The impact of declining coal business on East Coast railroads may have been greatly exaggerated, but the recent sharp fall-off in those volumes foreshadows a future in which CSX Transportation and Norfolk Southern Railway have less of an overall pricing hold on shippers.
As coal business declines steadily, intermodal volume will become even more important to the major railroads. Unlike many coal and industrial product shippers, however, most, if not all, intermodal customers can put their loads onto trucks if rail rates rise too high. And, with intermodal rail accounting for less than 20 percent of each railroad’s business, the loosening of railroads’ overall pricing power will be a long haul.
That pricing power was on display when CSX on April 17 reported a 6 percent year-over-year jump in first quarter revenue on a mere 1 percent rise in volume. The company’s profit rose 13.7 percent year-over-year to $449 million in the same period.
And despite investor reports overhyping the contrary, railroads won’t see the coal business disappear anytime soon. That’s because the double-digit drop in coal volume CSX and NS experienced in the first quarter is a temporary, worst-case scenario, not a barometer of the future pace of decline. A warmer-than-usual winter and less demand from slowing foreign economies exacerbated the ongoing decline in carloads caused by utilities shifting toward natural gas for fuel.
Coal volume on U.S. railroads in the last quarter was the lowest in 18 years, according to the U.S. Energy Information Administration. East Coast railroads were hit the hardest, with coal volume at CSX and NS plummeting in the mid-double-digits. The commodity is the biggest part of each railroad’s business, accounting for slightly more than 30 percent of each company’s revenue in 2011, said John Larkin, managing director at Stifel Nicolaus, in a late March presentation.
Still, concern over the decline in coal volume is “way overdone,” said Tom Finkbiner, senior chairman for the Intermodal Transportation Institute. “What we’ve seen is a perfect storm,” he said. Like the weather changes, the slowdown in economic growth in Europe and Asia is a short-term crunch. CSX this year still expects to match the 40 million tons of coal it exported in 2011, despite the global economic slowdown, Larkin said.
“The Chinese want to have a diversified supply base, and they do not want to be totally reliant on Australia, even though it is a much cheaper source for coal,” Larkin said. “The Europeans still seem OK with coal. In fact, Germany is replacing all their nuclear power plans with coal.”
Michael Ward, chairman, CEO and president of CSX, said the railroad expects year-over-year earnings growth in 2012, even if “utility coal-related headwinds are likely to be strong in the second quarter.”
More telling of the future of rail coal volume isn’t what was or wasn’t hauled in the last several months, but tougher emissions rules proposed by the Environmental Protection Agency in late March. The agency wants to further reduce carbon dioxide emissions from new power plants, potentially barring utilities from building new coal-fired generating stations.
The U.S. government expects the coal-electricity generation to fall from about 45 percent to 35 percent by 2035. Mounting pressure on utilities to shift toward natural gas energy production will help cause year-over-year coal traffic to fall 9.8 percent in 2012, 4.5 percent in 2013 and 2.4 percent in 2014, Larkin said.
For CSX and NS, the main question is whether the growth in intermodal and other non-coal shipments can offset the shrinking of the top commodity. Larry Gross, senior consultant for trucking analyst FTR Associates, thinks they can if U.S. manufacturing keeps expanding and consumer confidence strengthens. Shipments of motor vehicles and equipment, along with chemicals, have helped offset carload declines.
“With regards to the Panama Canal (expansion), it’s not a game changer,” he said. “Where you’ll see the most (intermodal) growth is on the domestic side.”
But because a carload of coal has inferior margins to an intermodal shipment, the railroads will need more volume to keep their overall pace of growth. CSX intermodal traffic in the first quarter grew 8.3 percent year-over-year, while NS’s intermodal volume rose 2.7 percent in the same period.
“We are just getting to where we were in 2006 with intermodal volume,” Finkbiner said. He said the “six intervening years of capital expenditures” taken by CSX and NS will help capture the intermodal growth potential, which will be driven by tightening truck capacity, higher transportation costs and improved intermodal service. Finkbiner doesn’t expect the railroads to try to offset declining coal business by hiking intermodal rates, however.
The railroads will raise coal pricing as that commodity market shrinks, and exporters may have to pony up more for transportation because their foreign customers won’t be on the hook like domestic utilities are, said Bob Szabo, executive director of Consumers United for Rail Equity.
Underscoring his point, CSX revenue per coal carload unit rose 10 percent year-over-year in the first quarter, compared with an overall revenue-per-unit rise of 5 percent.