August 2017

Columns

Supply Chain: Rail’s speed of change is all about efficiency

Railroads have long played a major role in safely and efficiently moving freight from origin to destination. However, for more than a decade, they have faced declines and slow growth in coal and other bulk commodities transported by carload service.

Donofrio, T., Argo Consulting

Railroads have long played a major role in safely and efficiently moving freight from origin to destination. However, for more than a decade, they have faced declines and slow growth in coal and other bulk commodities transported by carload service. To combat this, rail lines set their sights on new markets, such as crude oil and refined products. However, they must become more competitive by reducing travel times, improving reliability and safety, and developing new service approaches.

Increasing flexibility has resulted in improved productivity, competitiveness and a wider variety of customers. The rail industry constitutes approximately 20% of the supply chain transportation process across all industries. With regard to shipping oil and refined products, rail transportation constituted 5.3% of the supply chain as recently as 2014. However, rail usage has dipped to 3.8% over the past 3 yr.

What drives demand for rail?

According to the Association of American Railroads (AAR), shipments of crude oil dropped to approximately 1% of rail shipments in 2016 and early 2017.

Several drivers are behind the drop, including market demand. Between 2011 and 2013, crude oil shipments in the US increased from 5 MMtpy to 40 MMtpy. A decrease in the spread between West Texas Intermediate (WTI) and Brent oil prices caused crude oil rail shipments to decline in 2014/2015 by about 900 unit trains, or 2.5 trains per day. Data from 2016 points to a 45% reduction in crude oil shipments vs. 2015, and the US market forecast is that rail shipments in 2017 should mirror trends witnessed in 2016.

Cost is another driver affecting shipments. According to the US Energy Information Administration’s (EIA’s) Short-term Energy Outlook, oil and crude oil prices are expected to remain low in 2017. Crude oil prices are expected to remain suppressed due to oversupply, which means inventories will continue to remain high for the foreseeable future. The report estimates that global oil inventories increased by 1.9 MMbpd in 2015, marking the second consecutive year of inventory builds. Inventories were forecast to rise by an additional 700 Mbpd in 2016, before the global oil market becomes more balanced this year.

Meanwhile, global consumption of petroleum and other liquid fuels was expected to surge by 1.4 MMbpd in 2016 and 2017.

Geography also plays an important role in how oil is moved to refineries. For example, most pipelines run north to south—few, if any, pipelines are located from Chicago to the East Coast. Since the majority of domestic oil and gas production comes from the Gulf of Mexico, nearly half of the country’s refining capacity resides along the Gulf Coast. Most of that refined oil is shipped by barge to ports located along the Southeast, then trucked to the intended destinations. For example, Florida ships most of its refined fuel oils to ports on the West and East Coasts. The shipment of crude oil by rail is cost-prohibitive vs. shipping via tanker.

Crude oil/refined products, once delivered by rail transport, are disseminated to downstream customers with trucks (fuel oil for Northeast customers and gas for Southeast customers) or ships (for overseas customers, as well as Southeast customers in the Gulf states’ ports). Customer logistics and rail interface technology advancements enable improved coordination and strategic planning crucial to optimizing cost when moving assets.

Conversely, due to a shortage in pipelines, Canada will see an increase in crude oil rail shipments in 2017, according to the International Energy Agency (IEA). The net increase is driven entirely by oil sands growth, despite new offshore volumes as conventional oil production declines. Canadian oil output will continue to grow, forcing producers to look ahead for a needed expansion of the export network. While natural gas is presently denied access to rail shipments, the Alaska Railroad has secured a waiver from the US Federal Railroad Administration to ship LNG from Anchorage to Fairbanks as a test pilot to monitor capability for future expansion.

Transporting crude oil by rail is still more expensive than by pipeline. For example, shipping crude oil from the Bakken (North Dakota) to the East Coast costs approximately $9/bbl–$10/bbl. However, with limited pipeline capacity, moving crude by rail becomes a necessary option.

Meeting demand with innovation and investment

Rail has become a more attractive transportation option when it comes to safety. According to the AAR, rail safety is at an all-time high: the derailment rate on the country’s nearly 140,000-mi mainline network reached an all-time low in 2015. Since 2000, the train accident rate has decreased by 38%. Less than 1% of all derailments involve crude oil, with nearly 100% of all tank cars containing crude oil arriving at their destinations safely.

An increase in investments has resulted in increased rail safety. Over the past 30 yr, freight railroads have invested more than $630 B in infrastructure and equipment to maintain and modernize the nation’s rail network—averaging approximately $26 B/yr over the past several years.

Building adequate infrastructure also improves operations and capacity. Developing innovative ways to move more freight with less means that assets can be distributed in larger quantities, which improves cost efficiency.

A turning point for the industry came with the Staggers Act of 1980, which allowed rail organizations to set rates and eliminate duplicate lines through consolidations. The resulting revenues were put toward capital investments and technological advancements, such as equipment utilization, visibility tools for customers and key safety components impacting track, equipment and training.

According to the AAR, from 1980 to 2015, US freight railroads spent more than $600 B of their own funds—not government money—on capital expenditures (CAPEX) and maintenance expenses related to locomotives, freight cars, tracks, bridges, tunnels and other infrastructure and equipment. To clarify, more than $0.40 out of every revenue dollar was placed right back into a rail network that helps keep the economy moving. Consider that the average US manufacturer spends about 3% of its revenue on CAPEX. The comparable figure for US freight railroads in recent years has been around 19%, or six times higher—$28 B in 2014 and a record $30 B in 2015. To stay competitive in the triad of transportation modes—truck, barge and rail—three new service approaches have emerged: unit train design, intermodal service and transflow facilities.

Unit train design

Prior to the 1980s, railroads mainly relied on single-car shipments—those with 1–25 cars. Twenty years ago, trains were held to no more than 80 cars. Presently, they can operate up to 180 cars. These longer shipments are known as unit train service, and they became possible with the advent of distributive power, which increased locomotive horsepower tractive effort.

FIG. 1. Productivity gains made within the rail industry over the past 30 yr, due to investments in technology, infrastructure and train design. Source: US Department of Transportation’s Bureau of Transportation Statistics.
FIG. 1. Productivity gains made within the rail industry over the past 30 yr, due to investments in technology, infrastructure and train design. Source: US Department of Transportation’s Bureau of Transportation Statistics.

However, the receiver must also have the ability to handle the longer trains. Train service can only move as much product as the shippers and receivers can handle. When a major railroad was designing train service for an oil company, the train was designed to operate with 120 cars from Canada to a New York port. However, since the receiver could only handle 104 cars, the receiver’s infrastructure requirements limited the customer’s ability to maximize utilization of a train move.

To take advantage of railroad’s productivity gains (FIG. 1), it has become imperative for rail customers to right-size their storage footprint. Storing product in rail cars due to a fleet strategy based on infrastructure can be very expensive. For example, offloading product is critical to reducing cost for the customer, since building additional infrastructure or leasing additional car supply is expensive. Instead, oil and refined product customers should plan to store products in tank silos or schedule oil tankers to be available in a timely manner.

Intermodal service

Another service change has been the growth of intermodal service—different modes of transportation working together to move high-value, time-sensitive cargo. The classic forms of rail intermodal transportation are trailer-on-flatcar and container-on-flatcar. While trucks are good for local service, intermodal rail has the advantage when it comes to long-haul, enabling a shipper to potentially reduce cost by 45%, and carbon emissions by 75%.

Transflow facilities

Another service innovation is transflow facilities. It used to be that railroads had team tracks and warehouse facilities located adjacent to yards and terminals, where a customer could have a car sent to be unloaded into a truck and then delivered to a local customer. Transflow facilities located in major metropolitan areas have replaced that model, enabling a shipper’s product to be sent by rail car and then trans-loaded into a truck for local delivery. These facilities are easily accessible, modern and managed by rail leadership.

Rail transportation has also complemented river barge and overseas shipping in many ways. With river and ocean ports strategically located along rail lines, customers who need to transport products from a rail car can easily transfer a load to a barge or cargo ship. This strategy creates supply chain value for both the shipper and receiver, whereas solely moving product by river barge can be expensive and slow, due to the return of empty equipment.

Takeaway

Rail’s speed of change has left some customers behind. According to the US Bureau of Transportation Statistics, track mileage has decreased rapidly since 1990, as the sector has shed less-profitable routes. Declines in total system mileage have occurred primarily in parts of the network owned by Class 1 and regional railroads, while system miles owned by local railroads have grown over the same period. In 2012, Class 1 railroads owned 69% of system miles, with the remainder split between regional and local railroads.

The rail industry is rapidly becoming more efficient with routes. It will be imperative that the rail industries leverage these enhancements with customers, particularly in the crude oil and refined product markets. To maximize cost and cycle time, efficient management of “the last mile” will become more important to shippers—a win-win for both freight line parties. HP

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