Rail car leasing: 'Same old, same old' as the new paradigm — by Toby Kolstad

— by Toby Kolstad

It has been a while since it was possible to characterize rail-car lease market conditions as "same old, same old." However, just as we reported in February 2011, the number of idle cars is expected to keep falling as traffic increases and car retirements continue at a high rate; and fleet utilization rates are expected to keep rising for railroads that measure loads-per-year and leasing companies that report on-rental percentages. Meanwhile, lease rates are expected to continue to approach normal levels, however "normal" may be defined in these days of rapidly escalating rail-car prices.

During the last 50 years of the 20th century, "same old, same old" was an apt description of the year-to-year progress of the railroad and rail-car industries. A few dramatic and relatively sudden changes in a few years aside, there typically were gradual year-over-year variations in railroad traffic and rail-car statistics. In the rail industry, merger-and-acquisition activities occasionally absorbed management attention and financial resources — particularly in the mid- to late 1990s — and while the system maps changed quickly, much of the rest of the corresponding change proceeded at a glacial, yet inexorable pace.

In the rail-car realm, the situation was much the same. Although many new car designs were introduced during the latter half of the century, it usually took many years for the old fleets to be replaced. Also, the business cycles were much longer, with the last one of the century lasting 20 years — from the peak of 95,650 cars built in 1978 to 75,589 in 1998.

A Decade Of Unsettling Change

Since 2000, however, stability has disappeared. Thanks to their newly found pricing power, railroads have enjoyed a renaissance in revenue, traffic growth and profits. As a result, capital spending has accelerated and train operations are improving much faster than in past decades. Railroads are beginning to recapture market share lost to the trucking industry. Moreover, new traffic segments are emerging almost annually; witness the boom in the ethanol industry, the development of industrial sand traffic and the rebirth of petroleum shipments.

Change in the rail-car industry has been even faster. Since 2000, there have been two boom-to-bust business cycles, with lease rates for existing cars falling to 50 percent of quoted rates for new cars and fleet on-rental rates dropping to below 90 percent at some lessors in each cycle. Although there have been few new car designs and very little fleet replacement, new car fleets have been ordered or built in just a few years to meet the demands of new ethanol, industrial sand and petroleum traffic segments.

For leasing companies, whose assets can last 50 years, the pace of change has been a little unsettling. The wide variations in lease and utilization rates for most car types during the past 10 years introduced more risk into these investments than lessors anticipated.

Besides the risk associated with the frequent business cycles, owners of the new fleets that were ordered or built to transport ethanol, petroleum and industrial sand face another problem: the longevity of the demand for these cars. That question became even more pertinent with the end of the federal ethanol subsidies on Jan. 1 and the decision to reject the proposed Keystone XL oil sands pipeline. To date, most of the cars built for these industries were leased under short-term operational terms and leasing companies seem to be betting the cars will be needed for a long time.

Stability In The Offing?

Lessors face the same type of questions about — and are making the same long-term demand assumptions for — the covered hoppers ordered for industrial sand shippers. Economic turmoil in these industries, engendered by political decisions, keeps risk levels too high for prudent rail-car investors.

Will it be the same old, same old again next year at this time? Few lessors would bemoan the return of a stable, but improving marketplace. Although a quick return to normal lease and utilization rates would be better for short-term profits at leasing companies, maybe the slow, multi-year economic recovery that has been forecasted would serve them better in the long run. And maybe same old, same old will be the new paradigm for the rail-car leasing industry.

Toby Kolstad has been in the railroad industry for more than 30 years, with stints at the Illinois Central Gulf Railroad, Denver & Rio Grande Western Railroad, a car builder and lessor. Currently a consultant on rail-car matters and president of Rail Theory Forecasts L.L.C., he can be emailed at Tkolstad@aol.com.