As originally published in SupplyChainBrain
By: ProcurementIQ Analyst, Connor DiGregorio
During the past few years, rail cargo transportation service prices have been on a slippery decline. Despite increasing demand, tanking fuel prices have laid the track for cheaper rail transportation during the past three years. While falling prices have been a welcome relief to shippers, carrier profitability has still been increasing due to steady demand and absent competition for many routes. However, service prices rebounded in 2017 and look to keep pushing higher over the next few years as oil prices recover further.
The main cost for railroad operators is fuel. Diesel, the fuel that rail operators use, is a derivative of crude oil, and thus follows a similar price trend. Fortunately, fuel costs have plummeted over the past three years due to a boom in oil production. As the price of diesel has fallen, rail operators have been able to lower their costs. In turn, prices for rail cargo transportation services have declined at an annualized rate of 1.6 percent since 2014, according to ProcurementIQ.
While prices have dropped, demand for rail transport has remained healthy over the past three years. In fact, demand has strengthened for the same reason that operating costs have fallen. As domestic oil and gas production has erupted, the existing pipeline infrastructure has not had the capacity to distribute the massive amount of oil and gas being extracted. The resulting oversupply has made it necessary for energy companies to rely on rail transport to ship oil and gas around the country. Furthermore, as unemployment levels across the US have dropped and consumer spending has improved, the number of industrial and consumer goods being produced has increased. This has also boosted demand and translated into upward price pressure for rail cargo services.
However, demand has contracted in other areas. The total value of US traded goods has been declining since 2014 due to declining commodity prices and slower trade liberalization. Rail transport is an attractive option for both exporters and importers that need to ship their goods long distances to and from ports. As trade volume has declined, rail transport services have experienced a dip in demand from this sector. However, imports and exports in 2017 were both on track to surpass 2016 numbers, indicating the potential for demand growth. Still, any significant changes in trade policies or deals such as NAFTA could derail those improvements.
At the same time, operators have been able to maintain healthy profit margins. Because many routes are controlled by only one or two railroad companies, operators have retained leverage over prices. Relying on their monopolies or duopolies over routes, suppliers have been able to set prices at levels that result in profitability. ProcurementIQ estimates that the average profit margin in the rail cargo transportation market was 21.7 percent in 2017, though Class 1 railroad operators, which are the largest in terms of revenue, averaged closer to 30.0 percent due to weaker competition.
In 2018, the market is poised to steamroll forward. The Electronic Logging Device (ELD) mandate that will go into full effect will increase the price of trucking services, which may prompt shippers to switch tracks and start utilizing rail transport more often. The price of oil has recovered and, if it holds at current levels, rail cargo transport prices will remain elevated. Furthermore, with macroeconomic indicators such as unemployment, consumer confidence and corporate profit at extremely healthy levels, the market is set to roar full speed ahead over the coming few years.