Effect of Coal and Competition on Railroading Industry

[Gilbert B Norman]

Merry Christmas, Gentlemen--

While the term railroad is not mentioned anywhere in this article appearing in Friday's Journal, the potential of severely and adversely affecting the railroad industry cannot be dismissed:

http://online.wsj.com/article/SB1000142" onclick="window.open(this.href);return false; ... 10250.html

Brief passage:

• After burning coal to light up Cincinnati for six decades, the Walter C. Beckjord Generating Station will go dark soon—a fate that will be shared by dozens of aging coal-fired power plants across the U.S. in coming years.
  
  Their owners cite a raft of new air-pollution regulations from the Environmental Protection Agency, including a rule released Wednesday that limits mercury and other emissions, for the shut-downs.
  
  But energy experts say there is an even bigger reason coal plants are losing out: cheap and abundant natural gas, which is booming thanks to a surge in production from shale-rock formations in the U.S.
  
  "Inexpensive natural gas is the biggest threat to coal," says Jone-Lin Wang, head of global power research for IHS CERA, a research company. "Nothing else even comes close."

Some 24% of Railway Operating Revenues and 44% of the Tons originated on railroads today represent coal; with the efficiencies developed over the years I have been following industry affairs (coal was once handled in 50 ton Hopper cars and moved in consists of Merchandise trains), it is a safe assumption that so long as coal remains a dominant energy source, railroad will handle it.

But the Journal is reporting that state of affairs is under siege owing to environmental concerns.

Personally, I hold that the industry will be under severe threats during next decade of 2020; it the environmentalist initiatives favoring wind and geothermal generation become more dominant and if natural gas and nuclear interests, none of which have any need for railroad transportation, then the industry will be looking at the "hurts". Diversion from rails of Asian import traffic owing to the Panama Canal expansion from West Coast ports to Ports closest to the traffic's final destination will only result is less favorable line hauls. While the Eastern carriers such as CSX and NS will see increases, they will hardly be of size to offset those losses that BNSF and UP will sustain.

I sincerely hope such will not be the case, but are we staring at the '70's - the Dark Ages when I was in the industry - again?

Discussion, anyone?

[gokeefe]

Mr. Norman,

In short "no". Why? As I am about to post in this quiet corner of railroad.net, the Bakken Oil formation is spouting forth cheap light sweet crude (something not re-discovered in the continental U.S. in any quantity in decades). For the moment it is largely accessible for bulk shipment only by rail.

Serious reason #2: The export market. China is going to need every ton they can lay their hands on. India is not far behind. That I'm aware of they have little or no intention of serious regulation against coal fired industries.

Serious reason #3: International carbon protocol collapse. The only really serious attempt at global restraint of carbon, the Kyoto Protocol, is starting to collapse. Canada is in the process of withdrawing. This means efforts at carbon control will be limited to national regulation for the time being.

Serious reason #4: If energy prices in the U.S. really do start to decline, hold on to your hat as the economy starts to heat up. There is tremendous pent up demand in all areas which has been restrained by high energy prices. As energy prices go down the macro economy will go into overdrive. Think of it in development terms. The U.S. has slowed down its "natural" pace of development for several decades due to artificially high energy prices (politics not demand issues).

I'll be opening a topic in this forum about the Bakken Oil formation. Hopefully word will get around that this is a good place to discuss it. I'm kind of surprised given the substantial nature of recent developments that this hasn't appeared elsewhere e.g. BNSF forum.

[Gilbert B Norman]

Mr. O'Keefe

As a railroad security investor, by no means were I implying that the industry is going back to the Dark Ages; it is just there are some "Medium Approach" signals with the potential loss of line haul revenue from Asian import traffic presently landed at West Coast ports diverted to East and Gulf Coast ports when PANAMAX becomes a non-term, as well as the environmental issues raised by continued use of coal as an energy source.

You have correctly pointed out that there is a new source of coal traffic and that is export coal moving through West Coast ports such as the newly built facility at Longview WA (much to the environmental interests dismay). However, what is of concern to me is that the facilities in Northeastern WY (Gillette) seemed to be planned around an Eastward movement of coal and that to handle Westward movements, there will be considerable capital costs incurred to accommodate such.

As you noted at your Bakken formation topic, the present handling of Plains state crude oil by rail may well continue by rail, rather than what I expected would simply be a "stop gap" until pipelines can be built. There are of course two BNSF main lines (GN & NP) traversing this oil production region, so both East and Westward shipments can be accommodated. Hopefully, the petroleum extracting industry will consider the capital costs (including "frucus" in Washington) that will be involved to build the pipelines and simply stay with what is already there - the rails.

[gokeefe]

Mr. Norman,

Here is my analysis. While there is very likely going to be a reconfiguration of traffic flows among Class I railroads in the United States, over the long term I don't think this is going to ultimately be an issue for them from a traffic standpoint. I withhold this endorsement specifically from CN and CP due to their high levels of dependence on transcontinental intermodal freight traffic and their non-involvement in U.S. coal traffic.

First, I would strongly emphasize China's highly problematic energy balance as being one of the most significant issues that the U.S. railroads will be dealing with. Second, since low-sulfur content Powder River Basin coal is obviously going to be very prominent for domestic energy generation going forward my impression is that railroads that are involved in the Powder River Basin (to wit, UP and BNSF) aren't going to have a problem due to changes in environmental regulations. The Powder River Basin stands to be the single most important source of domestically consumed coal in the U.S. As such I don't see the current configuration of the rails in that area as becoming inefficient due to the eastward orientation of the trunks. In short Powder River Basin coal is not in my mind a candidate for export.

NS and CSX are a different question but to varying degrees they are protected as well. The new regulations strongly favor western (Powder River) sources over traditional (Appalachian) coal sources. However, NS and CSX both have recently taken steps to revitalize and substantially their coal export facilities at Hampton Roads, VA, which as you may remember were historically used to export coal to Western Europe in the early to mid post war era. As you might imagine the end of PANAMAX could have implications in the ability of these Appalachian coal producers to market their coal to China via Hampton Roads. In my mind this means that as the new regulations take effect you will see NS and CSX shifting more and more of their capacity toward coal export as opposed to coal delivery for domestic energy production. My suspicion is that due in part to the aforementioned history of export traffic to Europe NS and CSX have good route alignments for coal export from the East Coast. Even though this traffic may not have been significant for several decades it never completely went away, and neither did the basic infrastructure, is now be expanded upon, or reactivated.

As bad for the environment as Appalachian coal is the U.S. railroads should stand to benefit from the fact that it is also some of the cheapest coal for thermal energy generation in the world. I doubt this point will be lost on the Chinese as they continue to seek cheap sources of energy. Furthermore, and you will appreciate the utmost significance of this point, there simply isn't any alternative with sufficient capacity for throughput (both production and distribution anywhere else in the world to satisfy the expected level of demand from China.

Where does this leave railroads like UP and BNSF which have spent so much of the past two decades consolidating and improving transcontinental capacity in the U.S.? First, my impression of the situation is that although substantial capacity has been added along certain main lines it has been just enough to meet continued projections for growth. In short I do not believe the railroads have overbuilt. Part of the way they have done this is by increasing train length instead of increasing main line trackage. Certainly it is undisputable that a traffic drop would mean a loss of revenues but I do not believe that the railroads would be faced with the same severe overcapacity of main line trackage that they dealt with in the dark days of the 1970's.

In brief, the railroads have added capacity but these additions are controlled among a very small number of major national players. This consolidated control of transcontinental main line track capacity in my mind should prevent a collapse of freight rail tariffs and their consequent revenues and profits. In a situation like this there is certainly potential for collusion but I think the collective instinct not to slit one's own throat will likely prevail without the additional burden of malfeasance.

[Ken W2KB]

Environmental considerations aside, the abundance of cheap natural gas is forecast to displace coal in virtually all new electric generation to be constructed. It is also economic for many existing coal-fired stations to convert to natural gas. The carbon issue might add urgency, but ultimately economics will dictate the decline of coal use in the USA.

[gokeefe]

Environmental considerations aside, the abundance of cheap natural gas is forecast to displace coal in virtually all new electric generation to be constructed. It is also economic for many existing coal-fired stations to convert to natural gas. The carbon issue might add urgency, but ultimately economics will dictate the decline of coal use in the USA.

Absolutely true.

I had read about that recently as well.

I feel that the carbon issue in of itself doesn't add urgency. As a resident of a state that lives in the tailpipe of coal fired power emissions from the rust belt, sulfur dioxide, mercury emissions and particulate emissions concerns me a lot more than carbon dioxide.

Sulfur dioxide and mercury emissions in particular are a very serious issue that are being addressed by the EPA right now.

[gokeefe]

Mr. Norman,

Further down in this forum Jeff Smith posted a topic about another WSJ article "The Future of Rail" which seems to offer a somewhat optimistic view of the future for freight railroads.

What do you think?

[Cowford]

The case for natural gas is interesting: Comparatively clean, presently abundant and cheap (because it's presently abundant), and locally produced. I wouldn't write off coal too quickly, however. Every industry report I've seen shows overall US coal production increasing, albeit minimally, over the next 25 years. Alternate consumption methods (syn fuels, gasification) could further extend its commercial viability.

[gokeefe]

Cowford,

What are the predictions/indication for the coal consumption mix re: domestic v. international?

[Cowford]

Here's a link to the Energy Information Agency, which is a terrific resource for any energy-related production/consumption stats:

http://www.eia.gov/forecasts/aeo/MT_coal.cfm#lto

[gokeefe]

In response to Jeff Smith's thread asking the question regarding "The Future of Rail" I posted a brief economic thesis.

Obviously, the changes to the U.S. oil and gas market are part of the answer.

I remain convinced that U.S. coal production will be steady for the foreseeable future. However, domestic demand, especially for coal with high(er) sulfur content will likely decline. I expect this decline at least partially if not fully off set by gains in export sales.

[gokeefe]

Originally posted in the "Future of Rail" thread:

I found the following article in American Thinker, published today, very interesting:

I have reset the links that were on the original website for the reader's convenience.

The second story is that North Dakota hit a record high oil production in October of 488,000 barrels per day (bpd). This was up 100,000 bpd (or 25%) from June's production. Lynn Helms, director of the North Dakota Department of Mineral Resources, projects that the state's total oil production will exceed 500,000 bpd next year and 900,000 bpd the year after that. The state will soon surpass California (539,000 bpd) and Alaska (550,000 bpd), rivaling top-producing Texas (1.2 million bpd).

Another story reinforces these bracing estimates. The National Petroleum Council estimates that by 2035 -- if the regulators will just stop endlessly excreting new hurdles -- the U.S. will hit 3 million bpd of shale oil alone. There are about 14 to 16 new American shale oil fields just starting to be exploited.

This has led the federal Energy Information Administration to raise its estimates for total American liquid fuel output by nearly 40% -- for next year alone!

The prior report indicates that total (i.e., conventional and non-conventional) American crude oil production hit 5.8 million bpd in September of this year -- an increase of 300,000 bpd (or about 5.5%) from the year earlier. American crude oil production could hit 7 to 7.5 million bpd by 2013, and hit 8-10 million bpd by 2015. Add in natural gas liquids, and we may well hit 11-14 million bpd. That would place our crude oil production up there with Saudi Arabia and Russia and, when you add in our natural gas liquids and ethanol, would place us tops in the world by far in liquid fuel production.

In fact, it now appears that in 2011, America will become a net petroleum product exporter for the first time in 62 years.

Not only is America now a net petroleum product exporter, but as expert Dave Ernsberger (global director at energy consulting firm Platts) put it, "t looks like a trend that could stay in place for the rest of the decade. The conventional wisdom is that [the] U.S. is this giant black hole sucking in energy from around the world. This changes the dynamic."

I was utterly stunned to read the estimate which appeared to indicate that the U.S. was potentially on track to be the world's largest producer of liquid fuels within 10 years.

[Cowford]

The article is confusing two very different issues: Crude oil production and refined products production. We are a net petroleum products exporter, meaning gasoline, diesel fuel, etc. And that's in part because the US has enormous refining capacity which is not being used fully because of reduced domestic transportation fuel consumption. However, imports still account for nearly half of the total apparent crude consumption ("apparent" meaning domestic production + imports - exports).

[gokeefe]

Although others might not I completely understand the difference between distillate exports and crude exports, to include the macro-economic implications (or at least some of them).

Regardless, the implication almost certainly is that we are importing more crude than we need for present levels of demand. That in combination with rapidly rising domestic crude production means that the gap between domestic supply and domestic demand is closing from both directions, i.e. supply is increasing and demand is decreasing.

[Cowford]

"Regardless, the implication almost certainly is that we are importing more crude than we need for present levels of demand."

How do you figure that? Per the EIA, the US imports nearly half of its crude consumption on a net basis. The amount of crude we produce/refine and export/re-export pales in comparison to the amount of crude we import and consume domestically.