So much of major U.S. railroad volume this year depends on the weather.
The severity of winter will impact how much coal utilities burn and need to restock their inventories. Utilities’ shift toward natural gas generation — a result of lower prices and tighter federal environment regulation — and a warmer-than-usual winter pulled down rail coal traffic 10.8 percent year-over-year in 2012. A harsh winter is forecast for the Eastern Seaboard — January’s warm stretch, notwithstanding — while the weather is expected to be milder in the West.
The impact of ongoing drought on this year’s growing season will help determine the health of grain rail traffic, which plunged 9.5 percent last year, according to the Association of American Railroads. The Department of Agriculture on Jan. 11 said corn farmers got less than 75 percent of the yields they expected when seeds were planted in the spring, but the 10.7 billion-bushel harvest was still one of the largest in history.
The health of the two commodities, which account for nearly half of carload volume, will affect just how profitable the railroads are in 2013. As growth in volume slows, the top five U.S.-based railroads — BNSF Railway, CSX Transportation, Kansas City Southern Railway, Norfolk Southern Railway and Union Pacific Railroad — have seen their total profit growth slip.
Profits among the railroads rose 5 percent year-over-year in the third quarter of 2012, compared with a 16.4 percent year-over-year jump in the same period of 2011.
Fears of coal business weakness prompted Goldman Sachs and Raymond James to downgrade their fourth quarter earnings forecasts for CSX, which, along with KCS, will be the first of the U.S. railroads to report financial results on Jan. 22.
Healthy automobile, chemical, intermodal and domestic energy-related shipments have helped offset the grain and coal slumps, but they still can’t offset the losses in hauling the two commodities, said Charles W. Clowdis Jr., managing director of transportation consulting at IHS Global Insight. U.S carload traffic last year fell 3.1 percent from 2011, while intermodal volume expanded 3.2 percent. “This could be the year in which their profit growth levels off,” he said.
Gauging whether coal volume does the same is just as tricky. Estimates for U.S. coal consumption vary widely. The U.S. Energy Information Administration expects coal consumption to rise 5.6 percent, but many commodity analysts say stabilization is the best-case scenario. Stabilization of coal hauling wouldn’t just help carriers’ bottom lines but also would instill confidence in investors that the market has bottomed out, said Walter Spracklin, an analyst for the Royal Bank of Canada.
The price of natural gas also will play a major part in whether utilities burn more coal, said Bill Selesky, senior research analyst at Argus Research. The general assumption is that natural gas must be above $3 per million British thermal units before coal becomes competitive, and the spot price was at $3.14 in the first week of January.
Even without lower prices, natural gas is expected to eventually power more of the U.S. grid, as the Obama administration shows no sign of relenting on tougher environmental rules for utilities and coal-fired power plants, Selesky said.
For 2013, though, exports likely will be the tipping point for coal, because outbound shipments pale in comparison to domestic loads but enjoy high margins. Although export coal shipments fell in mid-2012, European and Chinese buyers have been expressing more interest, Clowdis said. Despite Europe’s green chutzpah, nearly half of the continent’s electric grid is powered by coal, and China will likely turn more to U.S. coal as its top seller, Australia, restores its flood-hit railroads.
Like the outlook for coal, this year’s grain forecast is murky and depends not only on weather conditions in the U.S. but also those in China. The Asian giant’s wheat crop is suffering as a result of a harsh winter, which could increase demand for corn imports, even though China expects a record harvest. An undisclosed grain exporter told investment research firm Wolfe Trahan that he is optimistic production will rebound in the second half of the year. The good news for the U.S. railroads is they appear ready for increasing grain volumes.
“This shipper does not own railcars and has found cars to be extremely plentiful from the rails given the downturn in grain and agriculture volumes recently,” Wolfe Trahan wrote in a Jan. 11 research note.
The rail industry also is gaining business as shippers shift traffic to the tracks from the barges, because low water levels on the Mississippi River is restricting capacity, said Bob Utterback, economist for The Farm Journal. Restricted capacity on the major waterway, or even its closure, could impede fertilizer shipments to the north, threatening crop yields.
Rail grain hauling also depends largely on whether farmers release their corn for sale, Utterback said. Plenty of corn inventory hasn’t been priced for market yet, so it’s unclear whether farmers will move the grain on the rails in the coming months or wait for depressed prices to rebound. Inventory levels are far from uniform across the farm belt, with grain “in position” in Iowa and Minnesota but less so in Illinois, Ohio and Kentucky, he said.
“The question is whether the corn is where it’s needed,” Utterback said. “If you don’t see product movement by mid-February, you’re not going to see it move until May.”