In in some ways, freight rail and trucking appear to be direct competitors. Companies that need to move a container of goods from one city to another can choose between them. Rail is more cost-effective, more fuel-efficient, and can move larger freight each way. Trucking is usually faster and, unless the container is being moved from one rail station to another, more direct. In the U.S., both industries have boomed during the pandemic as underserved shoppers stock up. Now they are all bracing for an economic slowdown that could affect them in similar ways.
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Start with the railroad. Cost cutting and price increases have delivered big profits for U.S. freight railroads in 2021 and 2022, even though freight volumes are lower than before the pandemic. The railway uses “precision scheduling”, which reduces the time that entire train cars spend waiting in yards to build long-distance trains. The industry is also consolidating, which leads to greater pricing power. On April 14, Canadian Pacific will complete its acquisition of Kansas City South, which is part of the Surface Transportation Board (set top box), the federal railroad regulator, has approved since the 1990s. That would leave the U.S. with just six large “Tier 1” railroads.
Counterintuitively, mergers may end up strengthening competition. This is because not all railroads compete directly with each other. Instead, the country is split into a duopoly: CSX Norfolk South dominates East; Union Pacific and BNSF Dominate the West. The lines converged in the Midwest, where they competed with the Canadian National Railway and now with the expanded Canadian Pacific Railway, which would provide the first train line from a Canadian port through the heart of the United States into Mexico.
In other words, customers on America’s most congested rail corridor, which runs through the middle of the country, now have the option of moving freight from the northern border to the southern border on one line, rather than having less choice. It is this “end-to-end” nature of the combined company – no overlapping tracks or shared customers – set top box was cited as one reason to wave through the combination of the two smallest Class I companies.
If mergers are unlikely to improve margins in the industry, can further cost cutting be done? Probably not. Fuel prices, while lower than recent peaks, are still higher than they were before the Ukraine war. Precision scheduling came under scrutiny after a chemical train derailed in Ohio in February; critics blamed the pressure to get the train out of the yard as quickly as possible on corner-cutting by safety inspections. If Congress passes rail safety legislation, that could reduce efficiency and increase costs. Non-fuel costs such as insurance are already rising.
The same goes for labor costs, as railroads recruit workers to improve service. By early 2023, they’re hiring 8% more people than they were a year ago, though volumes and traffic have declined over the past 12 months. Amit Mehrotra of Deutsche Bank points out that adding staff, even as traffic falls, shows that “the railroads are playing the long game and focusing on service”. But, he admits, “the period of windfall profits is over.”
The same is true for carriers for many similar reasons. During the pandemic, demand has skyrocketed and the number of trucking companies has steadily increased, one of which to start requires only the proper licenses and a truck from the entrepreneur. Today, there are nearly 600,000 such companies in the U.S., 100,000 more than in 2019. Capacity has been recovering from the covid-induced decline: February was 4% higher than the previous year. But the market is much weaker: Freight volumes in the fourth quarter of 2022 fell to their lowest levels since 2014.
The combination of strong supply and weak demand has created an unusual pricing situation. Typically, spot market rates that shippers use when they have cargo to transport immediately exceed contracted rates, which are set by shippers and trucking companies for a fixed period, usually one year. For about the past 12 months, “the spot market has been on life support,” says Dan Murray of the American Transportation Institute, an industry body (see chart). In February, the spot rate was more than 70 percent lower than the previous year, below the contract rate.
That price signal may send some truckers to their knees. Others may, like their rail rivals, try to consolidate. On March 21, Knight Swift, one of the largest truck drivers in the US, agreed to buy the larger but struggling company us Follow your heart. Mr Murray believes “more acquisitions are on the horizon”, not least because spot prices look unlikely to recover in the next six to 12 months.
In the long run, however, things may look better for American truck drivers and railroad workers. The government is pouring hundreds of billions of dollars in subsidies to boost domestic manufacturing, especially green energy equipment and semiconductors. If the handouts have the desired effect, it could mean more intermediate goods than finished goods can be transported across the vastness of the United States. ■
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