Intermodal Industry Outlook: 2019

Guest Post: Mark McKendry, Vice President of Intermodal at NFI

When compared to 2017 volumes, North American intermodal volumes grew by over five percent in 2018 – despite extreme congestion in Chicago, a chronic chassis shortage on the U.S. East Coast, and atypical demand trends driven by e-commerce growth and tariff threats. Although the railways had the opportunity to grow substantially more than five percent, their focus shifted to yield instead, rather than volume in Q2 and Q3. While this meant that shippers were paying more for rail service, they also began to see tender acceptance and overall service improve.

As we enter 2019, there is cause for optimism thanks to a stabilized capacity landscape, strong economic fundamentals, and more consistent train performance.

Momentum

When you consider the volatility created by a potential trade war with China, a widespread inability to recruit truck drivers and a steadily expanding economy, calling 2018 “unpredictable” would be diplomatic. Consensus estimates for Global Domestic Product (GDP) growth suggest that full-year economic expansion will exceed three percent for 2018, and while that is likely to ease in 2019, strong fundamentals are expected to drive continued growth in 2019.

Two threats to a positive outlook for 2019 are the potential for a trade war with China, and lowered consumer sentiment created by uncertainty in equity markets. While tensions with China have eased in December, recent history has taught us that this needs to be watched closely because of the interconnectivity between global trade, transportation and domestic output. If high tariffs are applied to Chinese goods, consumption will be reduced; further, domestic output would diminish because of the increased cost of raw materials. This would create a drag on economic output and lead to a weaker economy, overall.

The likelihood of a full-blown trade war with China is quite low, however. Once the rhetoric between both nations starts to de-escalate, equity markets should stabilize and allow the fundamentals of increased industrial output, strong domestic business investment, and a predictable global trade environment drive strong economic growth in 2019.

Rail Capacity

Class I railways are complex, capital intense networks that are not inherently nimble, so it is no surprise that service eroded once more volume was introduced into the system. To be fair to the railways, this increase in demand also happened to defy conventional seasonality trends. Despite strong financial performance from the railways in 2018, they absolutely do not want the inefficiencies of 2018 to hinder growth in 2019. Most are optimistic that the capital committed in 2018 will allow them to acquire more share of market, moving forward.

One answer to the capacity crunch of 2018 is the adoption of a Precision Scheduled Railroading model (PSR). While CN, CP and CSX are already on varying chapters the late Hunter Harrison’s PSR ‘playbook,’ all Class Is are now under investor pressure to adopt at least some of the tenets of a PSR.  From a very high level, this model enforces a philosophy of maximum optimization and utilization of all rail assets. This typically has the effect of increasing service on the routes that a railroad chooses to (still) serve. What remains to be seen though, is what the impact of a partial embrace of PSR tenets will bring. A PSR model requires a widespread, and often forced, adoption of changes to operating plans which are quite different from non-PSR methodologies. This creates some caution on our part with respect to how the Union-Pacific Railroad and Norfolk Southern Railway will perform in 2019, but if they get it mostly right, their increased velocity will enable more latent capacity to become available.

Another positive sign is the progress of the 75^th street corridor project. This project is a multi-year initiative that focuses on increasing rail fluidity through four Chicago neighborhoods and, once complete, will complement the initiatives that the railways themselves have undertaken to reduce Chicago congestion.

Drayage Capacity

One pain point from 2018 that is expected to ease in 2019 is the availability of intermodal drayage capacity. At several points in 2018, first and last mile intermodal drayage was extremely difficult to source in key markets like Chicago and Southern California. The drayage business needed to become more attractive to truck drivers for them to want to pursue it as a career path, and the price adjustments forced onto shippers throughout 2018 enabled stronger recruitment and retention of drivers. The payoff was an increase to drayage availability in major markets during peak season, albeit at a much higher price. The combination of tax reform which facilitated fleet expansion, a higher price climate, and a willingness to integrate more third-party owner operators will allow dray fleet operators to haul more freight in 2019.

Pricing Outlook

Whether it’s in the form of paying drivers more, purchasing additional tractors or adding containers to a fleet, adding capacity has come at a cost. This cost was largely presented to shippers throughout 2018, and while many expect to see a deceleration from 2018 highs, we do expect to see adjustments that exceed Consumer Price Index (CPI) by a few percent. What remains an unknown is how large of an impact lower diesel costs will have on total price, but it will have an offsetting effect to higher rail costs. Another unknown is to what degree increased truck capacity will limit intermodal price expansion, but it is something IMC’s and railroads need to stay connected to, as price remains second only to consistency in the decision-making process for most shippers.

In all, 2019 fundamentals for rail transportation are strong. The resiliency that rail and drayage carriers showed in 2018 are expected to pay off in 2019. This will be big positive for shippers, consumers and the overall economy. If rail performance remains consistent and container and dray capacity continues to stabilize, truck-to-rail mode conversion has the potential to intensify at levels not yet seen before.

Mark McKendry, Vice President of Intermodal at NFI, is responsible for NFI’s intermodal sales and operations teams.