Freight rail is the backbone of the nation’s economy and is an extremely safe energy- and cost-efficient means of shipping freight. But evolving challenges require adaptation and innovation to ensure railroads remain vital.
U.S. FREIGHT RAILROADS FACE A FUTURE OF CHALLENGES AND UNCERTAINTY
The American railroad industry has survived for nearly two centuries because of its ability to adapt and innovate in the face of unrelenting challenges. In the last 50 years alone, these challenges have included crushing regulation, economic downturns, fierce competition and the decline of U.S. manufacturing.
These challenges brought the industry to the brink of collapse in the 1970s. They compelled dozens of mergers for railroads to remain viable and achieve necessary scale and brought on technological and other operational advancements that reduced industry employment by hundreds of thousands while, at the same time, sharply increasing industry productivity and rail safety and leading to an increase in total freight volume.
The industry would not be the vibrant transportation system that it has become were it not for the massive changes railroads made in response to the challenges faced throughout this period.
Yet the challenges of the past persist, and new and evolving challenges – including the COVID-19 pandemic, which has resulted in substantial reductions in carload traffic in 2020 – will require further adaptation and innovation to ensure railroads continue to fuel the American economy.
No Guarantee of Growth or Increased Market Share
Over the long-term, demand for freight transportation – at least for commodities other than coal – should grow as the population and economy expand. This growth rate – projected by most economists at about 2 percent annually – supports the U.S. Department of Transportation estimate of total freight demand growth of 35 percent by 2040. Railroads are positioned to be the best way to meet much of this increased demand, particularly for longer haul freight traffic.
However, there is no guarantee of growth or increased market share, and railroads must continue to adapt their networks and offerings to better align with prevailing economic norms. Put another way, the fact that the overall freight transportation “pie” might grow in the years ahead does not mean railroads are guaranteed any piece of that pie. Railroads will have to earn it by making significant investments in infrastructure, equipment and new technologies and by providing transportation service more safely, reliably and cost effectively than their customers can obtain from other transportation options.
Intense Competition Demands Cost Control
Railroads compete intensely among themselves and with other modes of freight transport, particularly trucking. This competition is evidenced by the dramatic decline in rates charged to shippers. Since the industry was deregulated in 1980, revenue per ton-mile – a common proxy for rates – has fallen by over 40 percent.
Moreover, most rail customers operate in highly competitive environments themselves in which decisions about which mode of transport and specific carrier to use is often driven by price alone. So a need for cost control and a nonstop search for improved efficiency will remain defining characteristics of railroading.
These dynamics place railroads under constant pressure from their customers to keep their prices as low as possible and their service as efficient and reliable as possible. They also ensure that railroad cost increases cannot simply be passed on directly to customers. The competitive pressures of the market do not allow that to occur, requiring careful attention to cost control in all areas of a railroad’s operations.
THE DECLINE OF COAL WILL CONTINUE
Coal remains the top single commodity carried by rail, but rail coal volumes have fallen sharply in recent years due to economic and environmental forces that are sure to continue. Natural gas will remain cheap and plentiful, further enhancing the competitive position of gas-fired electricity generation. Meanwhile, coal will continue to decline as environmental objectives shift energy production towards lower carbon-emitting forms and renewables.
Coal will not disappear as a major source for electricity generation in the immediate future, but its market share in terms of U.S. electricity generation has already been cut almost in half in recent years — from 50 percent in 2005 to 23.5 percent in 2019 — and will continue to fall. For railroads, this means billions of dollars in lost top-line revenue in the years ahead.
Strong Economic Forces Will Challenge Goods-Related Sectors
For the goods side of the economy, recovery from the “Great Recession” has been slow. U.S. manufacturing output to date has not yet reached its pre-recession peak; total industrial production has achieved pre-recession levels only because of the huge increase in fracking-related oil and natural gas output. To the extent that manufacturing output remains constrained, railroads will be negatively impacted.
For decades, the U.S. economy has also become increasingly services-oriented and less centered on manufacturing. Railroads, though, are primarily dependent on the “tangible” (goods-using or goods-producing) sectors of the economy, which are directly responsible for far more rail traffic than service-related sectors. These goods-related sectors are more likely to be exposed to tough global competition. For example, U.S. agricultural exports, which comprise a large share of rail grain movements, must now overcome more competition from foreign producers for global sales. As a result, with increasing global competition, strong economic forces will continue to relentlessly pressure the sectors on which the railroad industry relies for huge swaths of its traffic.
And while global competition accelerates, the industry also faces increasing cross currents that are disrupting international trade. Currently, 42 percent of the carloads and intermodal units railroads carry – and more than 35 percent of total rail revenue – are directly associated with international trade. Simply put, this means trade disputes disproportionately impact railroads.
Moreover, trade wars and the accompanying uncertainty directly and disproportionately impact the manufacturing and commodity-related industries that are heavily served by railroads. The effect is twofold on railroads. First, lost traffic from decreased trade activity immediately impacts rail volumes. Second, foreign customers then search for and identify new suppliers and trade partners, thereby breaking historic supply chains. When this happens, history has established that the traffic does not simply return once the trade dispute abates – global customers have since found new suppliers.
ADVANCEMENTS IN TRUCKING THREATEN RAILROADS
Railroads are currently at a competitive disadvantage because they fully fund their infrastructure, while large trucks underpay their federal cost responsibility by around 27 cents per gallon of fuel and therefore offer artificially deflated costs. Nevertheless, railroads on average have been able to maintain a cost advantage over trucks for many long-distance movements. However, technological advancements related to autonomous truck operations (including platooning), electrification, and other areas could dramatically lower motor carrier labor and fuel costs, which together comprise well over half of total costs for a typical long-distance truck. This will make trucks even tougher competitors in many markets than they already are and could especially impact intermodal, a market segment railroads are counting on for growth to counteract declines in coal.
Threats of Increasing Regulation
Increasingly, there are threats of new or re-imposed regulatory burdens that could imperil the railroad industry’s ability to effectively and fairly compete. These threats come in the form of demands from some rail customers and their supporters in Congress and elsewhere for the Surface Transportation Board to make major changes in the scope and intensity of railroad rate and service regulation. Most of these changes would, in one way or another, limit the prices that railroads can charge and therefore limit the revenue railroads can earn.
If successful, these regulatory changes would make it much more difficult for railroads to make the investments they need to maintain and upgrade their networks and to provide the safe, efficient and reliable service their customers need to prosper.