Executive Briefings

Railroad Executives Promise Stable Service Through Peak Season

Major investments in equipment and infrastructure largely account for the ability to process traffic and volume efficiently, but industry needs to see continued ROI if such infusion of capital is to continue.

Rail shippers of all commodities should breathe a sigh of relief as the fall "peak season" kicks into high gear, or at least that is the message from the CEOs of all the major North American railroads. Despite record volumes of intermodal containers, grain and other commodities that traditionally hit their peaks from August until December, rail executives have given written assurance of trouble-free rail service for the remainder of 2006 to Surface Transportation Board Chairman W. Douglas Buttrey. Ever since the rail service debacles of 2003 and 2004, the STB, which regulates rail service and rates in the U.S., has asked railroads to warn shippers if they expect problems during the traditional peak demand period in the fall months and to describe how they plan to meet customer demand and provide acceptable service.

In letters to the STB, 18 rail executives told Buttrey that they expect freight volume to remain strong for the remainder of the year, but that congestion should not be an issue. For example, Michael Ward, chairman, president and CEO of CSX Transportation says that "improvements have been achieved in virtually all measurements," so the rail carrier can absorb additional fall peak traffic. He points to a 14 percent improvement in terminal car dwell time and an almost 50 percent improvement in on-time originations for the first half of 2006 compared with the same period in 2005.

Arthur Shoener, president and CEO of the Kansas City Southern Railway, says his railroad is completely recovered from last year's hurricanes and listed capacity-expanding initiatives such as its new intermodal service from the growing Mexican port of Lazaro Cardenas and the new double track mainline on the Meridian Speedway in Louisiana.

All the rail executives credited large infrastructure and equipment investments their companies are making for improved performance levels and for their confidence in continued good service. Matthew K. Rose, chairman, president and CEO of the BNSF, points out that between 2002 and 2006, his railroad invested about $10bn in its system, not counting rail car acquisitions.

"As long as our return on invested capital continues to improve, we will continue investing to expand our railroad's capacity," says Rose.

"Without market-based adjustments to our rate structure, we cannot invest and expand to meet the ever-growing transportation demands of our many customers."
- Charles W. Moorman of Norfolk Southern

Charles W. Moorman, chairman, president and CEO of the Norfolk Southern, echoes this sentiment by explaining that his railroad's 2006 capital plan of $2.8bn includes $1.5bn for ongoing maintenance, $305m for capacity expansion, $180m for new facilities and the remainder for equipment acquisitions. He cautions, however, that if the DOT predictions of increased demand for freight transportation are close to correct, substantial new capacity would be needed. There is a direct correlation between rail profitability and investment. He explained that railroading is the most capital-intensive industry in the U.S. and it is essential that railroads continue to earn adequate returns to justify making further investment in capacity.

"Capacity, service and rates are three legs of the same stool," says Moorman. "There is no free lunch. Without market-based adjustments to our rate structures, we cannot invest and expand to meet the every-growing transportation demands of our many customers."

CSXT's Ward complains that the rail industry does not earn a return on its cost of capital. The industry cannot invest in new capacity without the ability to sustain price increases that more accurately reflect the value of rail transportation and the full recovery of fuel expenses.

BNSF's Rose adds that the government has a role in helping railroads meet forecasted longer-term demand for rail transportation.

"That is why I continue to believe that we need a stimulus such as the proposed 25 percent investment tax credit," says Rose, referring to legislation introduced by Mississippi Sen. Trent Lott that would grant the rail industry tax credits for more infrastructure investment.

Rail shippers also have responsibilities in preventing rail service problems, according to rail CEOs.

E. Fred Green, president and CEO of the Canadian Pacific Railway, calls for more collaboration among railroads, shippers, receivers, ports and governments.

"Transportation is a 24/7 business that cannot make its maximum economic contribution if constrained by supply chain partners who are working a five-day schedule," Green says. "The congestion and capacity issues associated with volume crests are significant. A coordinated national strategy to utilize existing infrastructure can defer or reduce billions of expansion dollars required for our highways, ports and railways."

Hunter Harrison, president and CEO of the Canadian National Railway pointed out that the huge U.S. grain crop was already straining the rail system, and that grain shippers can assure their own capacity by financially committing for it now.

"We currently are experiencing a back log of basic orders for grain cars," says Harrison, adding that such cars are filled on a first-come, first-served basis with no guarantees. "Our customers do have options available to move their grain by paying a premium based on our auction or by buying premium service trains."

Several executives also used their letter to the STB as an opportunity to warn the STB against imposing further regulatory constraints such as those long called for by captive shippers with little negotiating leverage. CP's Green says that to meet the fall peak demand surge would require "a regulatory environment that encourages private industry to make the necessary investments required to have a vibrant and responsive rail system."

He warns that any suggestion of re-regulation or return to heavy-handed government regulation would cause immense harm.

"Re-regulation could lead to disinvestments in our rail network, an outcome completely at odds with the needs of the economy," says Green.

Shipper Confidence Mixed
At the same time the rail industry was assuring the STB about its service levels, the New York-based investment firm Bear Stearns was polling shippers about their transportation expectations in the fourth quarter. Bear Stearns analyst Edward Wolfe conducts a quarterly shipper survey called the Supply Chain Indicator. In the most recent survey, rail shippers expressed mixed feelings about service levels for the remainder of 2006. While two thirds of the respondents expected service levels to be generally stable, 28 percent of shippers expect service levels to deteriorate in peak season 2006.

"In general, we expect service levels throughout the remainder of 2006 to be relatively flat compared with the first half of the year and modestly improved relative to last year," says Wolfe. "While we do not expect cycle or transit times to be meaningfully shorter than last year, we do expect service levels to become more consistent throughout the year."

Wolfe adds that the extent of volume growth across the rail network will be the key factor impacting service levels, and that the remainder of 2006 will be extremely strong. However, unlike in past years when West Coast port congestion slowed rail service during the peak demand season, the railroads and the entire rail supply chain have done a better job in planning for the peak season. As an example, Wolfe points out that more and more ports are extending hours programs, such as PierPASS at the ports of Los Angeles and Long Beach, which shift cargo traffic out of peak commuting hours to new night and Saturday shifts.

Wolfe points out that 2005 was a particularly difficult weather year as several significant flooding and subsequent track washouts in the West, weather-induced congestion in the Powder River Basin and hurricanes Katrina and Rita created service problems. Wolfe believes the rails are better equipped to handle operating and weather issues going forward.

"The relatively quick operating rebound following the heavy Northeast flooding at the end of second-quarter 2006 illustrates the ability of the rail network to recover from service disruptions and temporary network closures," he says.

The major service concern shippers have is that rail capacity will remain tight. Forty-one percent of shippers in the survey expect roughly no change in available capacity, 21 percent expect increased rail capacity and the remaining 38 percent expect a decrease in available rail capacity.

"Another quarter of strong demand and steady volume growth, combined with few signs of a slowdown heading into heavier volume months, likely contributed to the increased expectation for tighter rail capacity during 2006," says Wolfe.

The outlook for rail rate increases was another issue that the Bear Stearns survey covered. Shippers in the survey now expect 2006 rates to climb an average of 4.4 percent, up meaningfully from survey results in first-quarter 2006 and in 2005.

"This marks the highest average year-over-year rate increase expectation since we have been doing our survey," says Wolfe. "Further, we believe that the survey data support the story of sustained momentum in rail rate increases through at least 2006 and likely into 2007, driven by ongoing tight rail capacity and unfavorable trucking dynamics."

Rail shippers of all commodities should breathe a sigh of relief as the fall "peak season" kicks into high gear, or at least that is the message from the CEOs of all the major North American railroads. Despite record volumes of intermodal containers, grain and other commodities that traditionally hit their peaks from August until December, rail executives have given written assurance of trouble-free rail service for the remainder of 2006 to Surface Transportation Board Chairman W. Douglas Buttrey. Ever since the rail service debacles of 2003 and 2004, the STB, which regulates rail service and rates in the U.S., has asked railroads to warn shippers if they expect problems during the traditional peak demand period in the fall months and to describe how they plan to meet customer demand and provide acceptable service.

In letters to the STB, 18 rail executives told Buttrey that they expect freight volume to remain strong for the remainder of the year, but that congestion should not be an issue. For example, Michael Ward, chairman, president and CEO of CSX Transportation says that "improvements have been achieved in virtually all measurements," so the rail carrier can absorb additional fall peak traffic. He points to a 14 percent improvement in terminal car dwell time and an almost 50 percent improvement in on-time originations for the first half of 2006 compared with the same period in 2005.

Arthur Shoener, president and CEO of the Kansas City Southern Railway, says his railroad is completely recovered from last year's hurricanes and listed capacity-expanding initiatives such as its new intermodal service from the growing Mexican port of Lazaro Cardenas and the new double track mainline on the Meridian Speedway in Louisiana.

All the rail executives credited large infrastructure and equipment investments their companies are making for improved performance levels and for their confidence in continued good service. Matthew K. Rose, chairman, president and CEO of the BNSF, points out that between 2002 and 2006, his railroad invested about $10bn in its system, not counting rail car acquisitions.

"As long as our return on invested capital continues to improve, we will continue investing to expand our railroad's capacity," says Rose.

"Without market-based adjustments to our rate structure, we cannot invest and expand to meet the ever-growing transportation demands of our many customers."
- Charles W. Moorman of Norfolk Southern

Charles W. Moorman, chairman, president and CEO of the Norfolk Southern, echoes this sentiment by explaining that his railroad's 2006 capital plan of $2.8bn includes $1.5bn for ongoing maintenance, $305m for capacity expansion, $180m for new facilities and the remainder for equipment acquisitions. He cautions, however, that if the DOT predictions of increased demand for freight transportation are close to correct, substantial new capacity would be needed. There is a direct correlation between rail profitability and investment. He explained that railroading is the most capital-intensive industry in the U.S. and it is essential that railroads continue to earn adequate returns to justify making further investment in capacity.

"Capacity, service and rates are three legs of the same stool," says Moorman. "There is no free lunch. Without market-based adjustments to our rate structures, we cannot invest and expand to meet the every-growing transportation demands of our many customers."

CSXT's Ward complains that the rail industry does not earn a return on its cost of capital. The industry cannot invest in new capacity without the ability to sustain price increases that more accurately reflect the value of rail transportation and the full recovery of fuel expenses.

BNSF's Rose adds that the government has a role in helping railroads meet forecasted longer-term demand for rail transportation.

"That is why I continue to believe that we need a stimulus such as the proposed 25 percent investment tax credit," says Rose, referring to legislation introduced by Mississippi Sen. Trent Lott that would grant the rail industry tax credits for more infrastructure investment.

Rail shippers also have responsibilities in preventing rail service problems, according to rail CEOs.

E. Fred Green, president and CEO of the Canadian Pacific Railway, calls for more collaboration among railroads, shippers, receivers, ports and governments.

"Transportation is a 24/7 business that cannot make its maximum economic contribution if constrained by supply chain partners who are working a five-day schedule," Green says. "The congestion and capacity issues associated with volume crests are significant. A coordinated national strategy to utilize existing infrastructure can defer or reduce billions of expansion dollars required for our highways, ports and railways."

Hunter Harrison, president and CEO of the Canadian National Railway pointed out that the huge U.S. grain crop was already straining the rail system, and that grain shippers can assure their own capacity by financially committing for it now.

"We currently are experiencing a back log of basic orders for grain cars," says Harrison, adding that such cars are filled on a first-come, first-served basis with no guarantees. "Our customers do have options available to move their grain by paying a premium based on our auction or by buying premium service trains."

Several executives also used their letter to the STB as an opportunity to warn the STB against imposing further regulatory constraints such as those long called for by captive shippers with little negotiating leverage. CP's Green says that to meet the fall peak demand surge would require "a regulatory environment that encourages private industry to make the necessary investments required to have a vibrant and responsive rail system."

He warns that any suggestion of re-regulation or return to heavy-handed government regulation would cause immense harm.

"Re-regulation could lead to disinvestments in our rail network, an outcome completely at odds with the needs of the economy," says Green.

Shipper Confidence Mixed
At the same time the rail industry was assuring the STB about its service levels, the New York-based investment firm Bear Stearns was polling shippers about their transportation expectations in the fourth quarter. Bear Stearns analyst Edward Wolfe conducts a quarterly shipper survey called the Supply Chain Indicator. In the most recent survey, rail shippers expressed mixed feelings about service levels for the remainder of 2006. While two thirds of the respondents expected service levels to be generally stable, 28 percent of shippers expect service levels to deteriorate in peak season 2006.

"In general, we expect service levels throughout the remainder of 2006 to be relatively flat compared with the first half of the year and modestly improved relative to last year," says Wolfe. "While we do not expect cycle or transit times to be meaningfully shorter than last year, we do expect service levels to become more consistent throughout the year."

Wolfe adds that the extent of volume growth across the rail network will be the key factor impacting service levels, and that the remainder of 2006 will be extremely strong. However, unlike in past years when West Coast port congestion slowed rail service during the peak demand season, the railroads and the entire rail supply chain have done a better job in planning for the peak season. As an example, Wolfe points out that more and more ports are extending hours programs, such as PierPASS at the ports of Los Angeles and Long Beach, which shift cargo traffic out of peak commuting hours to new night and Saturday shifts.

Wolfe points out that 2005 was a particularly difficult weather year as several significant flooding and subsequent track washouts in the West, weather-induced congestion in the Powder River Basin and hurricanes Katrina and Rita created service problems. Wolfe believes the rails are better equipped to handle operating and weather issues going forward.

"The relatively quick operating rebound following the heavy Northeast flooding at the end of second-quarter 2006 illustrates the ability of the rail network to recover from service disruptions and temporary network closures," he says.

The major service concern shippers have is that rail capacity will remain tight. Forty-one percent of shippers in the survey expect roughly no change in available capacity, 21 percent expect increased rail capacity and the remaining 38 percent expect a decrease in available rail capacity.

"Another quarter of strong demand and steady volume growth, combined with few signs of a slowdown heading into heavier volume months, likely contributed to the increased expectation for tighter rail capacity during 2006," says Wolfe.

The outlook for rail rate increases was another issue that the Bear Stearns survey covered. Shippers in the survey now expect 2006 rates to climb an average of 4.4 percent, up meaningfully from survey results in first-quarter 2006 and in 2005.

"This marks the highest average year-over-year rate increase expectation since we have been doing our survey," says Wolfe. "Further, we believe that the survey data support the story of sustained momentum in rail rate increases through at least 2006 and likely into 2007, driven by ongoing tight rail capacity and unfavorable trucking dynamics."