3 Important Trends Affecting Railroads in 2014

North America's leading railroads performed well in 2013, and investors were justly rewarded. The Dow Jones U.S. Railroads Index climbed 36% last year. But as investors, we are more interested in the future, than in the past.

Here are three trends that are sure to affect the industry in 2014, and are important considerations for any current or potential investor of Union Pacific (NYSE: UNP  ) , CSX (NYSE: CSX  ) , Norfolk Southern (NYSE: NSC  ) , Canadian National (NYSE: CNI  ) or Canadian Pacific (NYSE: CP  )

More oil on the rails
The trend to transport more of North America's oil by rail will continue to gain momentum over the next few years. New transportation infrastructure, combined with ongoing challenges facing new pipelines, bodes well for North America's railways.

The long delayed environmental impact report on the Keystone XL pipeline was released by the State Department in January. It confirms that in the absence of a pipeline to send Alberta oil to the U.S., rail will continue to fill the gap. According to the report, 180,000 barrels per day, or bpd, of Canadian oil is already being shipped by rail to the U.S., with the potential for that to increase to 700,000 bpd by the end of 2014. Keystone XL experienced another setback this week when a Nebraska district judge declared unconstitutional a state law that might have been used to force landowners to allow the pipeline on their property.

As lawmakers debate, and defer, pipeline decisions, the infrastructure necessary to move additional oil by rail continues to be built. Canexus opened a new crude-carrying rail terminal in Edmonton designed for 100,000 bpd, and Kinder Morgan Energy Partners announced plans to build a $170-million facility designed to eventually achieve capacity of 250,000 bpd.

It's not surprising then that the transportation of petroleum products was one of the largest contributors to volume growth for railways in 2013. CSX carried just under 50,000 carloads of oil by rail in 2013, and expects that business to increase by approximately 50% in 2014. Canadian Pacific moved 90,000 carloads of oil by rail in 2013, and expect volumes could increase to 210,000 carloads by the end of 2015.

Not all railways enjoyed such success, however. Union Pacific saw its oil-by-rail volumes decline by 22% in the fourth quarter driven by competition from pipelines, increased supply of crude oil at the Gulf Coast, and pricing dynamics that reduced the demand to ship oil by rail within their network.

Crumbling roads, bridges and congested highways
Transporting goods over America's roads is getting more difficult, a positive development for North America's railways.

A 2013 report by the American Society of Civil Engineers concluded that 42% of America's major urban highways are congested, and one in nine of the nation's bridges are structurally deficient. And a 2012 study by the Texas Transportation Institute said that the cost of congestion to the U.S. trucking industry, measured as wasted fuel and delay, was $27 billion.

That same study highlighted a critical issue to North American businesses -- an efficient transportation system is a critical component in the just-in-time, or lean, manufacturing process. If products don't arrive on time, store shelves empty and production lines stop.

Unfortunately for the trucking industry, governments across the U.S. are drowning in debt and have limited financial flexibility to improve the nation's transportation network. Railways, on the other hand, own their transportation network and have a strong economic incentive to keep it as efficient as possible. In 2013, Union Pacific, CSX, Norfolk Southern, Canadian National and Canadian Pacific invested a combined $11 billion to keep their tracks and equipment in good working order, and delivering goods on time. 

Increased trucking regulation
The trucking industry is also facing increased regulation which will increase costs, and hurt competitiveness.

Last year, new federal "hours of service" regulations took effect. In addition to adjustment to limit drivers' time behind the wheel during a single day or week, the new regulations require a mandatory rest period of 30 minutes during the first eight hours of a shift. They also limit the average work week for truck drivers to 70 hours, down from a maximum work week of 82 hours.

And this year, the U.S. government is set to usher in a new round of regulations. Tightening emission regulations in California, federal greenhouse gas and miles-per-gallon regulations, as well as potential speed limiter requirements will make the industry less competitive with railroads.

FTR, one of North American's leading freight transportation research firms, estimates that the additional regulation will shrink the industry's capacity and could lead to a 6% increase in truckload rates by the second quarter of 2014. Bad news for truckers, but good news for the nation's railways bidding to grow their revenue at the expense of the trucking industry.

A rising tide lifts all "boats"
By most accounts, 2013 was a record year for the railway industry. Many established records for revenue, earnings and operational efficiency. Of course, as with every industry, there will be winners and losers in 2014. But with a slow and steady recovery taking hold across North America, these three trends may just create another record breaking year for many of North America's railroads.

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