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12/23/2002



Rail News: Rail Industry Trends

Railroads and Imported Coal - Stalking Horse or Opportunity?
By Tony Hatch


The increase of coal imported into the United States has been dramatic — from just under 4 million tons a decade ago (0.4 percent of consumption) to almost 20 million tons in 2001 (about 3 percent of consumption).



This impressive growth has been a big story in railroad investment circles because of the small consumption percentage — and because the rails touch just about 2 percent of that amount, with the vast majority going to coastal utility customers.



But all of this could change, as a panel of experts discussed at a Nov. 19 "U.S. Coal Imports Conference 2002" in Philadelphia. The event was sponsored by McCloskey Group.



Coal is important to the rail investment community, of course: It represents 23 percent of total freight rail revenues, according to Association of American Railroads data. That's up from 18 percent since the Staggers Act of 1980 was enacted.



It's an extremely high margin business; railroads mostly move coal in long, heavy trains that are relatively labor efficient. And the outlook for coal remains positive — it's a cheap and plentiful energy resource, and it's protected under the environmentally conservative Bush Administration. For most moves, rail is still the best choice.



Nevertheless, there are some dark clouds developing over this "feel good" story. One is that intermodal (and other high-growth commodities) are taking up more of railroad leadership's time and resources; in fact, intermodal industry expert Tom Brown and I predict that sometime next year or the year after, given the secular unit growth rates of coal and intermodal rail loadings. (estimated at 1.5 percent and 5 percent, respectively), intermodal will surpass coal as the No. 1 source of rail revenue (Note: In September, Brown and I issued a report, commissioned by AAR, on this very subject.)



Coal's unit growth rate also means that rail rates will remain under some pressure (see the ongoing story in the Powder River Basin), because moving bulk commodities is itself a commodity business. And the long-time "star" of the coal transportation business — exports — is in deep decline. During the same period that imports grew by five times, exports were halved, albeit to a still significant 49 million extremely profitable tons.



Meanwhile, rails often view the dramatic import growth (which has slowed so far in 2002) as competition "picking off" coastal utility customers (mostly in the East) while central Appalachian coal supplies tighten. Many of the 150-plus U.S. Coal Imports conference attendees thought the "central App" issues represented a secular trend due to environmental regulations and delivered cost (the same issues fueling PRB growth), as well as labor and transport (trucking issues from the smaller mines more typical of the East). Importers from Columbia and Venezuela, as well as stand-by players Indonesia, Poland, South Africa and Australia — and newcomers like Russia, a big conference attendee, and China — all see a 750 million-ton market ready to be served. (Note: I excluded Canada, the No. 3 importer, only because I view the North American/NAFTA market as a single rail market.)



For utilities, which continue to merge into huge mega-power companies, the lure of imported coal is strong for three compelling reasons: economy (it is often cheaper on a delivered basis to ports), environmental (it's generally low sulfur, for example) and supply diversity. The latter has come into play during the past few years as central-App supplies tightened and prices increased.



And as imports have grown, so has comfort with international suppliers. The Southern Co. is just one major player that has indicated its intention to test a variety of off-shore coals to diversify its supplier base. That diversification gives utilities leverage over their traditional U.S. source suppliers, as well as their close allies — the railroads.

The rails long have seen imports as a growing nuisance — a competitor, a short-haul move that takes business away from their mainline long-haul backbone. Only Norfolk Southern Railway sent a non-presenting representative to the McCloskey conference: Ron Listwak, AVP Coal. There was considerable debate about the future of rail participation in imported coal moves, from today's negligible levels (most often hauled by regional rails such as attendee Providence & Worcester Railroad).



But today's rails are different, for a variety of key reasons. They are much more efficient and run on much more of a schedule, emphasizing not just on-time arrivals for highly demanding customers (witness intermodal) but rapid asset turns that have made selected short-haul shuttle runs high-margin (if seemingly low "yield") propositions. And they're definitely focused on growth and return on investment. Unlike the "Cut costs at all costs" rails of a decade ago — Canadian National Railway Co.'s Nov. 26 headcount reduction announcement notwithstanding — today's rails cannot and will not pass up profitable, high-return business.



The potential of backhaul makes this even more interesting. Rails still have a significant, albeit declining, export business from central Appalachia to the coasts. They currently haul empty hoppers back, but if they met ships carrying imported coal, they'd get the almost Holy Grail-like experience of a true backhaul, with all its asset-utilization and bottom-line impact.



If imported coal grows as many in the City of Brotherly Love expect (hope?), and it penetrates inland, the rails will have no choice but to be there.



Tony Hatch has been a senior transportation analyst on Wall Street for 16 years, starting at Salomon Brothers, proceeding to Argus, PaineWebber, and most recently at NatWest Markets (USA) prior to becoming an independent analyst/consultant at the latter's closing of operations. Recently, Mr. Hatch has been a leading consulting expert on the rail industry's B2B e-commerce efforts, working on both e-procurement and commercial ("virtual rail") applications. He has advised the AAR and the railroad industry's "E-Policy" Team on the selection of a strategy consultant and consulted on the Steelroads project, and has been an active consultant to Rail1.com. He also serves on the advisory board of iLink Global, a Chicago-based e-business 3PL.


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