Freight rail is the backbone of the U.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 led the industry to the brink of collapse in the 1970s. They compelled dozens of mergers for railroads to remain viable and achieve necessary scale. They brought on technological and other operational advancements that reduced industry employment by hundreds of thousands while, at the same time, sharply increased industry productivity and rail safety and resulted in an increase in total freight volume.
The industry would not be the vibrant transportation system that it has become were it not for the extensive changes railroads made in response to the challenges faced throughout this period.
Yet the challenges of the past persist, and new and evolving ones – including a shifting traffic mix, a rapid reduction and rebound in traffic during the COVID-19 pandemic and global supply chain issues –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 – is expected to 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 most efficient and environmentally friendly way to meet much of this increased demand, particularly for longer-haul freight traffic.
However, railroads have no guarantee of growth or increased market share, and they 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 slices 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 in which decisions about which mode of transport and specific carrier to use is often driven by price alone. Because of this, railroads have a constant need for cost control and a nonstop search for improved efficiency as defining characteristics.
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 railroad 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.
SUPPLY CHAIN DEMANDS CONSISTENT INVESTMENT POST-PANDEMIC
The pandemic and the economic recovery from it have sparked supply chain disruptions. The global supply chain is complex, and freight railroads have limited ability to influence non-railroad entities within it. Nevertheless, freight railroads are working with customers and other transportation modes to find solutions, expanding network capacity.
Helping the nation get back on its feet and smoothing out supply chain issues requires that the railroads make consistent investments in infrastructure and equipment, technology and operational enhancements.
THE DECLINE OF COAL
Coal remains the top single commodity carried by rail. Rail coal volumes have fallen sharply in recent years due to ongoing economic and environmental forces. Natural gas will remain affordable 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 21.8 percent in 2021 per the latest EIA data — and will continue to decline. For railroads, this means billions of dollars in lost top-line revenue in the years ahead.
GOODS-RELATED SECTORS FACE ECONOMIC CHALLENGES
For the goods side of the economy, recovery from the “Great Recession” was slow and railroads are still weathering the impact and effects of the pandemic and shifts in traffic. In addition, for transport of intermodal cars, a record-setting first half of 2021 gave way to a diminished second half as supply chain challenges persisted across the economy.
As long as manufacturing output remains constrained and demand is reduced, railroads will be negatively impacted.
For decades, the U.S. economy has 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 challenging 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 a great deal of its traffic.
And while global competition accelerates, the industry also faces increasing cross currents that are disrupting international trade. As of late 2021, 42 percent of the carloads and intermodal units that 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 shows 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 taxpayers subsidize the trucking industry with support for the nation’s roads and highways. 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, railroads face threats of new or re-imposed regulatory burdens that could imperil the industry’s ability to compete effectively and fairly. 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.
Freight railroads have invested much of that revenue back into their networks to the benefit of customers. Since 1980, railroads have invested nearly $740 billion of their own funds in their operations to create the best freight rail network in the world, and they are continuing to innovate for an even safer and more efficient future.
If successful, proposed regulatory changes would make it much more difficult for railroads to make the investments needed to maintain and upgrade their networks and to provide the safe, efficient and reliable service their customers need to prosper.