Safely Transporting Oil By Railroad

The oil price crash impacts the railroad sector. Transporting freight gets cheaper, but demand for railcars to bring oil out of the Bakken fields and other places where pipelines were never laid is now dropping off. Refer to US DOT MARAD's 2008 study "Impact of High Oil Prices on Freight Transportation" for technical discussions of how the rail sector behaved under different conditions. Times have changed, perhaps permanently. Safety rules can also change with the times.

Railroad accidents made headlines when America's oil shale boom was roaring. Horrific, sensational railcar explosions are less useful justifications for transportation policymaking than statistics. The US DOT's Federal Railroad Administration (FRA) Office of Safety Analysis has the data. Running a ten-year report shows that total accidents declined by over 31% from 2006 to 2015, with percentage declines in every single subcategory. Rail transport has gotten safer than ever during the oil shale boom.

Oil shale's critics used to claim that Bakken oil was more volatile and thus more dangerous to ship in railcars. The National Transportation Safety Board's (NTSB) chair debunked this claim after some high-profile accidents. A refining industry study also found that Bakken crude fits within existing oil safety standards. The volume of fuel spilled, not its chemical composition, determines its potential hazard. Anyone can search the American Fuel and Petrochemical Manufacturers (AFPM) website for "Bakken crude" and see the evidence.

Forest Ethics does the public a disservice with its alarmist Oil Train Blast Zone tool. The relatively small number of rail accidents could never endanger millions of Americans, as the tool misleadingly implies. Requiring railroad operating companies to emplace blast barriers around every yard and connecting track in populated areas would be costly and probably unnecessary. It would be better for the railroad industry, along with FRA and NTSB, to take a Six Sigma approach to estimating deaths from oil-related transport accidents. Reducing mortality is important and statistics will show us exactly which locations need better safety measures.

Policy advocates are often remarkably ignorant of science, math, and economics. I don't think a typical anti-hydrocarbon advocate can perform an energy returned on energy invested (EROEI) comparison between biofuels (for example) and hydrocarbon fuels. They are welcome to start with refining and transport data from the Western States Petroleum Association and the California Energy Commission but I don't think they'll have the patience to get very far.

I am not prepared to demonize tar sands and oil shale as "extreme fuels" in the style of some renewable energy advocates. Hydrocarbon energy will be part of human life for a few more decades until renewable energy's infrastructure catches up. Pipelines are the safest and cheapest way to transport oil over long distances. Railcars are still the next best way despite the pleadings of safety paranoiacs.

Financial Sarcasm Roundup for 10/22/12

I should have refreshed my investment portfolio today but was busy with a series of meetings that occupied all of my daylight hours.  Interacting with human beings can be a waste of time but sometimes it a necessary inconvenience.  I won't get sarcastic about the political debate from earlier this evening.  There are other matters to discuss.

Hey look, jobless claims are up again!  Did you miss that while you were buying socks again, like some newscaster said you should?  Getting past the noise on intermodal railcar loads brings us the revelation that shipments of metal and coal are way down.  Reduced demand for raw inputs is not a sign of a growing economy.

Japan's exports are down, and IMHO the country faces another credit rating downgrade whether it goes for QE or austerity.  Maybe they should rename the place Land of the Sinking Sun.

Stories on a probable market top in high-yield bonds remind me of similar stories I saw in early 2007 that wondered what was powering the high-yield market to seemingly impossible highs.  I had the foresight to exit U.S. equities in mid-2007 just as the stock market peaked.  Most people never saw it coming, nor do they see anything notable coming now.

Asia is now far advanced in its stealth run on the dollar.  China's trading partners have slowly replaced dollar holdings with yuan holdings.  Helicopter Ben has no idea what he started with his taunt to Asian central banks that they can just decouple.  His overconfidence that the Fed can now take the place of foreign bond buyers in the market for Treasuries will be the undoing of the dollar's domestic value.

Stay tuned for my portfolio update tomorrow.  I'm going to pull the trigger on a change I've hinted at making for some time now.

Tough Times For Rail Starting Fall 2011

Warren Buffett's favorite sector (besides insurance and banking) is rail.  American railroads had a good run for the past couple of years but now the rolling slowdowns in other sectors are hitting the rails (ha ha, a pun).  Big coal producers are cutting their production outlooks and won't need to order so many train shipments.  It's too bad that rail industry managers can't retrench as quickly as their share prices have declined.  Class I rail carriers are still hiring at a fast clip, and carriers of all sizes are still pulling idle cars out of yards for scheduling.  Neither of those trends will be sustainable for much longer if big customers keep reducing demand. 

The rail equipment sector also has its head in the sand with unrealistic expectations of rising demand for new railcars.  Those planned orders will be canceled soon once railroads put cars back into storage as quickly as they pulled them out.  Greenbrier (GBX), Trinity (TRN), and American Railcar Industries (ARII) are probably going to see a hard winter into 2012.  I wouldn't ramp up hiring if I were them; they'll just have to lay those folks off all over again once this bow wave of slacking demand works its way through the railroads to their servicers. 

Is there any good news?  There is for me, since I've got cash I'm waiting to commit to buying railroad stocks that can stay healthy through the next phase of Great Depression 2.0. 

Full disclosure:  No positions in any railroad stocks or other companies named above at this time. 

FAA Shutdown Leaves Hidden Blessings For Energy-Constrained U.S.

One early casualty of the federal budget battles is continued funding for air transit programs.  The FAA has partially shut down until Congress can re-authorize its budget.  I've had the displeasure of listening to coverage of this episode on NPR, where it's portrayed as some kind of disaster.  I prefer to look on the bright side.

The Essential Air Service bears the hallmarks of a useless government handout.  Rural air routes that were discontinued for being uneconomical should not be kept alive with government subsidies.  Ending the program will lead to no more than an inconvenience as rural travelers either switch to trains and buses or stay where they are. 

Loss of tax revenue will hurt in the short term but restoring this particular function is the easiest fix of all.  Loss of airport construction is the biggest hidden blessing possible in this situation.  We should put aside our envy of gleaming new airports in China long enough to realize that air travel is the single most expensive (and least fuel efficient) way to move people and cargo.  Letting go of nonviable airports that don't serve major metropolitan hubs opens growth opportunities for rail service.  Peak Oil will demand this transition anyway. 

The coming months will bring us plenty of sob stories about government programs that were once affordable at the height of our civilization's power.  Rural air transit and construction at low-traffic airports are inappropriate uses of capital for an empire in decline. 

Full disclosure:  No positions in airline stocks at this time. 

Fuel And Weather Teaming Up To Hobble Transportation Sector

Wouldn't ya know it, just as I was preparing to turn bullish on the transportation sector, a bunch of Black Swans take flight.  Just look at how fuel costs are driving up consumer prices.  Transporters are passing on their fuel costs because they can't afford to eat them with margin compression anymore. 

Kirby Corp. (KEX) has been doing very well this year but now thinks that Midwest flooding will have a greater than expected impact on its bottom line.  I further suspect that the flooding will disrupt rail movements in affected areas.  Willingness to buy into railroads right now is a bet that the imminent opening of spillways won't deluge any Class I tracks.  Railroad bulk traffic has begun falling anyway, so buying rail stocks now might be premature until all of this news shakes out. 

Silver lining?  You betcha.  These accidents of history will make the stocks I'm watching cheaper in the short term.

Full disclosure:  No positions in KEX or railroad stocks at this time. 

Rail Making Waves On Land

Rail's resurgence is evidence for some recovery given rail traffic's usefulness as a leading indicator.  Railcar owners are putting more idle cars into service from their unused fleets in anticipation of more orders.  RailAmerica thinks it can get more mileage out of short-haul rail lines in Alabama, although the interfaces with CSX now make RailAmerica more dependent on a much larger carrier.  Even rail container traffic in Russia is seeing good times.  Rail looks a lot more attractive than its main competitor - trucking - with diesel costs rising across the U.S.  What could go wrong with this rosy rail picture? 

Macroeconomic black swans could derail this surge, at least in the U.S.  IMF predictions of minimally stable growth are probably too optimistic in the midst of a double-dip in housing.  Massive spending cuts needed to bring the U.S. federal deficit down have yet to be made.  Rail's surging volume may be a mere echo of the asset inflation pumping the stock market. 

Full disclosure:  No positions in any rail stocks at this time. 

Possible Oil Price Spike Should Prompt Cheaper Transport

It just doesn't get any clearer than this. When Saudi Arabia's former oil minister says potential unrest in his country can lead to a serious oil supply shock, even casual observers should realize that the global economy is on thin ice.  Pursuing new hydrocarbon production can help mitigate supply shocks, and oil producers recognize the potential for unconventional oil sources to add to their proven reserves.  Note that healthy M&A activity in the oil sector now includes a big dose of unconventional resource plays. 

More production isn't the only way to keep the global economy on track.  More reliance on the most energy-efficient means of cargo transport - rail and barge movement - is in order.  Federal grants to improve passenger rail lines will likely have spillover benefits for freight rail.  The U.S. DOT has a plan to make America's waterborne "highways" strong enough to accommodate more container traffic.  These efforts are absolutely critical to keeping goods moving, since the trucking industry is unable to meet the current surge in demand for new trucks to carry freight. 

Speaking of demand for transportation, here's a related observation.  The most recent Cass Freight Index shows that monthly shipping activity rose 6.9% (13.8% yoy) while monthly freight payments rose by 6.3% (33.6% yoy).  Those yearly numbers are an alarming indication that the price of transportation is increasing faster than delivered volumes.  That's inflationary!  Rising fuel costs are undoubtedly a big factor in pushing rates up, and evidence is mounting that higher fuel costs are impacting service sector growth.  More focus on energy exploration and cheaper transportation can't come fast enough. 

Full disclosure:  Long TDW with covered calls.

The Haiku of Finance for 02/16/11

Cutting high-speed rail
Bad trend sweeping the country
Will hurt us long term

Tuesday Newsreel for 01/25/11

Headlines are magical things.  They lead to discovery of the world's wonders. 

Societe Generale doesn't want to be on the systemically important TBTF list.  The extra capital requirements would crimp their profitability.  Being on such a list would earn a bank closer scrutiny from credit analysts, probably hurting its credit rating and increasing its cost of capital.  A better solution is to let TBTF firms fail.  I'll bet SocGen wouldn't like that either.  What on earth are they worried about?

NYSE Euronext is bringing liquidity and transparency to the bond market.  Nice work by NYX.  Now the bond market will look more like the stock market, with bid-ask spreads on central exchanges.  The Bond Liquidity Providers program looks like a market-maker type arrangement similar to specialist firms on the NYSE equity floor.  I'll guess that the first firms to sign up will be the Fed's primary dealers.

Economists see growth everywhere; I see inflation.  Whatever aggregate revenue they're tracking is driven by rising prices, not demand for more goods.  Consider that distressed home sales are rising.  That shows how easy it is for desperation to be misinterpreted as growth just because it looks like frenetic "activity."

Class I railroads are minting money.  UNP had its best year ever.  CNI grew its operating income faster than its gross revenue.  CSX's profit gain was double its revenue gain, which in turn rose faster than its expenses.  Wow.  Rail is one hot sector.  I should have bought those stocks when Warren Buffett bought Burlington Northern.  Rail looks especially attractive now that steadily rising diesel prices make trucking look uneconomical by comparison. 

Announcements of the death of the "new normal" are premature.  Nationwide employment still isn't recovering.  Home values are still falling.  The U.S. economy is looking more like a stagflationary neverland every day. 

Full disclosure:  No positions in Societe Generale, NYX, UNP, CNI, or CSX. 

Smart Transportation Planners Wanted

There is intelligent life in Washington D.C. after all.  The Bipartisan Policy Center is calling for an overhaul of how our government plans its transportation spending.  The short version of a long story is that lack of comprehensive national planning leaves us with a patchy network unsuitable for a superpower. 

Improvement would be welcome news.  It would put an end to local nonsense thwarting the kind of national integration that global industry likes to see.    There is too much of such nonsense today with state governors turning down money for passenger rail lines that would help them build development around sustainable communities.  Shortsighted local politicians have no idea how much their communities will hurt when Peak Oil arrives and they missed the chance to build transportation systems to mitigate its impact.

Nobody likes kinks or hiccups in their supply chains.  Corporations will deploy capital elsewhere in the world where high-speed continental movement flows seamlessly into local distribution.  Politicians ignore this at their peril. 

Railroad Salad Days In Q3 2010

The good news for major rail carriers just keeps on coming.  Bulk rail volumes have hit their second peak this year.  Carriers can thank Russia's embargo on grain exports for the surge in grain loads (waterway operators on the St. Lawrence Seaway can be just as thankful).

Smart carriers are adding capacity as fast as they can.  Norfolk Southern just completed modifications to its Heartland Corridor that will enable it to carry double-stacked containers all over the middle parts of the U.S. of A.  Not to be outdone, Canadian Pacific Railway is adding capacity cheaply by increasing the number of intermodal and grain cars hauled per train.  Carriers and lessors are responding to high demand by pulling idle railcars out of stored fleets. 

It's a good time to be a railroad carrier, but I wonder about the sustainability of all this action as we enter the second part of this big recession.  Rail traffic is peaking in the face of macroeconomic negatives like persistent unemployment and record increases in the number of working-age people below the poverty line.  This is a contradiction that won't last long. 

Healthy Logistics Carriers Can Thank Constrained Shippers

Most railroads and some truckers are doing all right.  Kansas City Southern just posted a massive jump in net income.  Norfolk Southern reported a significant percentage jump in net income that far exceeded its topline growth rate.  Even the German railroad Deutsche Bahn posted healthy income gains, indicating that whatever is driving this industry to renewed health isn't confined to the U.S.  Not to be ignored, 3PL provider C.H. Robinson benefited from healthier air forwarding revenue and trucker Old Dominion doubled its net income thanks to enormous tonnage growth. 

Such impressive all-around logistics success ought to herald a global economic rebound.  Results like this make sector-rotation investors submit "buy" orders like mad to get in before more bulls do.  Before we get all excited about railroads and other carriers, let's consider the effects of constrained capacity in another link in the global supply chain - shippers.  Ocean-going carriers trimmed a lot of capacity in the first leg of this Great Recession.  Container ships joined ghost fleets that sat idle near Singapore while shippers waited for rates to turn up again.  Now shippers are faced with a mad scramble to add boats, containers, and crews to meet order backlogs. 

This leaves carriers in land-based logistics modes - trucking and rail - with a temporary boost to their pricing power.  They now have a short window of opportunity to set rates and accept higher-paying customers while ocean cargo carriers add back lost capacity.  The smart carriers are raising prices now while retailers are frustrated.  There is no telling how long these new salad days will last. 

Full disclosure:  No positions in any companies mentioned in this post. 

GATX Hits Earnings Out Of The Park

Wow!  GATX is one of the few firms that I don't hold a grudge against for not answering my resume submissions years ago.  I can't be mad at them because their bottom line results are so clearly stellar:

Rail equipment leasing giant GATX depended partly on a pickup in its shipping operations to post a 69 percent profit jump to $21.5 million in the second quarter, from a year earlier, while earnings at its dominant rail segment slid 34 percent to $29.4 million.

The rail segment's performance is disappointing given its high utilization rates.  GATX may lack the pricing power of major carriers; owning the track, not necessarily the cars, gives railroads their monopoly power.  In that sense GATX is just another supplier to the industry, albeit a very large one.  It also certainly helps that rail carriers get anti-trust exemptions that allow them to keep rates high. 

Rail traffic has a bright future as long as demand for bulk commodities like coal remains high.  GATX should have more than a decent future given its absence of long term debt, although it really ought to get its operating cash flow under control.  Its dividend of $0.28/share has been steadily climbing since it dropped in 2004 from $0.32 to $0.20.  Good news on earnings is important, but improving the company's dreadfully low ROE and ROA (single digits!) is even more important. 

Full disclosure:  No position in GMT.

The Haiku of Finance for 11/14/09

Burlington Northern
Buffett's century long play
But not a bargain

Buffett's Big BNI Buyout Bets On Buoyancy

Tuesday brought big news on Berkshire Hathaway's proposed buyout of Burlington Northern Santa Fe (BNI) railroad at $100/share, cash and stock. This transaction is a textbook window into Warren Buffett's equity valuation model.

Uncle Warren has dropped hints over the years on how he values a stock. Buffettology books (particularly those by Mary Buffett) have done an excellent job outlining his calculation of "owner earnings" (net income plus depreciation minus average capital spending), his use of the 10-year Treasury yield as a discount rate, and his preference for companies that consistently grow retained earnings per share over long periods.

I built an equity valuation model using these principles and got an interesting result. Discounting BNI owner earnings for the past four quarters at a discount rate of 3.5% (approximately the prevailing 10-year Treasury yield in recent weeks) results in a share price of slightly more than $150. Warren Buffett doesn't buy anything unless he can get a severe bargain, so paying $100 for a stock he believes is worth around $150 represents a 33% discount.

I believe Uncle Warren's key insight is his tweaking of the growth factor used in traditional DCF models. In place of the "b" retention rate for net earnings not spent on dividends, he substitutes the average long-term growth rate of retained earnings on the balance sheet. Multiplying this modified "b" by his version of ROE (owner earnings divided by shareholder equity) gives us the annualized growth factor "g" that he uses to estimate those future owner earnings.

I'm intrigued that Uncle Warren chose to assume BNI's relatively high long term debt load onto Berkshire's balance sheet. Apparently he thinks the cash flow from Berkshire's finance and insurance lines will be sufficient to pay that off. If this gamble works, it gives Burlington the operational freedom needed to continue investing in technological innovation.

It's almost a done deal pending regulatory hurdles. Anti-trust scrutiny will probably force Berkshire to divest its other rail holdings, namely Union Pacific (UNP) and Norfolk Southern (NSC). Forced selling of those large stakes might make them attractive plays for other value-oriented transportation sector investors. It would also give Berkshire additional cash if they need to sweeten this deal.

My play? I immediately sold a few short puts under BNI at 95 on the premise that Buffett's bid establishes a firm floor for the stock and will be approved without any glitches early in 2010. The worst-case scenario for this special situation would be a market dislocation that tanks Berkshire's own share price, forcing it to further dilute its own shareholders to maintain the agreed mix of cash and equity for this buyout. If my puts are exercised against me, my own worst-case scenario is that I end up owning a long-term position in either BNI (if the deal collapses) or Berkshire, two companies that the greatest investor of all time thinks are terrific to have.

Full disclosure: Anthony J. Alfidi is short Jan 2011 puts on $BNI at 95 (covered with cash) and holds no position in any other stock mentioned in this post.

GATX Corp.: An Interesting Prospect

GATX (GMT) is in the news for its proposed $3.5B purchase of GE Rail Services. Consolidation in rail car leasing bears watching, and is probably a smart move going into an economic downturn. GATX is IMHO looking to position itself as a dominant player when this downturn ends, and in the meantime the high price of oil makes rail movement more economical.

GATX's key fundamentals look enticing. Their 5-year EPS growth is in the neighborhood of 47%, and their 5-year ROE is almost 13%. The ROE isn't as high as I'd like for an investment, but this year's ROE of almost 17% may point to an upward trend.

GATX deserves further scrutiny. I need a good transportation-oriented play that will survive this sovereignty crunch.

Nota bene: Anthony J. Alfidi does not hold any position in GMT at the time of publication of this commentary.