Freight and the Economy: Will Katrina Hurt?
Best case scenario is that recovery will be quick, but trucking still must cope with high fuel prices, the driver shortage and new logistics challenges.
Patricia Smith
Senior Editor
We look to the rest of 2005 and into 2006 with an unanswered question: Has Hurricane Katrina slammed the brakes on economic – and freight – growth? In the days following the disaster, many economists warned of a slowdown or, worse yet, a recession by the end of the year. But almost as quickly, things seemed to settle down.
Fuel was a major concern. Damage to Gulf Coast oil rigs, refineries and pipelines threatened the U.S. supply of petroleum products, causing pump prices to soar. Fortunately, early damage estimates were quickly adjusted downward. Within 10 days, about half of the 20 refineries shut down by the hurricane had reopened. Two of the most critical pipelines that carry fuel to the Northeast and Midwest were running at 100 percent capacity. The U.S. government tapped into its Strategic Petroleum Reserve. Additionally, the International Energy Agency directed its member nations to make an extra 2 million barrels of oil per day available to the market for the next 30 days, including about 1 million barrels from the SPR. The U.S. Energy Dept. said a large portion of the oil from outside the U.S. would be released as refined products. A crisis was likely averted, but there were no bargains at the pump.
Trucking, of course, is most directly affected by the price of diesel. In its September short-term outlook, the Energy Information Administration noted that continued high oil prices were expected prior to Katrina, due mainly to continued strong worldwide demand. Even with a relatively quick Gulf Coast recovery, diesel prices would remain high. EIA's projected nationwide average for 2005: $2.40 per gallon, up from $1.81 last year. The forecast for 2006: an average $2.50 per gallon.
Fuel surcharges will help, but the offset is never 100 percent. Small fleets and owner-operators are typically hardest hit, not only because they usually pay more for fuel than their larger counterparts, but also because they still seem to have trouble getting shippers to ante up. "Some of our customers are giving us a little bit extra in the rates," confided one small fleet owner, "but when we try to talk to them about fuel prices they say that's our problem."
"For most motor carriers, fuel represents the second-highest expense after labor, accounting for about 25 percent of operating costs. The smaller the carrier, the higher percentage of operating costs that fuel represents," said the American Trucking Associations' Chief Economist Bob Costello.
High fuel prices also affect the overall economy. "Because of the impact of Hurricane Katrina and the EIA's recent increase to its average fuel price projections, the trucking industry will spend an unprecedented $85 billion on fuel this year," Costello said. "That's a $23 billion [increase] over the amount the industry spent in 2004. This is significant because the trucking industry moves 70 percent of all freight and 80 percent of America's communities get the freight they consume only from trucks. Ultimately, rising fuel prices have the potential to increase the cost of everything that is moved by truck."
EIA's best case scenario for gas prices is a national average of $2.34 per gallon by the end of the year and a $2.40 average for 2006. That assumes that Gulf Coast supplies would quickly be restored to normal. Its worst case scenario: $2.56 by the end of the year, $2.41 average in 2006. The agency also said that natural gas prices could increase as much as 71 percent in some regions this winter, heating oil could go up more than 30 percent, and electricity could jump 17 percent in some areas. All would put more stress on consumer pocketbooks.
Consumer spending is one key factor in the economy's general health. Construction is another. Katrina will have varied impacts on construction markets this year and into 2006, said Ken Simonson, chief economist for The Associated General Contractors of America. The industry had seen large increases in the cost of cement, steel, copper, gypsum and petroleum-based inputs. Now those costs could go even higher.
"Contractors use a lot of diesel fuel for off-road equipment, their own trucks, and the multitude of deliveries of materials and equipment," he noted. "Petroleum or natural gas is a key ingredient in asphalt, roofing materials, plastic pipe and insulation. And energy costs are built into the price of mining, milling, making, molding, and transporting metals, concrete and most other construction materials."
The disruption to ocean, rail and barge transportation and the loss of power to cement plants in the hurricane's path could cut further into those supplies. "At the same time," he said, "the urgent need to stabilize and rebuild roads, other infrastructure and buildings will increase demand for cement and other materials."
Transportation disruptions posed still more potential economic problems. In the New Orleans area, a concentration of ports, rail lines, barge traffic and major highways make up one of the nation's major transportation hubs. Some 6,000 seagoing vessels pass through the Port of New Orleans each year, loaded with bulk cargo and manufactured goods destined for ports and rail hubs along the inland waterways that serve the South and Midwest. Approximately 100 freight trains a day serve New Orleans.
The shutdown of that hub threatened to send prices soaring for some commodities like lumber and coffee. A large portion of the country's agricultural exports go through New Orleans, so farmers braced for huge losses. But trucking economists were generally optimistic.
"Our contention is that this probably isn't going to be a huge issue from the standpoint of the transportation infrastructure," said Eric Starks, president of FTR Associates, a Nashville, Ind., research firm that specializes in transportation forecasting. "There will be some short-term problems but, by and large, transportation will figure out how to get around them."
On Sept. 7, the Port of New Orleans announced that it expected to work its first commercial cargo ship the following week - thanks in part to the availability of reliable truck transportation.
The Congressional Budget Office also had some optimistic news. Analysts there had concluded that the devastation in the Gulf Coast region is not likely to knock the economy far off course. Katrina could dampen second half GDP growth by 1/2 percent to 1 percent, but accelerated rebuilding will likely bring a rebound in the first half of 2006.
Freight Growth & Capacity
The general consensus among fleet executives before the storm was that freight demand this year and next wouldn't duplicate the records set last year, but it would still be strong. ATA had already lowered its 2005 freight growth projection from 3-3.5 percent to 2.25-2.75 percent, in part because of modest growth in truck-tonnage weighted manufacturing production. A few days after Katrina, Costello said they had no plans to adjust those figures.
"In the short term, Katrina will have a negative impact on trucking because normal trucking operations in those regions have come to a near grinding halt," he said. "The storm is also forcing supply chain patterns to change for the time being as freight is re-routed. Freight that normally came by ship into the port of New Orleans, for example, is being redirected to other ports, which in turn puts pressure on local trucks in those areas. The trucking industry is participating in the relief efforts, and some carriers are contracting with FEMA, which is increasing their freight hauls at this time. In the longer term, rebuilding of the areas hit by Katrina will positively impact trucking because construction materials and goods to restock inventories all will have to be trucked into the region."
Will trucking have the capacity to handle those demands? There are some indications that the squeeze is easing. Bear Sterns does a quarterly survey of shippers to determine trends in air freight and surface transportation. In the second quarter 2005, about 46 percent of respondents said truckload capacity was "tight" or "extremely tight." That compares to 72 percent the same period last year. Just over half said they expected truckload capacity to get even tighter in the next 6-12 months versus 74 percent a year ago. Approximately 24 percent of shippers said less-than-truckload capacity is tight, compared to 32 percent a year ago. Some 40 percent expected tighter capacity in the coming months, versus 51 percent a year ago.
Bear Stearns analysts noted that some shippers seem to be moving away from the "core carrier" trend where they concentrated most of their business with a few – usually large – carriers. Instead, they were using more smaller carriers. In the survey, 44 percent said they were receiving a higher than normal number of solicitations from smaller truckload carriers. About a third said they would target a greater number of smaller carriers to distribute their freight.
Booming Class 8 truck sales have led many to conclude that fleets are adding capacity, but John Larkin, a transportation analyst with Legg Mason, says it isn't so. Larkin plotted monthly retail sales against what he calls his "fleet age indicator" and concluded that a good share of the buying is replacement, not expansion. Going back to the 2002 emissions-related pre-buy, carriers stretched trade cycles from three years to four or five years rather than gamble on higher costs and lower reliability of the 2002 engines. Now carriers are in another aggressive pre-buy mode in order to reduce their average fleet age before the new 2007 EPA-compliant engines.
As for reported growth of the small fleets, Larkin is equally skeptical. Citing ATA data, he noted that the number of loads hauled by small truckload carriers in the first half of this year actually declined from the same period last year.
"At the end of the day, it looks to us, based on the data points we can gather from the ATA and a few other sources, that in fact small fleets are not adding a lot of equipment," Larkin told attendees of the 2005 Georgia Tech Transportation Summit in late August. "I think the small fleet argument is really a function of a feedback from large brokers like C.H. Robinson, who suggest that they're not having any problems finding capacity."
The big brokers, he added, aren't seeing expansion of their existing carriers. Instead, "their carrier recruiters are doing a very good job of absorbing new fleets that are having trouble finding backhaul loads on their own and really need the size, scope and financial horsepower of a C.H. Robinson to balance their networks in today's difficult operating environment."
But the acid test for the supply-demand cycle is rates, Larkin said. Data from publicly held companies indicates that rates have been moving up fairly consistently for truckload, LTL and intermodal freight. "As shippers have become highly educated supply chain managers, we can be sure that they do not believe there is not going to be a huge infusion of capacity anytime soon if they continue to accept higher and higher transportation rates," he noted. "They are very concerned about running out of capacity, and are looking at every conceivable alternative."
His conclusion: "Capacity remains tight for the foreseeable future. Of course, there will probably be periods when it loosens some. But over the long run, five to 10 years out, we do not see huge amounts of incremental capacity coming on stream relative to demand."
Drivers, Insurance & Equipment
Finding and keeping good drivers is a huge cost to the trucking industry that isn't likely to ease soon. FTR tracks labor supply and demand issues that affect the driver pool. In June the number of people available to be hired as truckers fell slightly. But they also look at other factors that affect the industry's ability to fill seats, such as turnover.
"When freight demand starts picking up, drivers start playing the game," explained Starks. "They start jumping ship, going from company A to company B. If one guy jumps from company A to company B, and another jumps from Company B to Company A, you're short two drivers until you can get them back into the system. In an up cycle you're always going to have a shortage of drivers even if there are plenty of people out there to be hired, because you physically can't hire them fast enough."
The point of equilibrium is when there are enough drivers in the seats to move freight, no matter how hard it is to hire new ones. "My guess is that we probably won't get back to something like equilibrium until mid or late 2006, but a lot is going to depend on how the freight cycle continues to move," he said.
Insurance is another key cost issue. Health and workers' compensation coverage continue to present challenges but, on the liability side, insurers say there are some "decent" rates out there for carriers with good safety records. Again, though, it's the small carriers that are less likely to get a break.
"It's really a go/no-go situation for them right now," one insurance expert told us. "If their record is clean, they should be able to find good coverage at affordable prices. But if their record isn't clean, it's very hard to get insurance – and even one accident can knock them into that category."
Hurricane Katrina isn't expected to have an immediate or dramatic effect on insurance rates. Early estimates put the losses at about $100 billion. About $25 billion to $30 billion was covered by private insurance. The rest was covered by the federal government's National Flood Insurance Program, or wasn't covered by insurance at all, either because property owners couldn't afford it or because they were self-insured. At this point, insurers believe the storm will cause insurance premiums to rise, but mainly in hurricane-prone areas.
Higher materials costs boosted the price of new trucks and trailers this year, and most industry analysts expect those increases to stick. Now buyers are looking at higher costs brought on by stricter emissions rules.
Unlike 2002, fleets should have test time with the 2007 engines before the mandated changeover. That could ease reliability concerns, but higher costs seem almost certain. Anticipated price increases currently range from $5,000 to $7,000. Higher maintenance costs plus reduced fuel economy, by some estimates, could add another $2,000 to $4,000 a year.
Peter Nesvold, an analyst at Bear Stearns, noted that build rates for new trucks have remained relatively strong despite a seasonal pullback in orders, which might indicate some artificial demand the end of this year and into 2006.
"If freight starts to moderate, typically you would expect to see a slowdown in orders and builds, but I think that is unlikely to occur ahead of the 2007 standards," he said. Instead, carriers that are financially able will pull-ahead some intended trades. "If you can afford to do so, why not bring the average age of your fleet below target age, then you'll have some wiggle room in 2007?" he noted.
Serving the World
International trade has been a growing trend, and international transportation systems are under pressure to support growing demands for international freight flows. Much of that involves imports, with the gap between imports and exports expected to reach a new record this year.
Conventional wisdom says that imports are not good for U.S. trucking. The often repeated rule: a domestically produced good requires three or four truck moves from raw materials to retailer, an imported good only requires one or two. Experts say that rule still stands, but the impact of globalization on trucking is apparently much more complicated than that.
"I don't think that, from a trucking standpoint, you need to be concerned about imports," said Starks. For one thing, international freight accounts for about 60 percent of intermodal loadings. In 2004 intermodal had about 10 million loadings and dry freight tucking had about 200 million loadings, "so it's not a very large percentage of all trucking movements," he noted. "Even if you have very healthy growth in the international side, it still wouldn't have a dramatic impact in trucking."
FTR tracks more than 200 commodity groups and, according to Starks, the largest one hauled by trucks is food products, which account for some 14.5 percent of trailer loadings. Stone, clay and glass account for 11.5 percent, chemicals 8.5 percent. Next is transportation equipment, then paper. "A lot of those things that get hauled by truck are domestically produced goods," he said. "Where you get the international concern is more toward the consumer sector and that's still relatively small."
Ted Prince, vice president of Optimization Alternatives, argues that trucking is going to get its share of the freight business, with or without globalization. "Think of the production process – raw materials, work in progress, finished goods. If you think of that process left to right, the further you get to the right, the higher the number of moves are done by truck," he said. "Raw materials go by rail or barge, intermodal is in the middle, finished goods by truck. That hasn't changed, whether the goods are coming from across the street or across the ocean."
What has changed is the way many carriers and/or their shippers manage international freight.
"Globalization is a dynamic that is currently – and will have – profound implications on the transportation environment in North America and the world," said Mark Morrison, senior vice president, TNT Logistics North America. "I think we've just now begun to see the implications of that impact relative to the transportation and distribution infrastructure in North America."
One change is traffic patterns. More imports from Asia, especially China, means more traffic on the West Coast. Terminal managers in busy ports such as Los Angeles and Long Beach are trying to ease congestion by offering night and Saturday shifts. At the same time, shippers are looking to move some of their business to other ports.
In the Bear Stearns survey, some 42 percent of shippers said they have already rerouted shipments into smaller ports less likely to experience congestion or delays during the peak season. Another 41 percent said they're closely monitoring freight flow and ready to divert if congestion emerges. Facilities in the Northwest appear to be the first choice, but shippers are also looking at Gulf Coast and Eastern ports as well as Mexican facilities.
Globalization also means that many U.S. shippers and their transportation suppliers must expand their distribution planning from North America to the world. A substantial portion of TNT's business is satisfying the just-in-time manufacturing requirements of North American auto manufacturers. Morrison said he doesn't expect car makers to move assembly out of the region, but many tier one suppliers are now sourcing materials offshore. And no matter where materials or components are sourced, they must still meet JIT schedules at plants in Mexico, Canada and the United States.
"What that means is that transit times and supply chains have been extended," he said. "So the disciplines we've developed in North American logistics over the last 10-20 years must be extended across the global supply chain. If we can't address a North American customer's global requirements, we may not get to address their local requirements."
U.S. shippers are taking over more control of their global freight, said Prince. In the past many of the big retailers didn't take possession of imported goods until they reached the United States; now they're taking possession overseas. "Instead of having shippers paying ocean freight on 500 containers a year, you've got shippers paying ocean freight on 200,000 containers a year," he added. "They're getting the benefit of lower rates by taking possession further up the chain."
Moreover, controlling distribution further back in the chain enables retailers to better manage their inventory. "Before, if you were selling red, blue and yellow sweaters made in China, a distributor in Hong Kong would make the decision as to how many sweaters of each color would be loaded in a container and shipped to distribution centers in New York, Los Angeles and Chicago," explained Prince. "Now the retailer tells the manufacturer in China to fill a box with red sweaters and ship it to, say, L.A. By the time it gets there, it will be two weeks later and the retailer will have 20 or 30 fewer sweaters in the pipeline, so they'll distribute them based on how many red sweaters they're selling in each area. The more you shrink the time, the less amount of inventory you need to maintain the same level of safety stock."
TNT Logistics North America is part of a worldwide company with operations in 40 countries, so they're well positioned to compete in the global arena, said Morrison. "We are definitely bolted into this global question. It's a big part of our future."
Many U.S.-based trucking companies are expanding to serve global customers. For instance, Yellow Roadway recently became part owner of JHJ International Transportation, a China-based freight forwarder. And Schneider bought American Port Services, a company that provides transloading, warehousing and distribution services at six major U.S. ports. About 20 percent of Schneider's revenues are currently driven by imports, said President and CEO Chris Longren in a conference call with analysts. "Given the significant growth and changes toward international trade flows, we believe it will grow to be much larger."
Reshuffling the Deck
Tight capacity has prompted more shippers – domestic and international – to seek outside logistics advice and assistance. "The third party logistics business wasn't so good in the early 2000 period, but it's growing a lot now," said Mark Rourke, general manager of transportation management for Schneider. At least for them, much of that new business is coming from smaller to medium-sized shippers, i.e. those spending $10 million to $20 million a year for transportation. "They're finding that the transportation environment is more challenging relative to capacity and the ability to control costs," he noted.
Big shippers often farm out pieces of their logistics needs and frequently want 3PL services on a fee basis with pass-through transportation costs. But Rourke said smaller shippers typically prefer fixed prices for certain volumes because it enables them to easily predict costs.
Over the past five years or so, one trend is that shippers tend to think of transportation as part of a supply chain rather than an end unto itself, said Tom Finkbiner, former president of Quality Distribution. "They tend to control their shipping costs by moving things around. Maybe at one point in time they shipped from plant to warehouse to retailer. Now they might bypass the warehouse and move product LTL on a regular daily basis to retail stores. They've shuffled the deck, and by shuffling the deck they tend to get real savings or at least control cost increases. That's what supply chain management has done for them: made them look not at the individual modes but at the whole transportation package."
The Bear Stearns survey indicated that the shift from truck to rail continues to be price driven, although some shippers cited lack of truckload capacity. The shift from rail to truck is still driven mainly by service. While there are still complaints about rail service, Rourke said it has improved.
"The railroads are fairly fluid right now," he noted. "Industry wide we're seeing 5-8 percent growth in intermodal loadings the first half of the year, which means intermodal is growing more than short, medium or long haul freight. My experience is that the shipping public is looking for ways to improve their cost position and everybody's talking about intermodal."
Rail capacity, like truck capacity, is still an issue. According to Prince, that's partly because the railroads are starting to think more like motor carriers. "Rail was initially popular because it was a cheap product able to handle surges," he said. "Now they're saying 'we need to level our loads.' Some are saying they're not going to add capacity for one day of the week or one day of the year. They'll add capacity if they can support it year-round, but they're not going to suffer the vagaries of the market. If they can support This is what we can support and if we can support this year round we'll add capacity, but we're not going to suffer the vagaries of the market. So we're starting to see balance. The railroads are just 50 years late catching up to trucks as to what it means to be an effective and efficient carrier."
It may also be time for truckers to start thinking multimodal. Both Finkbiner and Prince serve on the board of directors of the University of Denver Intermodal Transportation Institute, a program that enables transportation industry managers a chance to get a Master's Degree in Intermodal Transportation Management while continuing to work at their current jobs.
The Institute, said Finkbiner, fills an education gap. While there are a lot of great logistics schools, there isn't much on the carrier side. And the idea is to give people an education not just in their own mode, but in all modes and how they fit together to perform in a logistics environment rather than a stand-alone basis. "You have to know transportation because it's changing," he noted. "Thirty years ago most truckload movements were carried by LTL companies or in box cars. I would argue that if you were an LTL, truckload or railroad executive, a general education in the other modes would have been very helpful in understanding what direction the market was headed. The whole idea of planning is to impact something before it happens, not retroactively."
Outlook 2006 continued...
