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SK Snavely King Majoros OConnor & Lee

Economic and Management Consultants

Rail Industry Overview and Trends


A Report to CSCMP 2006
Tom OConnor
Snavely King Majoros OConnor & Lee
1111 14th St. NW Suite 300 Washington, DC 20005
Phone 202 371-9149 email skmoltom1@aol.com October 17, 2006
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Four Key Rail Trends


I Intermodal: Dramatic increases Surging growth in Asian economies leads to higher US rail volume with lower rail profits per unit - Capacity is a key issue II Rail Economics: Costs And Rates - Their use in negotiations and regulatory settings III Rail Regulation and Competition
Fuel Surcharges Legislative and Regulatory Initiatives

IV. Mergers And Strategic Alliances mergers may be coming and strategic alliances have already arrived
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

I. Macro Rail Industry Overview


Increasing importance of Intermodal Relatively weaker profit position of Intermodal rail industry wide; BNSF appears to be an exception Strategic Alliances of Rail and Truck
Schneider allies with BNSF and with CSX in Intermodal JB Hunt first quarter revenue was 41 % Intermodal

Intermodal now 23% of Rail Revenue, more than Coal Relative cost advantage of rail over truck increases as fuel cost rises
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Recent Trend: Increasing importance of Intermodal


Jan 06 to Aug 06: Intermodal up 6.4% and Carloads up 1.5%

Railroads Pursued Intermodal Cost Subsidy by Federal Government - A response to Revenue Constraints on Intermodal.
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Long Term Trend: Increasing importance of Intermodal

Source: AAR, Traffic World

Intermodal growth can absorb railroad capacity and cut into carload service
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

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Economic and Management Consultants

The Highway Network: Approaching and Exceeding Capacity.


1998 2020

Chart Source: Batelle

Highways over-capacity are shown in red for 1998 and forecast 2020 Highways approaching capacity shown in blue for 1998 and forecast 2020
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Factors Affecting Railroad Capacity In The Future: Import/Export And Intermodal

Increasing use of back haul to reduce cost and increase capacity


Tropicana back hauling other products to FL

Projected growth in Intermodal is both welcome and a concern to Railroads


Volume levels up and profit levels down

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Long Term Shifts In Production Have A Major Impact On Domestic Transportation


Chemical Business: persistent shifts of
Mexico is the second largest US trade partner and has growing importance in trade with Asia Continued Impact On Freight Flows Of Long Term Shifts In Domestic Industrial Production US Trade Deficit with China was $202 Billion in 2005 US Trade Balance Was Running At Annual Deficit Of $763 Billion As Of April 2006
6.4% Higher Than The Record $717 Billion US Trade Deficit In 2005

domestic production overseas


$100 $80 $60 $40 $20 $0 1994 1995 1996 1997 1998 1999 2000 2001 2002 Trade Balance (right axis) Imports (left axis)
Source: US Department of Commerce

$25 $20 $15 $10 $5 $0 ($5) ($10) Exports (left axis) Trade Balance Trend Line

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Long Term Shifts In Production Have A Major Impact On Intermodal Volumes and Port Congestion
Continued Impact On Freight Flows Of Long Term Shifts In Domestic Industrial Production

US trade showed a deficit with China of $19.6 billion in July 2006; 12 months at this level would yield a US deficit of $240 billion; 20% above the US deficit in 2005
Monthly US deficit worldwide was $68.0 billion in July 2006

US Deficit

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

II. Rail Economics: Costs And Rates


Commodity Comparison
Compare rail rates to other rail shipments of the same commodity

Year over Year comparison


Compare year over year change in rail rate

Rail Profitability; Revenue Cost Ratios (RCR)


RCR is Revenue divided by variable cost RCR estimates the profit the railroad realizes from each rate. RCR is used for regulatory purposes at the Surface Transportation Board (STB)
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

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Economic and Management Consultants

The Profitability of US Rail Shipments Varies Widely as measured by Rail Revenue divided by Rail Cost (RCR)
Revenue Cost Ratios: Commodities with $2 Billion or More in Revenue
Source: STB; 2004 Waybill Sample

Total Rail Freight

135%

Misc. mixed shipments ex. forward Transportation equipment Chemicals Food and kindred products Coal Farm products 0% 20% 40% 60% 80% 100% 120%

127%

118%

164%

119%

145%

150%

140%

160%

180%

Revenue Cost Ratio: Rail Revenue Divided by Rail Variable Cost

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Converting Chemical Shipments From Domestic Rail Carload to Converting Chemical Shipments From Domestic Rail Carload to Intermodal Import Can Lead to Dramatic Changes in Rail Rates Intermodal Import Can Lead to Dramatic Changes in Rail Rates

To This From This

Revenue Cost Ratio is railroad revenue as aa percentage of railroad cost. Revenue Cost Ratio is railroad revenue as percentage of railroad cost. Misc. Mixed is Primarily Intermodal Misc. Mixed is Primarily Intermodal CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

III. Rail Regulation and Competition


Initiatives At Surface Transportation Board (STB)
Two major STB initiatives will impact Shippers Fuel Surcharge Railroads Reporting Fuel Revenue and Cost to STB Fuel Surcharge linked to Fuel Cost Small Shipment Rate Case A Rulemaking to redefine procedures Reflects a more proactive approach
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

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Economic and Management Consultants

14%

2005 Average Fuel Surcharge Compared to 2005 Change in Fuel Cost


13% 13% 13% 12%

12%
11% 11%

10%

8%

6% 5% 4% 4% 3% 5% 4%

2% 2%

0% BNSF CSXT KCS NS UP Total


Source: Railroad SEC filings and Company websites

2005 Average Fuel Surcharge

Change in Fuel Cost as % of Total Cost

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Economic and Management Consultants

Fuel surcharges claimed by the BNSF and the UP are virtually identical. Fuel surcharges claimed by KCS, NS and CSXT are also virtually identical. In contrast with this uniformity, fuel cost as a percent of operating cost differs widely
20.0% 18.0% 16.0% 14.0%

US Class I Railroad Fuel Surcharge: BN and UP


20.0% 18.0% 16.0% 14.0%

US Class I Railroad Fuel Surcharge: CSXT NS and KCS

F u e l S u rc h a rg e

10.0% 8.0% 6.0% 4.0% 2.0% 0.0%

F u e l S u rc h a rg e
Month

12.0%

12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0%

Ja n F e -0 4 b M a -0 4 r A p -0 4 r M a -0 4 y J u -0 4 nJu 04 l A u -0 4 g S e -0 4 p O c -0 4 t N o -0 4 v D e -0 4 c J a -0 4 n F e -0 5 b -0 Ma 5 r A p -0 5 r M a -0 5 y -0 Ju 5 nJu 05 l A u -0 5 g -0 Se 5 p O c -0 5 t N o -0 5 v D e -0 5 c J a -0 5 n F e -0 6 b M a -0 6 r A p -0 6 r M a -0 6 y -0 6

Source: Class I Railroad Websites

Source: Class I Railroad Websites

BNSF

UP

Source: Railroad SEC filings and Company websites

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

Ja n F e -0 4 bM a 04 rAp 04 r M a -0 4 y -0 Ju 4 nJu 04 l A u -0 4 g S e -0 4 pOc 04 t N o -04 v -0 De 4 cJa 04 nFe 05 b M a -0 5 rAp 05 r M a -0 5 y -0 Ju 5 nJu 05 l A u -0 5 g S e -0 5 pOc 05 t N o -05 v -0 De 5 cJa 05 nFe 06 b M a -0 6 rAp 06 r M a -0 6 y -0 6
Month

CSXT

NS

KCS

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Rail Costs as measured by RCAF are very similar with and without fuel RCAF-A is Rail Cost Adjusted for Productivity Costs and Productivity and Fuel all as Measured by Rail Industry

1.200

RCAF U (Unadjusted) RCAF-U Less Fuel Un Adjusted For Productivity

RCAF A (Adjusted) RCAF-A less fuel Adjusted For Productivity

0.800

Adjusted or Unadjusted, There is Little Difference Between RCAF With Fuel and RCAF without Fuel

RCAF-U 2002 Q4 =100

0.400

19 94 19 94 19 95 19 95 19 96 19 96 19 97 19 97 19 98 19 98 19 99 19 99 20 00 20 00 20 01 20 01 20 02 20 02 20 03 20 03 20 04 20 04 20 05
RCAF-U is Rail Cost Adjustment Factor Without Reflecting Productivity Gains
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Railroad Financial Performance


Union Pacific, the largest US railroad
70 percent growth in 2005 net income to $1.03 billion, Revenue jumped 11 percent to $13.6 billion.

Burlington Northern Santa Fe, second-largest US railroad,


93 percent growth in 2005 net income to $1.5 billion, Revenue of $13 billion, up 19 percent, for 2005.

CSX, the third largest US railroad


237 percent growth in 2005 net income to $1.2 billion Revenue increased 7 percent to $8.6 billion.

Norfolk Southern, the fourth largest US railroad


39 percent growth in 2005 net income to $1.3 billion Revenue rose 17 percent to $8.5 billion

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

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Economic and Management Consultants

IV. Mergers and Strategic Alliances Major US Ports And Metropolitan Areas With Populations Greater Than 1 Million People

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Rail service via Mexican Ports is a Response to US West Coast port congestion The Mexican ports and the Meridian Speedway Joint Line links to NS and targets service to East Coast population centers and rapidly growing Intermodal freight This could foreshadow major shifts in rail flows

IV. Mergers And Strategic Alliances


Ports of Los Angeles and Long Beach handle: 70% of cargo moving between Asia and the US 40% of total ocean cargo shipped to US every year from the world.

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

KCS Estimates

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

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Economic and Management Consultants

Most Observers See Virtually no Network Redundancy left in the Rail System

Segments of many mainlines at capacity Operating issues in some terminals Recurring shortage of crews due to retention and training challenges Need to acquire and refit locomotives The Railroad Metrics tell the Story
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Rail Mergers: Lessons for the future


Continued high demand Traffic is up Freight volumes expected to double in 20 years Increasingly, new highways are a non-starter Railways will have a bigger role If they can do the job
Source: Jim McClellan NS Sr. VP Strategic Planning June 2004

Strategic Alliances Are an Alternative to Mergers


Source: Tom OConnor VP SK October 2006
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Major Independent Railroads


CP UP CSX
KCS

CN

BNSF
TFM FXE

NS

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Major Independent Railroads Showing Some of the Rail Strategic Alliances CP UP CSX
KCS

CN
G

NS

BNSF
TFM FXE

Alliance

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Four Key Rail Trends


I Intermodal: Dramatic increases Surging growth in Asian economies leads to higher US rail volume with lower rail profits per unit - Capacity is a key issue II Rail Economics: Costs And Rates - Their use in negotiations and regulatory settings III Rail Regulation and Competition
Fuel Surcharges Legislative and Regulatory Initiatives

IV. Mergers And Strategic Alliances mergers may be coming and strategic alliances have already arrived
CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Background on Snavely King


Snavely King Majoros OConnor & Lee has provided consulting services to the Rail Industry, rail shippers and hundreds of other clients in transportation, telecommunications and utilities in the US, Canada and Overseas. For more than three decades SK has built its success on developing and applying practical market and economic solutions for its clients. The firm's financial and strategic advice is backed by the professional staff's wide experience in designing and applying business solutions, evaluating corporate transactions, analyzing start-up companies, and in providing strategic planning services to commercial, institutional and government clients. In more than 2,000 projects, the analyses and expert advice provided by SK have significantly assisted both private and public sector clients.

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com

SK Snavely King Majoros OConnor & Lee


Economic and Management Consultants

Tom OConnor
Tom OConnor is Vice President of Snavely King Majoros OConnor & Lee, an economic and management consulting company. He has been engaged in the business of economic analysis for more than thirty years, beginning as an economist with the Interstate Commerce Commission (now the Surface Transportation Board) and subsequently in economic consulting and management positions of increasing responsibility with:
The United States Railway Association as Manager of Local Rail Services Planning Conrail as Assistant Director of Costs and Economics Association of American Railroads as Assistant Vice President of Economics DNS Associates as Vice President, and since 1988 with Snavely King Majoros OConnor & Lee as Vice President

Tom OConnors practice centers on transportation with specific focus on negotiations and infrastructure issues including rationalization and redesign of the railroad infrastructure in the US as well as rebuilding of the railway infrastructure in Eastern Europe. Mr. OConnors work in the Balkans in Eastern Europe focused on both transportation and telecommunications. Tom OConnor has provided testimony on a wide range of issues in proceedings before courts and regulatory commissions in the United States and Canada including:
Interstate Commerce Commission; Surface Transportation Board; United States Railway Association; Regulatory Commissions in New York, Indiana and Pennsylvania; State Courts in Indiana, Montana and Virginia; Arbitration Panel in New York; Mediation Panels in Massachusetts and Washington DC; Canadian Crown Commission; US District Court for Eastern District of Virginia, and US District Court for Arizona

Military- US Army - Combat Engineers

o Education- Economics BA and Graduate - Phi Beta Kappa

CSCMP 2006 San Antonio Snavely King Majoros OConnor & Lee, Inc. 1988-2006 www.snavely-king.com