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Talking Freight

Credit Crunch and Impacts on the Freight Industry

July 15, 2009 Talking Freight Transcript

Presentations

Laura Feast
Good afternoon or good morning to those of you in the West. Welcome to the Talking Freight Seminar Series. My name is Laura Feast and I will moderate today's seminar. Today's topic is Credit Crunch and Impacts on Freight Transportation. Please be advised that today's seminar is being recorded.

Today we'll have three presentations, the first given by Noël Perry, of FTR Associates. The second presentation will be given by Greg Arnold, of ProLogis. The final presentation will be given by John Gray, of the Association of American Railroads.

Before founding Transport Fundamentals, Noël Perry served for thirty years in senior research positions at Schneider National, Cummins Engine Company and CSX. He now continues his strategic work on customer logistics, economics, North American transportation demand, carrier competition and ground-breaking research on truck driver supply and demand. He is a member of the Transportation Research Board, the Transportation Research Forum, the National Business Economists' Issues Council, and the Council of Logistics Management.

Greg Arnold is Senior Vice President, Director of the Global Corporate Services Group, where he has responsibilities for ProLogis' Global Customers in North America. Prior to, Mr. Arnold was Director of the Global Services Group and prior to, the First Vice President within Global Services with account responsibility for the North East Region of North America. Mr. Arnold joined ProLogis in 1995 and is located in New Jersey.

John Gray is Senior Vice President — Policy and Economics for the Association of American Railroads (AAR). He assumed this role in 2008; his responsibilities include the collection, analysis, and presentation of economic data related to railroads and their economic environment as well as development of policy positions on current significant rail issues. His principal duties are conducting and supervising economic, financial, statistical, and cost studies dealing with various aspects of the rail industry.

I'd now like to go over a few logistical details prior to starting the seminar. Today's seminar will last 90 minutes, with 60 minutes allocated for the speakers, and the final 30 minutes for audience Question and Answer. If during the presentations you think of a question, you can type it into the smaller text box underneath the chat area on the lower right side of your screen. Please make sure you are typing in the thin text box and not the large white area. Please also make sure you send your question to "Everyone" and indicate which presenter your question is for. Presenters will be unable to answer your questions during their presentations, but I will start off the question and answer session with the questions typed into the chat box. Once we get through all of the questions that have been typed in, the Operator will give you instructions on how to ask a question over the phone. If you think of a question after the seminar, you can send it to the presenters directly, or I encourage you to use the Freight Planning LISTSERV. The LISTSERV is an email list and is a great forum for the distribution of information and a place where you can post questions to find out what other subscribers have learned in the area of Freight Planning. If you have not already joined the LISTSERV, the web address at which you can register is provided on the slide on your screen.

Finally, I would like to remind you that this session is being recorded. A file containing the audio and the visual portion of this seminar will be posted to the Talking Freight Web site within the next week. We encourage you to direct others in your office that may have not been able to attend this seminar to access the recorded seminar.

The PowerPoint presentations used during the seminar are available for download from the file download box in the lower right corner of your screen. The presentations will also be available online within the next week. I will notify all attendees of the availability of the PowerPoints, the recording, and a transcript of this seminar.

We're now going to go ahead and get started. Today's topic, for those of you who just joined us, is Credit Crunch and Impacts on Freight Transportation.

Our first presentation will be given by Noël Perry, of FTR Associates. The second presentation will be given by Greg Arnold, of ProLogis. The final presentation will be given by John Gray, of the Association of American Railroads.

As a reminder, if you have questions during the presentation please type them into the chat box and they will be answered in the last 30 minutes of the seminar.

Noël Perry
Thank you, Laura. I will get started, and I will move through the slides pretty quickly. I have more than my time allows, but will slow down on the several that warrant full discussion. Let's get started. I will talk, mainly, about the interaction between the economy and the transportation industry to help you all understand the magnitude and affect the economy has had on the industry's peak, the biggest, probably, since 1933. All this first slide points out is that for tracking and rail, the pain of a recession is not limited to the time when the GDP is falling, which is the red area in this particular slide. There is also pain felt when GDP falls below approximately 3% growth which refers to back in 2005. We do not expect it to get above 3% until well into 2010. When below 3%, neither rail nor truck freight rose. It is longer than the census bureau's definition of recession. And set up this being a four quarter recession, which the government has defined it as so far, this is a 14 quarter deal, actually 15, and now.

People have just enough cash to last three or four years. They are starting to run into real problems and my friends in the security analyst industry say that right now, the only thing that is preventing a lot of bankruptcies is the creditors would rather not to resell old equipment, since I will show you later that there is an a surplus to that. There are a lot of companies running which should be bankrupt, but are being forgiven by their creditors. This slide speaks about portion of the industry that is hurting the most is, usually, in a downturn, concentrated amongst the small fleet. They are the swing capacity in the industry. You can see this registration data shows that the share of registrations by small fleets always falls in a down term. That is certainly the case this time.

This slide depicts how I measure this recession, the vertical access depth and the horizontal is length is the length of the recession in 1982. Even though the economy was not quite as bad that time around, freight has experienced one of these things, certainly in my working time. However, compared to the last two recessions, one in 1990 and one in 2001, this recession is much bigger. This hurts and you should expect quite a bit of pain and withdrawal from the industry amongst the carriers to match your neighborhood. When you get that kind of freight dropped, you get dramatic drops in truck utilization. This next one might be even worse than 1982, given the fact that we entered this event with a surplus because of the 2007 engine pre-buy. We are down.

Right now we only have around 76% of trucks getting full use, but we like to be at 90% or better for profitability. This is a big thing for profitability. When margins get down to 76%, you get into the neighborhood of somewhere between minimum sustainable margins, 2% to below the zero margins, which can last for to nine months. My best guess now is that we are somewhere below zero. This is the worst time in this recession right now. If you are in the manufacturing business, supporting the industry, it follows that orders dry up.

We are now in our sixth consecutive month when orders have been below replacement. According to my partner, FTR Associates, orders have never been below replacements. Notice, however, that sales did not drop below replacement until this year. Even though there was quite numbing bit of stress in the Industry in 2007 and 2008, it now makes it harder.

What happens next is not usually recovery. It is what I call bottom, where the economy goes along at very low growth rates and, of course, that means for transportation that there is no recovery until the acceleration. The bottom is better than falling. Truck fleets, as an example, can rationalize their routes under these circumstances, because demand is stable. We are pretty sure that we have a bottom.

If you look all of the indicators that people published about all of the economy, three months ago they were all negative, this chart, by direction, most of them are up or flat. That is a good thing but does not imply strong recovery, yet. The problems lie somewhere between three and six quarters and the annualized growth rose between zero and 2%. Many politicians will declare victory if we get to present route. For the trucking and railroad industry, is still a recession. When will growth start, and how strong? Well, it is likely to start early next year. There are two strong scenarios to consider. One of them is the data on banking failures, the large economies, all of which outside of the U.S. we have not had a banking failures since 1933, the data says that banking failure of recoveries are slow to recover. They are also a little bit longer than normal. If you look this data, if you look at the left-hand side of the reception length, we are already equal to what a banking failure ought to be and the time to read-equal to read the previous peak, the standard forecast that is in red, says six quarters and this one, the average of all outside economies is five. In that regard, the forecast is consistent with a banking failure recovery. Where they are not consistent is the growth rates. If you look at recession depth, this recession is a little deeper. It is 3.8% versus 3.5% for the average. If you look at the growth, the growth under a banking failure would be half a percent the first year. What is significant to the transportation industry is the first year does not matter much because they are all below three. The second year, the conventional forecast that most people are saying is starting substantial growth in transportation, but if it stays below three as indicated by the banking failure data, we would get another year of recession.

You can see, even the end of 2011, capacity utilization would be barely above 80% and we would still have a surplus of 120,000 vehicles. So, the banking bill your recovery would have substantial negative impact on transportation. Now, the other way to look this, however, is to look that the history differently. Putting aside the banking failure data for a moment, every recession which the United States has had since 1949, with the exception of 2001, there has been pretty substantial growth in the next year. The year 2001 is not pretty well accepted because we did not have a recession. On average the economy grew by 5% in the first year after the recession, which would make 2010 on pretty good year. This says that, maybe, pessimism is not justified. What I have done is to compare this recovery with the 1982 recovery, which was passed the 1983 recovery which was after a recession a lot like this one. One of the things that come out of that is that even though that was not called a banking failure recession, there was a radical worsening in lending conditions from the previous peak. You can see that in green to the recovery period, even though the recovery shows real interest rates around 20%, down about 10% from the peak. They were still way above what they were the beginning of the period in the previous peak. That the economy recovered despite the fact that it still had big financial drag. These rates, by the way, include higher risk borrowers. Now, this time, the data is quite similar. It got worse. That is why we have the banking failure, but it looks like real interest rates, even for the borrowers will be lower than they were last time. Remember last time the economy recovered anyway.

This chart here that shows corporate profits in a couple different terms and what is important to note you see at the right with the arrows that profits are quite a bit higher even at the bottom of this recession than they were in 1983. There is corporate money to fund capital investment this time, when there was not last time. Finally, this was not a surprise to me and those of you in the public sector might not find this surprising, last time there was a very substantial federal stimulus to the economy, almost as big as this one. You can see the data shows that. Last time it was mainly in tax relief speak of this time it is mainly in spending. The fact is the federal government really stimulated the economy in both cases. Now, if this happens, look what happens in the trucking business because we get back to read equilibrium in terms of surplus late in 2010 rather in late 2011. The banking bill really means a whole year extension of the recession. Even if we get a good, strong recovery, freight will not get back to it previous high of 2006 until sometime in 2013. This was a pretty bad deal and from a capacity standpoint, broad capacity, parking capacity, truck capacity, we will not get back to those levels of capacity for another four years. Also, here is an estimate that my partners at FTR Associates do that shows the overhang of used trucks. You can see that we are in the neighborhood of 110,000 right now and this is above normal. We will not run that down for another two years. A couple of other comments, longer-term trends and then I will quit.

People are interested in the driver problem. It is a very simple one. Prior to the middle 1990s, the steady increase in productivity meant that the amount of people, as I have shown in this example, if the work had been growing at 3%, because productivity was growing at 2%, the number of drivers only had to grow one percent. Each year, drivers could do more. That was about equal to the growth in the labor pool. What has happened since is because our society has decided not to build any more roads and not to allow truckers to increase their load size for and good or bad, they have changed that policy, and now, productivity is not rising, it is falling. Even though the growth in ton miles is 2.5% on trend, because productivity is falling, it requires more than 2.5% in growth in drivers, not the one present that we have had before is because you can see if you look at the labor pool that we have a deficit, a substantial deficit of a demographic deficit. That deficit is only going to get worse because what I have done here is to show the effect of retirements and labor force growth. The red is retirement were actually a positive in 1996 to 2006 because the baby boomers had not started to retire yet. The next 10 years retirement will now be a net reduction in the work force. The same time the labor force is growing slightly slower.

Finally, some comments about the green initiatives because it is clear, running long distances with relatively simple operations that railroads produce substantial over trucks with respect to fuel consumed and the amount carbon produce. However, to get to the full leverage public policy questions you have to say, what are we measuring here? If you measure door to and door, this happens to be driving, which is less advantageous to rail than the bulk, but if you are going door to door and factored in inventory facts, when you waste inventory, you waste the fuel that was burned to make the inventory. The truck now is not inferior to rail but equal compared to carload that has substantial inventory problems. It is superior. It is important in making decisions about intermodal. If you are trying to get things coal from women to lead Georgia, you favor rail. If you are getting toys from Philadelphia to Washington D.C. and southeastern Ohio, truck is a very virtuous way to do it. Finally, when you talk about emissions, greenhouse gases, particularly, it is important to realize that as yet the railroads are largely unregulated in a very critical gas. That is NOx. It turns out that NOx is not bigger contributor to greenhouse gases than carbon. I know that the EPA says an equal volume of NOx produces 305 times the equal volume, same volume of carbon. So, in order to understand who is cleaner in today's technology, coming after factor is the fact that trucks are tightly regulated and rail is hardly regulated at all. When you do that, it turns out that trucks, at least properly maintained trucks are substantially cleaner with respect to the greenhouse gases than railroads, right now, because railroads are largely unregulated. That is changing and by 2015, the railroads will be much more tightly regulated. Congress, however, as of yet is not requiring the railroads to be as clean with NOx as the truckers are. Even with the 2015 improvements, truck will still be slightly cleaner than rail, because the truck standard for emissions, even in 2015 is substantially lower than for rail. One final point about that, the marketplace has spent the last 50 years figuring out what each of the many modes has done well. It has not changed much and is unlikely to, unless there is some radical change in economics or regulation. What this chart shows the most sensitive of the three modal shares is domestic intermodal that is in direct competition with trucks because it tends to bounce up and down and even when fuel was the right thing and then rising through 2003 through 2007, when fuels in 2008, there was a change, customers were looking for a way to save money, but when fuel fell again, the share fell. What I would like for you to remember is the marketplace has been quite efficient in figuring out which each one of these modes do and test of strong place in our economy. There is no economic evidence that the government should change those based on cost, fuel, or green initiatives. That is what I had to say today. I will be glad to answer questions when it is time for questions.

L. Feast
Thank you Noël and thank you to those of you who posted questions. We'll address your questions at the end of the seminar. We'll now move on to Greg Arnold, of ProLogis.

Greg Arnold
Okay. I have a little bit different presentation for you today. What I want to bring up is warehousing demand is directly tied to consumer consumption. The stronger the economy, the inventory increases. As the increase that is the freight movement. At one point in the supply chain or another, these products are in a warehouse. I will not go into a lot of economics because I think that Noël covered it very adequately. I will reaffirm some of those statements in my presentation. Just a little bit highlighting of that's because we have to abide by million feet in Asia, 350 million the in North America and 120 million feet in Europe. That is about 3,000 buildings. I think is very important to point out and the way my presentation is set up, we will take the comparison to past recessions. Today, it has been said that the recession we are experiencing started in 2007 and felt the impact of in October of 2008. There is certainly no development of industrial warehouses across the U.S. We just recently went through a review of the markets, the 55 markets in North America and believe there were five buildings going on that time. I cannot give you a projection of when we are going out. I think Noël did a better job than I can come close to, but we will compare the recessions of 1989 with the S&L challenges and that is when the warehouse challenges stopped and picked back up in 2004. Noël's presentation highlights that. We look it as a five year term. If this recession is any worse than the last one too, 1988 and 1989, it could go longer. I will cover world trade. I will talk about trends and supply chains; what will it do for transportation, where will we be building our next distribution facility? And I will go up until 2007 as the date, because everything stopped and that was the start of the recession.

The world GDP grew from 1988 to 2007 a little over 200% stake of the important thing you should know is from 1988 to 2007, world trade increased over 470%. What is important there? The world growth GDP is the production of a country. World trade is the trade between those countries. Now, today, with the supply chains as flexible as they are, people are sourcing in different locations back 1988 timeframe, they might only be resourcing in the Western Hemisphere but now looking that the product coming from China, Vietnam, Malaysia, South America and looking for get the lowest land and cost three the U.S. because that will change constantly. We want more flexibility to speak of, the world change is increasing significantly. It is a point to note in 2001 when China was admitted to read the WTO, look the increase of the purchasing power of the United States of what we bought from China. When we talk about transportation or the supply chain tends, we look the airports or seaports. Using this, 2006 was the highest volume of activity, we have 2.9 billion metric tons in seaports and only 0.072 billion metric tons at airports. Around 97% of the world's goods go to seaports. In 1996, back in seaport and globalization of the supply chain, we have 68 million TEUs because that is a one container, 20 feet long. Typical contenders are 40 feet long, so that is two TEUs. In 2007, 211 million TEUs moved. That is significant because we have 450% of in world trade and former percent growth and in TEUs move from ports in 1996. This is indicative of where the top ports were out throughout the world. Look at the dispersion, Hong Kong and Singapore, typically, lead. As many of you know, those are hubs in Asia and South Pacific where all of the containers go in and put on another ship to go over and Los Angeles and Long Beach. We see several Japan locations. That was 1996. In 2007, out of the top 15, seven are China. Look at the TEU between the years of 2006 to 2007. There was still growth when we started looking at it and that was when the recession hit in 2007. Why is that important? One of the things we will use today is the cost of the product to the consumer and the landed cost is important to our manufacturers and distributors. Time is money.

From Shanghai, transit times to the West Coast are roughly 13 days, and moving the product across to the mainland or East Coast, this is average days are from 5 to 8 days. The ports of the West Coast, the depth and ease of connection, we have had some expansion. We have been talking about port dispersion, how long does it take to get to the East coast? This slide shows that it takes 28 days to get to Houston, and 26 days to Newark. The important thing to note is the more time to touch a product means more cost goes into that product. That has been equalized by the rail and equalizing the rights from the long haul swing from Los Angeles and Long Beach or from Vancouver to Toronto. As the slides also highlight Dallas, Chicago, Toronto, those are inland ports where the product is being imported. We have done couple of new ports coming up in Canada and bringing it down to Toronto to come into the U.S. Because these are some important things that I want to highlight, Los Angeles and Long Beach, have the largest warehouse market in North America. There is roughly 91 billion square feet of warehouse in that market. Chicago is the second largest in North America, as you can see it as the goods is an inland port for us because it is the heartland of the United States. Toronto is the third largest market for warehousing in North America and New Jersey and Eastern Pennsylvania is the fourth. North America port activity is highlighted here. Los Angeles forward looking statement is the 15 to 16 million TEUs. It is three times larger than the Newark and goes down to the other ports down the list because that is important for trends later.

The North America contain container market share, we can see 55% was going to the West Coast in 2006. It dropped a little bit in 2007 and had a run significant drop-off in 2008. What is important to note here is the fact that there is an increase on port dispersion, but the product the East Coast and Gulf areas. Some more information about transportation across the United States or intermodal was 55% to bring it to the East Coast through the Panama Canal went up 40% and through the Suez Canal is only by 2%.

Here is the point of the Panama Canal update. It was initially started by the French and the United States stepped in early 1900s. It runs about 14,000 ships a year. The capacity is only good for 5,000 TEU ships and, basically, we have ships being built over 10,000 TEUs. We noted that the Panama Canal has taken on tremendous projects to expand the canal and expected to be completed in 2014. That will help the secondary parts of the East Coast for traffic. Here is a comparison. The current canal dimension is 1,000 by 110. Look a Post-Suez Max Ship, this is about 14,000 TEUs. We can increase the number TEUs and doubling that volume. How does that impact North America? I want to go back to some important points. One, when you look that the cost of sales, logistics of it is 8.8%. The major component of the logistic cost is transportation. That is your rate for transportation. About 1.5% is only warehouse and that includes the labor component of that. The rent is less than a half of a percent. Many times you say it lets build a building in an outlined location, and bring a company into our community, but it is really not the case. Transportation dries the location. When you talk about dispersion through the United States, and where you locate warehouses, it goes along with the United States population. This is indicating the major metropolitan markets and their percentage of population within 500 miles, 500 miles being an average day that the truck can drive. You can see Columbus, Ohio has the highest percentage of population at 40%. As you know, we have over 67% of the population east of the Mississippi. When we talk about warehouse locations, which is where trucks and freight move back and forth to, if you pick the 10 best locations, I will start the first and put it in the middle of Indiana and then to put it in basically northern Kentucky and Los Angeles and I will move through this quickly, but just to give you a good idea, and it matches the population density of the United States and focusing towards the East Coast. Today, major retailers have focused their import centers and their growth to the ports. I highlighted where Wal-Mart put their locations. I did not indicate the major three to four million square foot locations to the East Coast for the imports and the locations. What are the driving factors? If we look that with the recession, it did not see a recovery until 2004. We compare that to today. We could be going into, potentially, 2014, as a recovery or future demand for data warehouse growth. The key for top markets in the future would be proximity to local population bases, the capacity of the port, and, most importantly, the good road the structure and inland ports such as Kansas City Port is doing with significant project with Kansas City. I think they wanted it will be talked about. You should always be obvious to cost of labor, degree of union activity and risk of labor strikes will determine the use of those ports and availability of a dedicated liner service because we have noted that certain services today have initiated in Mobile. They have invested heavily in the activity through the East Coast.

With future trends, how do we see it? We see where housing moving closer to the inland ports such as Chicago, Dallas, Memphis, Toronto, major metropolitan markets. The reason being is the intermodal cost. We will see increase in flexibility in supply chain and is most importantly the diversified port strategies that will be totally determined by the sourcing aspect. You could be sourcing in China today, but as flexible as the supply chains are and how quick they change, you could be seeing sourcing come out of South America to back the historic future. We are seeing some manufacturing move back from China to Mexico and seen an increased demand in our facilities in Mexico right now. The important point that of supply chain is we are continually changing as we grow back to the activity level of 2006 because right now, people are looking that network adjustments, what do I do with my warehouses? Do I move them closer to the population bases or if you consolidation centers as part of my network, it is a terminal where you bring in the container is and move those into the truck or rail. We see that as big activity for the future as well as new development be more on the East Coast as the Panama Canal open in 2014. I have tried to be brief and quick through my presentation and look forward to answer your questions the very end. Thank you, very much.

L. Feast
Thank you Greg. Our final presentation will be given by John Gray, of the Association of American Railroads

John Gray
Thank you, Laura. It is an interesting time to be talking about some of these issues. It is one where we are seeing a lot of change, and then lot of issues involving in the industry, as well as having to deal with the economy. What I'd like to do as we go from here today is point out some of the mega issues that we are dealing with right now, and then focus down on the economy and where we have come from on that and some comments on where some of the changes look like they might occur in the future as they go forward with some of the business lines that we are involved in. If you look that the industry today, just to give you a quick overview, the vast majority of the industry is made up of the seven large operations. It is those seven carriers that basically made up about 90 plus percent of the railroad business, at less in the terms of the freight that is out there. There are a number of smaller carriers operating local or regional areas that have a substantial amount of mileage but generate far less the in terms of total freight traffic.

The issues that the industry is looking that today and ones that we think are the big deal items that are on the horizon in 2009 is an one that is the perennial favorite in our business and has been ever since the industry was partially deregulated in 1980 is preserving the regulatory structure that allows us to generate the capital necessary to support the industry and generate the returns necessary on that capital that can provide the very high cost of infrastructure that we have to support. A newcomer to the list, one that could be a major item for the rail industry going forward is the climate change and the potential climate change legislation, both the impact and opportunity. The impact being that one of our major commodities handled is coal that is under attack and the desire to reduce greenhouse gases produced by coal burning utilities. The opportunity is potential growth within some of our intermodal business related to both fuel efficiency and greenhouse gas production issues. The third item that has emerged during the last year or so is the development installation of positive train control systems mandated by Congress, an unfunded mandate of between five to seven billion dollars for the industry. This is technology that is, quite frankly, still in developmental stages. Another item that is, again, both a talent and potential opportunity is the renewed interest or new interest in high speed rail for the industry, eight billion dollars appropriated by Congress during the stimulus package of for high speed rail. The challenges for us all are that it would be very disruptive to the it freight operations, and the opportunities, of course, are that there might be opportunities for improving physical plans for both freight and passenger operations if these funds are in some cases properly coordinated. An item that is a recurrent problem for the industry is moving highly hazardous materials because we are required, by law, to move highly hazardous materials, whether we want to or not. We are not allowed to charge for moving those materials, other than normal freight rates, but the liability from them is huge, potentially disastrous liability for back the industry is because the big guy out there and the one I want to spend most time on is the economy.

If you look at the rail system in the U.S., our traffic movement and business levels have closely followed GDP for many years, and if you send this line back another couple decades, you would see the same kind of relationship out there. Quite frankly, the little diversion we have of here at the top for 2007 and 2008 is one of the biggest diversions we have had in traffic versus GDP for sometime. In fact, it confirms that we are starting to see them lot of the impact of the recession issues as far back as late 2006. I will show you some of those down the way. Why do we act with the GDP? One of the reasons is a lot of the things that we handle tend to move with the economy, as you might expect. The two largest items that we move are coal and the intermodal business, both being about 20% of our business portfolio. A large number of carload and bulk items come up some for various parts of the economy, both food production, construction and production of consumer goods along the way, as well as consumer goods including automobiles, in this case. So, to give you a little background on how we got here, beginning in 2003, there were no lot of factors out there in the economy, not as the U.S. economy but worldwide that were pushing freight toward the rail industry. One of these factors was the GDP growth. Another was the growth in export markets for U.S. goods we have shown here as grain, but is far greater than grain, including things such as fertilizer, coal, a whole group of manufactured goods, machinery, all kinds of that states' goods that were heavily involved in the export market. Growth in electricity consumption from coal, the rail haul of coal as electricity production and demand both in the last decade, the coal required to handle that has also grown. In addition to that, there was the growth and congestion on the highway system, which for a number of trucking companies made their cost such that it came to intermodal movement for a lot of their goods as well as the growth of international traffic, which international consumer traffic that also provided a very large growth opportunities for the intermodal business. The bottom line is it meant a lot more real traffic, 12% in the last decade, resulting team and tighter capacity for the rail system. The capacity index, it grew by about 30%, substantially more business per mile of railroad. With that tightening of capacity, the freight rates have been falling since about 1980, the day started to increase with the increases in demand. Really, this is the first meaningful increase that we have seen during the 25 year period. The net result is more traffic, higher rates, equals higher revenue, something that has improved dramatically for the industry between the years of 2003 and 2008. What do you do with that? Well, that improves the net income; it has also given the industry the opportunity to dramatically increase and an increase capital spending. In capital spending, mostly for infrastructure projects have almost doubled in the last decade in the rail industry, largely because the income is there to provide that. Capital spending has, in fact, gotten up to the level with the four largest railroads, you are seeing the spending levels roughly equivalent to the larger state spending programs that are going on. As with all good things, this had to come to an end. Now, keep in mind that the rail industry and all transportation of freight is a drive to demand. That demand is driven mostly by consumption in the economy. The GDP made up the biggest component of it by far in consumption. The other component that affects the rail industry to some extent is mostly government spending with government construction projects. Of course, there is the export and import balance, even that will have some impact for us because of the amount of import traffic that was going on, as well as the export opportunities.

Where are we today? Because fewer people are working out there that, you have seen an economy producing a lot of jobs to turn negative, giving us a lot fewer jobs, back to 2004 levels in those jobs, unemployment increasing and the net results of that and consumer confidence dropping rapidly and retail sales after peaking in 2008, dropping by about $40 billion per month to 2009 levels, keep in mind that this $40 billion reduction in retail sales represents about almost a half of a trillion dollars a year in reduction. A half of a trillion dollars with the logistics being roughly 10% of that gives you a reduction of almost $50 billion in spending related to the logistic business, which, as you recall, is about the equivalent of the entire rail revenue stream for 2008. It is a big number that has come out of the economy. Now, since rail intermodal is heavily focused on consumer goods, much of it for large retailers, it has been an area that has been heavily impacted for us. As you can see here, the 2009 data and late 2008 indicate that the intermodal business, both domestic and international business has dropped to levels that would be equivalent to reap roughly the lowest month of most years. December is traditionally the lowest month of intermodal business. This year, 2009, is pretty much running at or below with December levels. It is a fairly grim picture for what we are seeing for movement with the intermodal business because another area that is really a big area for our business and the economy as a whole is our lumber and wood product business. If you look that this you will realize that you will see serious decline the in the carload business for lumber in as far back as 2006. If you have been in this business very long by the end of 2006, we knew something really bad was going to happen this because we did not know how bad or when, but we knew that you only see patterns like this at the beginning of recessions and only see these patterns, patterns are extreme in a recession that will be fairly serious because it confirms what we said earlier that you are starting to see some of the effects of the other recession as far back as 2006 and 2007, that you did not really have to wait until the official beginning of the recession in early 2008 to appreciate some of the impact of what was going on.

Another area where there was serious impact was in automobile sales and auto parts, as well as the suppliers for that the automobile industry, such as plastic, glass, a variety of people like this. The thing we are seeing about the auto industry is for railroads, a double effect, because as our car loads had declined and they have declined more sharply than the automotive movement as a whole, the reality on it is that back in 2005 and 2006, the carloads back then were very heavily weighted towards the movement of light trucks, pickups and SUVs because that was a big part of the movement. These are large vehicles that only have eight to ten to a rail car. These have been replaced by the automobiles that are actually being sold by much smaller cars that load 15 to 18 to a rail car when being moved to market. So, if we assume that the green initiative is a real issue that we are going to be facing going forward, it becomes very likely that we will never be, or it will be a along time before we see enough carloads in the light truck area to really boost up the total carload for the rail industry. Some of these carloads, as the industry changes, the automotive industry changes, they might not ever come back, even if automotive production is resumed to former levels. Now, another area that has had a big impact on our business and will continue to as the recession recovers is the U.S. dollar exchange rate. First of all, with the grain business, we can see as the exchange rate improved in late 2008, we had two facts. One was the U.S. products getting more expensive abroad and less demand from that area and in addition to that, foreign economy is having less cash to spend on U.S. goods.

The next effect was a fairly dramatic drop from about 24,000 carloads weekly down to about 16,000 carloads weekly of grain moving to market. The recession, incidentally, has had very little impact, as you would expect, on the domestic market of grain, simply because, obviously, people will still be eating. The export market has gotten dramatically smaller for United States grains. Likewise of for U.S. coal, it has been exported both metallurgical and utility coal, been moving offshore, particularly U.S. ports. That dropped dramatically towards the end of 2008 as the dollar began to have lower versus offshore currencies because the net result is that we are seeing a recession in which the carloads and intermodal taken together are running about 18% below where they were a year ago. This 18% level has been reasonably stable now. It has run between 17% and 20% for a fair number of weeks to read this point. Are we confident that we are the bottom? No. Are we anticipating that maybe we have found the bottom? Perhaps, at is point. It is looking more and more like that. How long this autumn will last, we are not sure. We do know that to recover, and looking that past recoveries, it will not be a quick process to get back up to 2006 levels, simply because there is, it will take time for the economy to regenerate itself. It will take time for the various stimulus projects to become a part of the economy. That is becoming very clear. We are not looking forward to a rapid recovery act as point in times. Now, the other kicker that has been in our business is that there has clearly been some volatility in fuel prices, leading to some interesting cost management issues over the past several years speak of the spike last summer, serious cost management issues, the one thing that we are happy with is with the prices down where they are today, it is a little bit easier to manage the one element of cost and volatility than it was a year ago.

What is the state of the industry? The year to date is off 18%. That puts about 500,000 freight cars those owned by railroad and private companies, almost a third of the total, into storage, along with 5,000 locomotives. Some locomotives are coming off of the assembly time in is point in time and going directly into storage, rather than putting revenue miles on, immediately. The same time about 17,000 employees, 70% of the workforce is on furlough. The interesting thing is because the industry entered the recession in good financial condition, it to still making the infrastructure investment, infrastructure improvements that were ongoing before in 2008 and earlier, to the extent that 2009 will end up being about the third largest year for infrastructure development in rail history. Most of the projects are ongoing and in some cases, time frames for completion have been extended slightly, in some cases, significantly. For the most part, the infrastructure products and then projects moving forward in the industry prior to 2009 are still ongoing. Another reason for that keeping them ongoing since the cash is available to do so is they are significantly cheaper to implement this year than they were a year ago and certainly better than two years ago. So, what is the summary? We do not know. Certainly, the forecast for economic recovery can take you anywhere from late 2011 for a full recovery to late 2013. Where that will fit, we do not know. Are there some commodities that we watch that seem to be indicators of where that might be? One in particular is plastic pellets moving because it is such a foundation product for back so many in the economy and tends to move before many other things would in the recovery process. So far we have not seen anything that we are the end of the recession. As I say, the one bright point is there is some indication that we might be moving along the bottom of the economic process. With that, I would like to go ahead and end it. Laura, I will hand it back to you for any questions.

L. Feast
Thank you John.

I'd now like to start off the Q&A session with the questions posted online. Once we get through those questions, if time allows I'll open up the phone lines for questions.

Question and Answer

L. Feast
I would like to keep you in the hot seat John. First question- How has rail pricing been able to stay positive with such a huge overhang of idled equipment?

J. Gray
I can not even begin to answer this question. Talking about pricing, even in a general senses tends to be illegal when you are doing it on behalf of a large group of companies.

N. Perry
I do not work for a railroad so I can comment. I was a railroad pricer for 17 years, so I have some experience. First off, when railroads finally figured out they were at capacity in the late 1990s, they came to understand they were underpriced to what the market would bare. Second, typically to the hyper competition of the merger era that particularly when you are at capacity that the market shares competition and by stealing you're your competitors you will not get anywhere because what you steal from your competitors, they would steal back on the next contract. It is easy to do in the railroad industry because 90% of the railroad is owned by seven or eight outfits. You do not have to, as you would in the trucking industry, get 300,000 people to see to make good, smart decisions, you only need to get seven. So, with the great encouragement of the security, the people who do their stocks, what they have done exhibited really good business sense over the last five years, something that I have been waiting for a long time and applaud. The benefit is in that stunning slide that John showed is that they have kept their capital investment of in the worst year they have had since 1933. That is extraordinary. We need to spend money on railroads. I applaud that.

L. Feast
Okay. No problem there. I do not want to get you in any sort of trouble, whatsoever. Is the vision for getting the railroad industry to sell the tracks to the DOT and only zero locomotives and cars, the trucking industry?

J. Gray
I do not think you would find anybody in the railroad industry today even remotely interested in that possibility.

L. Feast
In the rail traffic GDP graph, is the diversion beginning around 2006 an economy issue, or does it reflect the capacity of the rail system?

J. Gray
It reflects a little bit of both. First it was an economy issue in construction and automotive products. We have been seeing then on and on since early 2006 and automotive industry more than that. Around the beginning of 2006, capacity was tight. There was probably some business not taken on because of this tightness. In 2007, there has probably been enough capacity added that there was not too much impact on the business level from capacity constraint. By 2007, there were clear economic issues on the horizon.

L. Feast
You mentioned that railroads shipments are an early warning sign for recessions. What can be done to warn others about this and is this data available to the transportation industry?

J. Gray
This data is published weekly by our organization and is available on a weekly basis to supply a number of public organizations that specialize in this area such as the Federal Reserve and is also used by a number of the large investment companies. One that occurs to me right off hand is Berkshire Hathaway; Warren Buffett tends to use rail data as economic indicators.

L. Feast
Where is there a published rail industry growth plan to meet the upcoming freight transport demand of the coming decade or two?

J. Gray
We do not publish rail growth plans. That is the responsibility of the individual railroads. You have to remember that these are private businesses and sharing growth plans of that nature, other than doing large scale estimates for capital requirements, sharing growth plans of that nature can get into shirt and tan issues such as market allocation that violate antitrust law.

L. Feast
In the face of increasing environmental impact of human activity which primarily occurs as a function of commerce, why are we building our warehousing and distribution systems around truck in and truck out of warehouses moving from and to intermodal facilities, rather than direct rail service?

G. Arnold
Good question. One, your major all regional distribution centers are really put into putting the focus on the customer, how effectively they can run the transportation to the customer and the fact that it takes so much capital, and John can answer this, too, to put in more rail, the flexibility of putting a warehouse and using them. Trucking has more flexibility than the rail. There are also minimal development opportunities in rail locations today than what it would have been 10 or 20 years ago. Would you agree with that, John?

J. Gray
I would agree that for the most part, our growth areas are related one way or another to rail and trucking. That is about 65% of the rail business now has a trucking component somewhere in the process. We tend to be very concerned with the health of the trucking industry because of that.

L. Feast
On your regional distribution map, where is Detroit?

G. Arnold
I can answer that quickly. Detroit is not considered a regional distribution location. Typically, how you can look that it is the size of the markets because of the regional distribution or inbound distribution being Los Angeles, Detroit is roughly summer in 30 to 40 million square feet of warehouses. Indianapolis is somewhere around 250 to 300 billion square feet of housing. Typically it is considered an endpoint distribution but not regional because that is why it was not on the screen.

L. Feast
Are imports from China sustainable and what does this mean for our ports/freight?

G. Arnold
This is another good question. Right now, imports from Asia are down, our port traffic is down anywhere from 9% to 15%. A unique fact is that we have made greater decrease on the West Coast than on the East Coast. Routes from Europe to the East Coast are holding up and because of this the East Coast is staying strong. The recession, or the economy, has affected China, as well; development of warehousing has slowed a little bit in China. So, I cannot answer how long it will be sustainable, but we are looking that are looking alternative sourcing locations other than China. We are seeing a tremendous talk, discussions regarding Vietnam and Malaysia for new sources of the sourcing. That could change the traffic patterns, basically, contain our traffic patterns, as well. I hope that answers your questions.

L. Feast
With world trade increasing faster than world GDP, are we heading toward increasing environmental costs of commerce from the impact of transportation?

G. Arnold
I am not a sustainability expert. I think that Noël had some comments on that. Obviously, we are moving our products further and more often speak of that is being touched more. So, I would say that, generally, it might be environmental, but I do not have the information to answer that.

N. Perry
Well, I will give two answers to that. First off, the long term economic answer is that we would have to have a truly amazing environmental problem to reduce the value of world trade. Any economic study has shown that world trade benefits both sides in a substantial way. The other answer that is slightly contradictory is that this particular that the growth in world trade will not be what it was in the late 1990s. It will probably still exceed the growth in GDP, but not the two or three times the rate. It is not the problem that it could have been had that geometric curves that we saw earlier were sustained.

L. Feast
How do you see cap and trade affecting the freight industry?

N. Perry
I will give two answers because the basic long term answer is that transportation, by it nature, is a heavy consumer of carbon based fuel. Therefore, it is almost certainly to be a target for any kind of cap and trade legislation. It is going to be an additional cost that will be given to the consumer of the transportation. The other half of the question is whether or not we make good policy, understanding the full environmental impact of the supply chain not making decisions simply based on the line haul of one or another. What I am basically saying is that the U.S. has far and away the most efficient logistical system in the world and is distinguished by the balance between the four major modes and if we maintain that in our public policy, that will be a fairly positive things. If we single out one mode or the other for and extra thing, it will distort the economy and not help the environment, either.

J. Gray
Can I add a comment on that? It is a major thing for that our industry, cap and trade systems. That is that there is one other really important effect of cap and trade. That is since the legislation is designed to go with carbon production at the source of that production to be the greatest extent possible, it will, potentially, have substantial effect on any industry that is energy intensive in the production process. This is not simply transportation, but in the broad transportation, utilities, heavy industry, particularly, and in back, most industries that use carbon produced industry to any extent. It goes beyond just the transportation uses of the energy to the fact that, again, we are a huge demand business and there are release substantial impacts for the customers of transportation too.

N. Perry
That is a good point, John. In the work that I have done, energy content of the good and the production process is roughly three times the transportation energy.

L. Feast
Seems like there will be significant jobs in the trucking industry in the future - why is this not being promoted as a form of job stimulus?

N. Perry
I cannot speak for Capitol Hill, but I know the trucking firms have always been aggressive in their desire to cooperate with local employment agencies. Maybe the answer to meet the short term is right now is there is a surplus of truck drivers about 200,000 to 300,000 because of all of these idle trucks. The trucking firms are not clamoring for bodies right now. I can guarantee you that in two to three years, this will be reversed. I do not think there has ever been a problem with cooperation between local authorities and the trucking industry to employ truckers. All of the stimulus in the world right now would not hire a single driver if there is no freight to move. If you notice that John mentioned that he has made quite a few, 17,000 people laid off in the railroad business because the same goes there.

L. Feast
If the number of trucks only reaches 2006 levels again in 2013, should we be concerned? How does the debate in truck size and weights affect this?

N. Perry
Should we be concerned? If you are a seller of truck equipment, you should be concerned. That implies that there will be a lot of surplus equipment for a while. I would turn around the issue of size and weight. As long as road congestion is relatively low, and it is right now, partly because trucks are down, and also, astoundingly, because passenger car travel is down, the big argument for size and weight increase is congestion. You can reduce congestion by allowing bigger trucks. In the absence of strong increases, there really is not a big body of support for those changes because there is always the resistance that the Automobile Association provides. One other point about size and weight speak of this is a fundamental that a lot of people do not understand. The truckers, themselves, are against increases in size and weight because the market forces will require them to reinvest in bigger equipment and then pass on to their customers 100% of the increase in efficiency and. The people that benefit are the customers if indeed size and weight was lower than the delivered cost. So, the place that question needs to be directed is to the millions of customers out there and at some point, if contestant reasons it place in the economy-tossed congestion resumes it place in the economy, they will move to Capitol Hill and battle on.

L. Feast
As we consider increasing funding possibly thru gas tax increases at both federal and state levels affect freight decisions?

N. Perry
It will affect it a little bit. Remember that there are two parts to this answer is because there is no question that government taxation of all forms of transportation is going to go up dramatically over the next 15 years. There is simply, too big of a deficit to fund infrastructure improvements and, number two, they off. There is not enough money to pay off the deficit unless we find new taxes. Transportation taxes are an obvious source, one by the way that the Europeans depend on. I am not saying it is good policy, I am saying it is inevitable speak of the North American transportation, all of the modes are so efficient that a 5% or 8% increase in cost is not going to fundamentally change supply, because we are talking about an extraordinarily productive assets, that if necessary, will bear the additional cost. The customer suffers, but it will not change that it will not change the system dramatically.

L. Feast
Is the U.S. as a country spending enough relative to GDP compared to China on the transportation network?

N. Perry
Well, I would not compare to China. China is going crazy with the spending. By any engineering standard, we know two things about the U.S. economy. Number one, our structure is the best in the world by a factor of two or three. That is the good side. The bad side is we are not spending enough to keep it completely fixed. We have not made great system that needs a little bit of expansion but needs a lot of repair. The answer to that question is, compared to our needs we are not spending enough on infrastructure, particularly with respect to repair.

J. Gray
I would like to add to that. In our industry we are the point that we are starting to close to spending enough on repair but not spending enough on the capacity issues as we go forward, even though that, certainly, is not a issue now and will not be for the next several years, but we think there will be sending out there. Particularly with relationship to our industry, and I suspect the rest of the transportation industry, it is easy to make comparisons to countries like China and Europe, but the fact is that when you look not what they are spending on their transportation, it looks very different. For our industry, when we compare what we spend on rail transportation with foreign governments, we are comparing apples and oranges. A big part of what they spend, even though it might be on infrastructure used occasionally by the freight is heavily focused on their passenger system. It is really hard to make the comparison. I know where we have done comparisons with the European countries with real spending on freight, we all spend them by a rate of several times of what they put into their system.

L. Feast
Thank you all for attending today's seminar. The recorded version of this event will be available within the next week on the Talking Freight website.

I'd like to give a brief mention about the FHWA Freight Peer to Peer Program. The Freight Peer-to-Peer Program (P2P) puts public sector freight transportation professionals in touch with experts in the field and provides technical assistance in order to enhance overall freight skills and knowledge. The program is available to public entities, including State departments of transportation (DOTs) and metropolitan planning organizations (MPOs). To learn more about the program or to arrange a peer exchange, or to discuss participating as a peer/expert please visit the Freight Peer to Peer web site.

The next seminar will be held on August 19 and will be about Highway Networks and their Relationship to Freight.

If you haven't done so already, I encourage you to visit the Talking Freight Web Site and sign up for this seminar. The address is up on the slide on your screen. I also encourage you to join the Freight Planning LISTSERV if you have not already done so.

Enjoy the rest of your day!

Updated: 03/28/2011
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