Spend Matters welcomes a guest post from John Bauman, Senior Economist at IHS.
Last year, rail rates increased by 3.2 percent. We are expecting them to rise 3.6 percent this year and 4.0 percent next year. Rail demand has been hit hard by low coal traffic and, to a lesser extent, weakness in grain. Better performances in other materials and within the intermodal sector failed to make up the gap. Also drifting downwards are prices for fuel.
Without any pressure from the cost or the demand sides, railroads do not have much leverage for price increases. In addition, plentiful capacity is available to the railroads, despite an acute need to modernize the fleet of railcars. The rise in rates forecasted for 2014 and 2015 are higher than other transportation modes, but lower than recent trends in the rail industry. In general, the naturally less competitive nature of rail—particularly in certain sectors and regions—gives rail carriers more pricing power than other modes.
Demand for rail services is generally improving, albeit mildly, across most shipping sectors. After a 0.2 percent decline in total rail traffic last year, 2.2 percent growth is anticipated for 2014. Grain and coal were the major culprits behind the weak 2013. The declines in the latter are particularly harmful, since coal constitutes about 40 percent of carload traffic.
Years of warmer weather and low natural gas prices have undermined coal demand and drastically pulled down coal traffic. The cold winter of 2013‒14 will likely prop up demand, but not enough to reverse these trends. Coal traffic is now down by about 30 percent compared with five years ago. The outlook for coal does not look any stronger in the coming years. Production declines are slowing, but resurging growth appears unlikely.
Grain, meanwhile, is on an upswing following a resurgent 2013 crop season. Traffic in the first half of 2013 was affected by the drought-heavy 2012 growing season, but agricultural output bounced back in 2013 and rail traffic followed late in the year. The rebound in grain traffic will continue as the latest harvest gets shipped.
Railroads have been slow to invest in new equipment, with tank cars being the major exception. Sluggish demand has also caused them to take some equipment out of service. Deliveries of new railcars fell in 2013, but a bounce back is expected for 2014. The fleet is aging and replacement pressures will help drive future orders.
As of January 2013, the average age of the North American Free Trade Agreement area fleet stood at 20.8 years, and more than 32 percent of the cars in service were more than 25 years old. These older/smaller cars are not the kind of equipment that shippers want to see rolling up to their loadings docks, nor are they the kind that allows railroads to maximize productivity, efficiency, and profitability. These cars will not be scrapped and replaced on a one-for-one basis, but the process of weeding out these units from the fleet will provide much of the foundation for continuing healthy investment in new equipment in the years ahead.
The primary risk to pricing is from fuel. Rises in fuel costs are simply passed along to customers. While there will always be some amount of price volatility, fuel prices are expected to drift slightly upward over the next couple years, helping to keep a lid on rate escalation. The price of diesel fuel is expected to rise less than 1 percent annually in 2014 and 2015. Rail rates will rise if fuel costs increase more than expected, which could be caused by any number of economic or political factors.
We at IHS are anticipating a certain amount of decoupling between rail rates and fuel prices over the next year, allowing for rates to post mild increases even as fuel prices slip. If the relationship between fuel and rail rates remains very strong, rates will drive lower than forecast as fuel prices decline. Furthermore, a sharp drop in fuel prices would likely drag rail rates well below forecast levels.