It goes without saying that the COVID-19 pandemic has wreaked havoc on all facets of freight transportation. That’s been especially true for both the rail carload and intermodal markets, both of which were seeing pretty average volumes in advance of the onset of the pandemic.
A tough truth when it comes to gauging what happens next on the tracks is that the current free fall could continue for a while. With the initial first quarter GDP reading at nearly -5%, and the second quarter expected to be worse, weekly volumes for rail carload and intermodal are both down roughly 20% annually.
To help bring the current state of the nation’s rail and intermodal network into clear view for shippers, Logistics Management is joined by some of the nation’s foremost experts in the market, including Larry Gross, principal at Gross Transportation Consulting; Tony Hatch, rail analyst and principal at ABH Consulting; Bill Rennicke, partner at management consultancy Oliver Wyman; and Jason Kuehn, vice president at Oliver Wyman.
Logistics Management (LM): How would you define the current state of the rail carload market?
Larry Gross: Like all freight transportation modes, rail carload has been gravely affected by the COVID-19 lockdown as volumes are down sharply across the board. Among the important commodities, motor vehicles and equipment shipments have almost entirely ceased due to plant shutdowns and crude-by-rail (CBR) has been curtailed by the plunge in oil prices. This is on top of the ongoing volume challenges that predate the coronavirus crisis, including the drawdown in coal shipments, which has been exacerbated by the slowdown.
On the precision scheduled railroading (PSR) front, the practitioners have more than fulfilled the first chapter of the revolution, improving railroad efficiency and profitability. A portion of this success story has been that the railroads have become more selective in the business they solicit and as a byproduct volume has declined. The second chapter of the PSR revolution playbook calls for railroad management to then utilize the newly efficient and competitive network to convert volume back from truck to rail. The U.S. railroads have not yet demonstrated this capability and any such trend will likely now be postponed until the immediate crisis abates.
Jason Kuehn: Given the state of the economy and the situation with COVID-19, we’re seeing expected levels of decline in all carload markets. Railroads do appear to be faring better than other transport sectors and are showing good ability to adjust their operations to match supply and demand.
There’s great variation in demand across commodity groups, however. Automotive and products driven by heavy industry—such as metallic ores and metals, coal, and crude oil and petroleum products—have weakened. Some sectors driven more by direct-to-consumer demand appear to be doing better, including grain, grain products, forest products, and non-metallic minerals. Intermodal, chemicals, and plastics are in the middle of the road.
Tony Hatch: Well, things are in free-fall at the moment, but they won’t be forever. We have seen a collapse in energy—whether that’s coal, which was down 38% in April, or crude-by-rail-related, that we’ve not seen since after the multi-year secular decline in 2008. LM: How do things look for rail carload volumes for the remainder of 2020?
Bill Rennicke: There could be some recovery as soon as late May or early June, but certainly by the start of the second half of 2020. We may see an initial volume surge as inventories replenish and businesses start to reopen, but then the pace of the recovery will slow, as overall demand will remain low. Heavy industrials will lag behind consumer-oriented sectors. Rail-centric businesses in direct-to-consumer sectors, such as automotive and appliance manufacturers, will be dependent on overall consumer confidence and employment.
Hatch: That’s a tough question to answer. As of right now, the second quarter will be darker than dark, and the third quarter might be slightly better, with the fourth quarter in recovery. However, that will not be the case for coal and not fully in the huge auto supply chain. Keep in mind that autos and parts volumes were down more than 86% in April.
Gross: Recovery from the lockdown looks to be a long and perhaps fitful process. A quick “snap-back” to something approaching normal is unlikely in my view. We will see some improvement as currently shuttered manufacturing facilities reopen, but every increase in volume will be hard-won and subject to reversal if the virus flares again. Although the mechanics of production will once again be operational, the market impact of the huge numbers of unemployed will dramatically reduce the volume of all non-essential purchases. Conditions can therefore be expected to be challenging through the rest of this year at the very least.
LM: Intermodal volumes, while slightly outpacing rail carload volumes, have been seeing declines. What are the key reasons for these declines and what is the outlook for intermodal going forward?
Hatch: Looking back, 2019 was a confusing year for intermodal due to a few different factors such as trucking capacity; rails going PSR, with some shedding business and others having business flee in fear; and the strange market dynamics of the trade wars. So, 2020 was to be the test year, with CSX and UP no longer de-marketing and the trade wars cooling off due to a late reprieve—and then COVID-19. The first impact was on supply, specifically Chinese exports. Now, the bigger issue is on demand lockdowns, and to a lesser degree the bottlenecks caused by all of these wild gyrations. North American intermodal was down around 16% in April. So, let’s wait until the fourth quarter and see where things go.
Gross: Remember that intermodal is really the combination of two separate markets, international and domestic. Intermodal’s share of the long-haul truck market has declined for seven consecutive calendar quarters through the first quarter of 2020, for a total drop of 2%. This is an unprecedented decline that has taken place thus far prior to the current crisis.
The international intermodal sector was already hit hard the first quarter of 2020 by the disruptions in shipments originating in China that occurred during their initial role in the crisis. Now, China has recovered, but its restored manufacturing capabilities are colliding with collapsing demand here in the U.S. We have forward visibility as the ocean carriers have canceled numerous ship voyages going out well into June. West Coast ports are losing share to the East and Gulf Coast due to changes in the origins of the imports—from China to Southeast Asia for example. This is generally unfavorable for intermodal due to shorter lengths of haul off the East Coast. Through the end of the first quarter, domestic intermodal held up considerably better than international. Even as the pandemic lockdown took hold, shipments of household essentials held up. But it looks as if volume has taken a huge hit in April along with long-haul truck. The outlook is challenging and very much dependent on the course of recovery, which of course is entirely up in the air.
Kuehn: As Larry mentions, international intermodal business has been on a secular decline as the traffic has shifted from the West Coast to the East Coast ports from where much of the inland move is handled by truck due to shorter hauls. Additionally, the COVID-19 pandemic has caused a precipitous drop in inbound containers from China, and is now disrupting the U.S. economy.
During economic uncertainty and supply chain disruption, shippers must make rapid network and supplier adjustments. Trucks offer a more flexible and faster transit solution as well as greater transparency, creating a short-term disadvantage for rail intermodal. While rail service is at all-time highs, truck pricing has become aggressive because of the demand drop, steep declines in fuel costs, and an abundance of drivers.
However, intermodal will continue to be a growth opportunity for railroads. The speed and size of the recovery in this sector will depend a lot on truck and driver supply and fuel prices. An increase in bankruptcies could be a tailwind for resetting the supply/demand balance driving a faster recovery.
LM: How do you view the current service levels compared to this time a year ago?
Gross: Based on both STB data and industry reports, the railroads are supplying excellent intermodal service right now. Speeds are substantially higher than both prior year and the five-year average almost across the board. This is likely the combined result of both PSR initiatives and substantially reduced volume running across the network.
The intermodal trains are running faster because there are fewer other trains out there to interrupt their progress. What’s not clear is just how much of the improvement is due to PSR and how much is simply an effect of lower volume. This will only become clear as business returns.
Rennicke: As Larry mentions, railroad service levels are excellent. While service levels are often at their peak during downturns and low-volume periods, the railroads have made structural changes to people, processes and infrastructure during the past five years that have made them more resilient, more agile, and more responsive to shifts in network demand. There is reason for optimism that this high service performance will continue as volumes return.
LM: As a follow-up, what can shippers expect in terms of service over the course of the next year?
Kuehn: The biggest risks to service in the next 12 months will be exogenous events, such as weather or other external disruptions, as well as the potential for a large restart volume surge and lack of shipper fluidity that leads to network congestion, causing service to suffer. We’re seeing some signs of this at ports currently.
If shippers carefully plan the restart and ensure that their operations remain fluid, rail system velocity can remain high, resulting in better service and lower costs. Congestion because cars can’t be delivered or because containers are not turning—creating chassis shortages—could make an impact on the entire network if not well managed. In the meantime, it will likely take many years to return to 2018 volume levels. While railroads have excess capacity in terms of plant and rolling stock, they have often been a bit slow to pull the trigger to reactivate locomotives and recall furloughed employees as volume has grown.
Hatch: I believe that service will be excellent on the network, but service cuts are possible, if regrettable, as was the case with Union Pacific recently shutting down its Cold Connect refrigerated service offering. Gross: Keep in mind that the railroads have always shown the ability to follow the market down and adjust their operations to meet reduced volume. Their record in scaling back up is considerably more mixed. Should we have a more energetic rebound from the current economic downturn, it will be an excellent test of the PSR philosophy. PSR is supposed to make the railroads nimbler and better able to adjust to changing market conditions, either up or down. It should be interesting to observe.
LM: Is pricing where it needs to be for railroad and intermodal in light of the major capital expenditure outlays made by the carriers?
Hatch: Pricing needs to remain above “rail-inflation” for a wide variety of reasons, but capex is by far the most important one.
Gross: Current pricing levels are more than adequate to fund necessary reinvestment. In 2019, for the six publicly traded Class I railroads, spending on share buybacks was 21.2% of revenue, exceeding the 18.7% of revenue channeled into capital expenditures. More money was being returned to shareholders in the form of share buybacks than was being reinvested in the business. Of course, in light of current conditions, share buyback programs have been suspended and capital spending has been reduced. During the Great Recession, the domestic intermodal sector gained share versus truck, a trend that continued for the following six years. This was the result of new terminals and services, as well as aggressive pricing against truck. Today’s railroad managements have largely signaled that they will continue to hold current pricing and not follow truck rates down, preferring to wait for the markets to “normalize.” This makes near-term share gains unlikely and may well result in further erosion in market share.
Rennicke: Intermodal profitability within the railroad portfolio has improved drastically in the past 10 years. It’s no longer the poor cousin of the carload business and is seen as the growth engine of the future. There’s still tremendous opportunity in the intermodal channel to take out costs, reduce transactional friction, and improve the value proposition—all of these things will raise the competitive position of intermodal and allow a higher ROI for the product line.
LM: How will the rail and intermodal markets look five years from now?
Gross: The landscape in which intermodal operates will be transformed by the pandemic for years to come. International cargo flows will become more dispersed in terms of both origin and port of entry as the North American economies slowly, but inexorably, “de-couple” from China. Growth in ocean imports will slow to no more than that of GDP, with the potential to fall even lower as near-shoring and re-shoring slowly, but steadily, gather momentum.
Important intermodal customer sectors, such as retail, will also be transformed, with previous stalwarts like department stores falling by the wayside and e-commerce surging. Consumers will also become more dispersed with more telecommuting, and there will be less need to cluster in dense urban areas.
What this means for intermodal is that the large east-west flows of international containers will not be a growth sector. Intermodal flows will become more dispersed with secondary locations gaining importance and north-south flows growing faster than average. The intermodal sector will need to change its playbook in order to successfully participate in this fast-changing environment.
Kuehn: Their rapid response to PSR and the COVID-19 crisis has proven that railroads can successfully execute massive change in a short time frame when required. Railroads stand to benefit from potential near shoring of traffic to Mexico or even back to the U.S. from Asia. But it won’t happen easily without better supply chain transparency, both for the carload business and for intermodal. While each carrier has worked on improving the user experience independently, it’s still a challenge to manage multi-carrier service across the North American network. The Canadian carriers have some advantage over carriers south of the border, as their coverage of most or all the Canadian market and their retailing of intermodal service enables them to have better control over door-to-door service and supply chain transparency.