Railroads Post-PSR

The New Landscape

In a recent report entitled Taking the Railroad Playbook Beyond PSR the authors wrote, “Railroads must cope with headwinds arising from threats to demand, evolving customer expectations (particularly for reliability and transparency), and increased competition from trucking.”

In looking at the railroad financials from 2019, it is easy to see “trouble ahead” for the railroads in the 2020s. Demand for a number of key commodities is falling and the global fallout from the novel coronavirus is exacerbating an already shaky economic situation attributable in part to the US-China trade dispute and other ongoing trade spats. And while the current Covid-19 crisis is unlikely deep into next cycle (2021), the economic underpinnings of lower demand for commodities like coal, steel & steel products, agricultural products, autos and others will impact rail fortunes in the near future.

Coal has always been the life blood of railroads. The decline in demand for coal shipments for power plants, metallurgy (steel making) and even for export markets has been a major factor in declining volumes, and to a lesser extent, revenues. According to a report by the EIA (Energy Information Agency), “The United States exports metallurgical coal and steam coal, and exports of both decreased in 2019. U.S. steam coal exports were affected by the downturn in global coal demand, dropping 30% in 2019 from 2018. Metallurgical coal had a more moderate decline of 12%.” [see charts] 

And it isn’t just coal, other bulk and liquid commodities are down as well. With oil dropping to the $30 a barrel range as Saudi Arabia and Russia square off for global market share in oil, higher priced US and Canadian oil (largely shale oil) is compelled to sit on the sidelines. The cheap oil and gas (which means competition from pipelines) also means that power plants are less likely to buy coal, pushing demand even lower. The good news is that fuel expenses are also lower, but the offset to traffic loss isn’t sufficient. 

For a little insight, it’s worth looking at UP’s annual results for 2019. For the year UP reported a net income of $5.9 billion, a one-percent decrease over 2018. What’s interesting is freight revenue totaled $20.2 billion, a 5% decrease to 2018, while carloadings were down 6% versus 2018. The reason for the decline was “growth in industrial volumes more than offset by fewer agricultural products, premium and energy shipments.” So, despite a best ever OR of 60.6%, a decline in bulk volumes flattened the bottom line. With fewer carloadings in the future and likely a different mix in commodities, what will the bottom line look like in 2 years, 5 years or ten years from now? 

It’s an industry trend that throws into question just how far the PSR strategy will take the railroads.