG) powered locomotives. GE Transportation's Len Baran was on hand, noting that GE had recently had its third railroad (CSX, after CN and BNSF) announce specific lane tests and had just track-run a test loco on Nov. 19. The opportunity is huge — reduced fuel expenses at current rates of some 50 percent with reduced emissions (save methane) and no performance or safety loss and transparency of operating (i.e., limited retraining). The expense will come from retrofitting to dual fuel (80/20 gas/diesel) use (maybe $400,000 per unit), tenders ($600,000/plus supply chain complexity) and a two-year infrastructure build-out. GE reckons the break-even date at five years, reminding us that it took 35 years in that steam-to-diesel "moment"! We have noted that the AAR is already well advanced in interoperability and standardization rules, and the STB had no objections (implying it wouldn't use the savings against the railroads in SAC cases, etc.). We will stay on top of this and expect to hear more as well from EMD in 2014.

In summary, RT13 proved all over again that the railway industry is anything but staid, boring, change or technology averse. Innovations in operations, power, rolling stock, marketing, and industrial and market development were the story of the day (and a half). Growth in share, efficiency and opportunity is the story for tomorrow. I'm sure we'll cover that in RailTrends 2014, Nov. 20-21, 2014 — back at the W in NYC.

Tony Hatch is an independent transportation analyst and consultant, and a program consultant for Progressive Railroading's RailTrends® conference. Email him at abh18@mindspring.com.



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