Rail Freight: What’s Coming Down the Track?

Tags: Supply Chain Management, Intermodal, Rail, Mexico, Canada, Logistics

Hop aboard with Inbound Logistics to find out.

Double-stack intermodal trains have become a familiar sight and sound in Canmore, Alberta, a sleepy enclave situated 64 miles west of Calgary in Canada's Rocky Mountains. The town, created in 1884 by Scotsman Donald Smith, co-founder of the Canadian Pacific Railway, was once a major provincial coal-mining center. That boom period has long since passed.

Today, a panoply of technicolored 53- and 40-foot intermodal boxes—Canadian Tire red, Hapag-Lloyd orange, APL blue, and Yang Ming white—regularly dominate Canmore's townscape. Less frequently, bleak gray coal trains break up the ennui, representing the ongoing shift in freight traffic across North America.

The growth of domestic and international intermodal, grain exports, crude by rail, and frac sand—all of which offset the corollary drop in coal shipments—is pushing railroad capacity and velocity to the max. Investment and development, often unseen and in places far removed from the beaten tracks, is happening at pace. Class I railroads are spending billions of dollars to upgrade infrastructure and equipment.

It couldn't be happening at a better time.

North America's energy and manufacturing revival, and the railroad's reckoning as a conduit to that end, is assured. As environmental mandates, cost containment directives, and capacity constraints shade transportation decision-making, the railroad is becoming a bigger part of the solution.

Invariably, there are some headwinds as well. Service disruptions and delays in the Upper Midwest in winter 2013 placed railroads on notice. Captive shippers are pushing for regulation to address the lack of competition and capricious rate increases. In the aftermath of 2013's Lac-Mégantic accident in Quebec, Canada, railroad safety is under greater scrutiny as the rollout of positive train control (PTC) progresses at a glacial pace. And, the changing commodity profile is forcing industry to rethink conventional network design.

Inbound Logistics hit the road during fall 2014 to get an up-close view, around the bend, of where the railroad industry is tracking in 2015 and beyond. From New York City's skyscrapers to America's oil and gas headquarters in Houston, to Canada's Rocky Mountains, hop along as we block, switch, and brake our way through trends and topics shaping the future of rail freight.

Intermodal All the Way

The growth story in the railroad industry is intermodal. As capacity concerns choke transportation efficiency, and driver availability continues to drain capital resources, shippers are running to the rails.

Speaking at Progressive Railroading's RailTrends conference in New York City in November 2014, Joni Casey, president and CEO of the Intermodal Association of North America (IANA), documented this growth.

"2014 was an atypical year," she said. "Volume growth accelerated from February to March. But it kept increasing through May at a higher rate compared to last year. This reflects earlier international shipments, especially imports, that were coming in to the West Coast in advance of the labor negotiations."

Year-to-date volumes in November 2014 were 500,000 units more than 2013. Total intermodal volume rose 5.1 percent in the third quarter. Both domestic and international volumes reported gains of 5.5 percent and 4.7 percent, respectively, year-over-year.

More telling, international and domestic intermodal volumes are beginning to balance out, reflecting an ongoing shift in these two markets, according to Casey. On a seasonally adjusted basis, domestic volumes exceeded international in third-quarter 2014 for the first time since IANA began tracking this type of data 17 years ago.

"Domestic intermodal volume is tightly connected to overall growth because it drives everything," Casey said. By comparison, international is exposed to more volatility in monthly loadings, as the current West Coast labor situation demonstrates.

Intermodal's sweet spot is between 750 and 1,500 miles—a range that contributes to almost half of all loads, as IANA's data indicates. The 750- to 1,000-mile haul is the fastest-growing segment. Still, as carriers such as Florida East Coast Railway have demonstrated, in certain markets short-haul intermodal less than 500 and even 300 miles has become advantageous.

On the tracks, railroads have felt the accelerating pulse of intermodal growth. Canadian Pacific's (CP) Calgary yard is swelling with boxes, a consequence of increasing Vancouver port traffic due to the U.S. West Coast labor impasse, explains Michael Arena, regional account manager of Canadian Pacific Railway.

" A move from Philadelphia to the Chicago Belt Railway Company (BRC) for delivery to one of our western rail partners takes four intermediate handlings. With the Bellevue expansion, it will require two. We'll bypass the BRC by blocking cars further into our western partners' network. That's how you increase capacity. " Deb Butler, Executive Vice President of Planning and Chief Information Officer, Norfolk Southern

CP's commodity portfolio comprises about 22 percent intermodal, 36 percent general merchandise, and 42 percent bulk. It traditionally had strength in coal, grain, and forest products. But the railroad expects to grow intermodal traffic 50 percent over the next four years. CP's revival under CEO Hunter Harrison's leadership is predicated on building longer origin-destination unit trains, and eliminating stops. This creates better margins.

CP currently runs 61-hour train service from Calgary to Toronto, and 96 hours from Vancouver to Toronto. It also experienced a spike in Canadian National (CN) carload traffic, and highway conversions between Vancouver and Calgary—a 32-hour run. The challenges of moving freight over the road in the Canadian Rockies have always given rail an edge.

Shippers are taking note. Sears and Canadian Tire have distribution centers adjacent to CP's Calgary yard. Home Depot is building two facilities, totaling one million square feet, mere minutes away. The new complex is part of a supply chain strategy to leverage rail intermodal deeper within its distribution network, and provide rapid deployment to stores across Western Canada—in lieu of serving these locations from Vancouver.

CN, which opened a $200-million intermodal facility on the outskirts of Calgary in 2013—complementing an existing yard downtown—also expects volumes to grow. The new facility is designated specifically for intermodal movements while the other yard handles bulk and automobiles.

Similar to CP, CN's intermodal share comprises 23 percent, its top product category in terms of freight revenue. Volume was up 13 percent in third-quarter 2014, according to Jim Vena, executive vice president and chief operating officer for the Montreal-based railroad.

The challenge for growing intermodal locations is creating balance between moves. "Calgary is an inbound market with lots of empties," says Vena. The railroads are exploring opportunities to find product that can move back west so they can better utilize equipment and position containers. For example, grain and beer are strong export commodities out of the Canadian prairie. Railroads and service providers are also looking at innovative ways to box bulk cargoes—grain, for example—that traditionally moved on other equipment.

MEXICO: THE LAST GREAT FRONTIER

Mexico holds even more opportunities. Kansas City Southern's operational bailiwick is cross-border trade. The railroad has seen increasing growth in automotive, heavy appliance, and household movements—and that potential is bleeding into other industries.

"Kansas City Southern's market research indicates that approximately 3.1 million trucks move across the border to our target U.S. markets," explains Patrick Ottensmeyer, executive vice president and chief marketing officer for the Missouri-based Class I railroad. "Currently, we have about two to three percent of this available market."

There is a huge upside in terms of potential conversions. So why hasn't the railroad tapped this brimming revenue stream yet? Simply because the infrastructure didn't exist until recently, acknowledges Ottensmeyer.

Kansas City Southern has been building out its network between Houston and Mexico City over the past five years, spending more than $300 million acquiring terminals and adding capacity. "Cross- border U.S.-Mexico movements are the last great frontier for truck-to-rail conversion," he adds.

If that isn't incentive enough for shippers, Mexico's opening energy market sweetens the pot. The government's decision to modify its constitution in 2013, and allow more competition and foreign investment in its oil and gas industry, has lit a fuse. Ottensmeyer expects Mexico's energy market will eventually explode, much like the current situation in Canada.

Despite rail's resurgence as a major mover and shaker in the U.S. industrial complex, rapid growth has exposed some cracks in the machine. At the 2013 RailTrends conference, Hunter Harrison pointed to the reality that railroad networks built a half-century ago have outgrown their utility. In some cases, railroads need to reconfigure their networks and eliminate underutilized hump yards, which reduces touches.

Harrison has breathed new life into CP by following the precision railroading mantra he pioneered at CN. Industry at large is following that lead by focusing more attention on origin-destination unit trains.

"The unit train model is an express train that doesn't stop," explained Richard McClure, president of ARC Strategic Advisors Group, while presenting at the SCM Leaders on Demand Oil and Gas symposium in Houston in November 2014.

"A conventional manifest train, which is made up of 10, 15, or 20 different products, has to stop off along the way," he said. "If a train starts in Fort Worth, for example, and goes to the West Coast, it might stop in Nebraska, Utah, and Arizona. That process usually takes 34 days. The unit train model reduces that time to five days. The only reason railroads stop is because they have to change out crews every 12 hours by law."

MIXING IT UP

If there's enough demand to build and run more unit trains, it makes sense to prioritize that business because it increases velocity in the system. But increasing traffic mix on the rails has created a challenge. BNSF's well-documented service meltdown in winter 2013 has been attributed to bad weather and operational constraints. Railroads have been quick to deflect captive shipper claims that problems are structural and systemic.

"One big issue is the change in traffic commodity mix," explained Ed Hamberger, president and CEO of the American Association of Railroads, at RailTrends. "We've had two record grain harvests, and growth in domestic intermodal. The traffic lanes that are transporting record domestic intermodal volumes are the same ones moving coal out of Powder River Basin."

Deb Butler, executive vice president of planning and chief information officer for Norfolk Southern, supports that claim. "The bulk network, which includes crude units, is now trying to occupy the same routes as our premium intermodal network," she says. "The change in mix creates different dynamics of how the railroad operates. It creates the need for resiliency in terms of crews, locomotives, and infrastructure."

Apart from that, a sluggish and congested railroad is also impacting the rollout of PTC technologies. The deadline for full deployment remains a moving target as industry seeks an extension beyond the mandated Dec. 31, 2015, date.

"We are at the point of PTC deployment where, regardless of when the deadline falls, we need to start putting hardware out in the field and testing it," Butler adds. "That requires track time. But track time in a congested network will only create more congestion. We'll manage it as best we can."

Challenge: Increasing Velocity

Railroads are "putting steel in the ground" and buying more locomotives and equipment to counter decelerating rail velocity and swelling terminal dwell times. BNSF, for example, pledged to spend $5 billion in 2014—$2.3 billion on its core network; $1.6 billion on equipment acquisitions; $900 million for terminal, line, and intermodal expansion projects; and $200 million on PTC.

As the science of railroading evolves, carriers are taking a more sophisticated approach to speeding up the network. At RailTrends, Butler presented a step-by-step overview of how Norfolk Southern has reconfigured its network.

The Norfolk, Va.-headquartered railroad operates 20,000 miles of track in 22 states and Washington, D.C., with access to every major eastern U.S. seaport. Ninety-five percent of its routes are cleared for double-stacked intermodal trains; two-thirds of its core network is double-track or better.

"General merchandise roughly represents one-third of the units Norfolk Southern moves," Butler explained. "Although that network offers significant leverage during up cycles, single carload business requires gathering, distribution, and switching functions, which result in materially disproportionate consumption of locomotives and crew start resources."

In other words, manifest trains are a more labor- and capital-exhaustive business, especially compared to the unit train model. So the rails have even greater incentive to drive efficiencies in this area.

"Origin and destination handling represents between 25 to 50 percent of total transit time," Butler said. "That leaves 50 to 75 percent of transit time on road trains and in intermediary terminals. If we want to return the network to the velocity we saw in 2012 and 2013, we need to focus our attention here."

Norfolk Southern started looking at different metrics to measure performance, teasing out data to support better analysis of its network. The railroad gave higher priority to line haul miles per day—the average miles per day for all general merchandise shipments from departure origin terminal to destination arrival terminal. In sum, Norfolk Southern was able to make a correlation between line haul miles per day and on-time shipment performance.

spinning up the network

"As long as we are adequately resourced for the volumes we move, we have a long theoretical runway before we reach the part of the curve where incremental costs creep up as velocity increases," Butler said. "That's why we often talk about our goal of spinning up the network. We have proven, all else being equal, the faster our velocity the lower our incremental operational costs."

As such, the railroad identified three primary levers for improving velocity in its system: invest in infrastructure, eliminate freight car switches between origin and destination, and reduce handling time.

Capacity Concerns

For the industry at large, infrastructure investment has become a rallying cry, especially given negative publicity over recent operational and service issues. Simply put, railroads need to ramp up capacity to accommodate growing volumes across all commodity groups.

"As volume increases, or as the mix of traffic tilts toward unscheduled unit trains on our core intermodal routes, increasing velocity may require more than an adequate supply of locomotives and crews," said Butler. "We may also have to invest in infrastructure and technology."

She pointed to two specific examples.

First, the recently opened Englewood Flyover in Chicago is a bridge that separates Norfolk Southern and Amtrak trains from Metra, Northeast Illinois' regional commuter rail system. The $142-million project is part of Chicago Region Environmental and Transportation Efficiency (CREATE), a public-private partnership between the U.S. Department of Transportation, the state, the city, Metra, Amtrak, and Class I railroads to invest upwards of $4 billion in 70 different projects aimed at easing passenger and freight rail congestion in Chicago.

The flyover opened in October 2014 and Norfolk Southern has gained an additional six to eight hours of access to its Chicago mainline every day. That's a pretty considerable upside.

Second, Norfolk Southern is in the process of expanding its Bellevue, Ohio, yard. When the railroad first opened the facility in 1967, it had the prescience to allocate enough property to double future capacity. That's exactly what Norfolk Southern has done more than 40 years and $161 million later.

The Bellevue yard is situated where Norfolk Southern's major north-south and east-west corridors meet. "Every network study we've conducted shows that more traffic wants to flow to Bellevue than it could hold," said Butler.

The railroad is in the process of phasing in its new operational plan, but Butler expects the expansion will deliver immediate impacts.

"A move from Philadelphia to the Chicago Belt Railway Company (BRC) for delivery to one of our western rail partners takes four intermediate handlings," she explained. "With the Bellevue expansion, it will require two. We'll bypass the BRC by blocking cars further into our western partners' network. That's how you increase capacity," she adds.

On the regulatory front, competitive switching remains an unsettled topic as rail shippers and carriers await a long-overdue decision from the Surface Transportation Board on how to proceed.

" You can't have it both ways. Either allow the industry to continue to earn revenue and re-invest that capital, or reregulate, cap rates, and have a service diminution. Which one do you want? " Ed Hamberger, President and CEO, American Association of Railroads

National Industrial Transportation League (NITL) CEO and President Bruce Carlton has been a staunch advocate of increasing rail competition among Class I carriers through mandated reciprocal switching. As the North American energy boom continues to grow, it presents a new wrinkle.

Railroads are carrying record volumes of "domestic energy," raw materials (frac sand), and equipment to and from drill sites. As they gravitate toward the lucrative oil and gas business, captive shippers are feeling the pinch. Lingering service issues have only escalated their angst.

Carlton's antagonist on the rail side, AAR's Ed Hamberger, has led the charge against competitive switching. At the 2014 RailTrends, he again stated the association's position.

"NITL points out reciprocal switching will only affect 1.5 million carloads, which saves them $1,000 a carload—or $1.5 billion. Our study says it will impact 7.5 million carloads. At $1,000 a carload, that's $7.5 billion," he explained.

"But let's take the average, 4.5 million. That's $4.5 billion that goes out of the industry, 4.5 million more switches, and 4.5 million times more inefficiencies loaded onto the network," Hamberger added. "That means more locomotive time in the yard, and more crews to manage the switches. Every switch is worth one day, so that's 4.5 million more days in transit time."

Ironically, the railroad's poor record of late has become its biggest defense. Shippers want better customer service, and they want more competitive switching and pricing.

"You can't have it both ways. Either allow the industry to continue to earn revenue and re-invest that capital, or reregulate, cap rates, and have a service diminution. Which one do you want?" Hamberger asked.

Reciprocal switching remains a divisive issue among shippers and carriers—and one that's unlikely to be resolved in the immediate future.

Tank Car Standards

Of greater importance and urgency for the railroad industry is the issue of new tank car standards. Ever since the Lac-Mégantic derailment, Canadian officials have been pressing Class I railroads and tank car suppliers to adopt new crude-carrying equipment standards.

The DOT's Pipeline and Hazardous Materials Safety Administration (PHMSA) is expected to announce a rulemaking in early 2015 regarding specifications for hazmat tank cars that carry crude oil and ethanol.A few different options are on the table, with varying modifications that include steel jacket thickness, electronically controlled pneumatic brakes, and head shields. The only certainty is the hefty price tag associated with retrofits and new builds. Some estimates have pegged the total cost at more than $60 billion.

PHMSA is looking at three impacts: technical, regulatory, and economic. Not surprisingly, there's some difficulty justifying the costs of the new rule. The challenge is that "standards are still being defined, which creates a lag in production and pushes back deliveries even farther," says McClure.

Making matters worse, a shortage of railcars already exists.

The unsettled Keystone XL pipeline debate, and growth in crude oil and natural gas production, has been welcome news for railroads, especially as coal traffic continues its long, slow decline. South Dakota's Bakken fields also are experiencing a gush in frac sand movements—to the point of a major equipment shortage.

"Demand for frac sand increased 100 percent this past year. Sand mines are at capacity," says McClure. "Three years ago, there were five frac sand mines in Wisconsin. Today there are 105."

The Railway Supply Institute (RSI), a Washington, D.C.-based lobby that serves the interests of railroad suppliers, offers another perspective.

"Fourth-quarter statistics indicate a backlog of approximately 100,000 freight cars that have been ordered but not yet delivered," notes Tom Simpson, president of RSI. "We haven't seen numbers like this since the late 1970s, when economic policies in place made it imperative to invest in freight cars to earn a return on investment."

The equipment shortage has hit tank cars the hardest—53,000 by RSI's estimate—as well as small covered hopper cars (21,000) that are used to haul frac sand. Some observers expect it will take five years to replace the fleet. Companies that buy new equipment today can expect deliveries by the third quarter of 2017.

RSI's research suggests the PHMSA proposed regulation will force more than 90,000 tank cars from service at various times until shop capacity can carry out necessary modifications. If that alone isn't cause for concern, consider that upwards of 50 percent of the crude oil and ethanol fleet could be idle by 2020; or that 70,000 more trucks will be carrying 1.6 million loads of crude and ethanol on U.S. highways by 2018.