Following up on last week's episode about the booming business that is rails, this week's episode of Industry Focus: Energy is all about shipping goods.
Motley Fool analyst Sean O'Reilly and regular contributor Adam Levine-Weinberg look into the most important differences in shipping goods by air, train, ship, truck, and pipeline, and what the cheapest ways to ship different goods are. Find out why overnight shipping is so expensive, where the majority of the cost in the shipping process comes in, why it might be cheaper to ship one good by plane and another by ship, why the rail industry is booming while the shipping industry is struggling to stay afloat, and more.
A full transcript follows the video.
This video was recorded on June 22, 2017.
Sean O'Reilly: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, June 22, 2017, so we're talking about energy, materials, and industrials. I'm your host, Sean O'Reilly, and joining me in studio is our special guest, Motley Fool contributing investor Mr. Adam Levine-Weinberg. How's it going today, Adam?
Adam Levine-Weinberg: I'm doing very well. How about yourself?
O'Reilly: Not too shabby. I'm glad to be inside, out of this D.C. heat.
Levine-Weinberg: Yeah, absolutely. Another 93-degree day. It's too much.
O'Reilly: I will never understand why the Founders decided to build the capital in what was essentially a humid swamp. Today is a very special episode, because we're going to be talking about all the different modes of transportation that keep commerce in the U.S. economy coming. That is right: We're talking about planes, trains, and automobiles.
Adam, transportation is a multitrillion-dollar portion of the U.S. economy. Knowing what different types of transportation are most attractive is arguably vital for investors today. You had a really good idea: Let's break this down into two sections, the first section being moving goods and services that are non-oil, and then oil -- the reason being, oil gets to use pipelines and no one else can. So right out the gate, if I want to ship something across the country, how do I figure out what is the best mode of transportation to use?
Levine-Weinberg: There are several factors that are important to making that decision. The main one is how fast you need your item to get where it's going. So, speed, there's a big trade-off between speed and cost. Obviously, on the flip side, you have cost. How much is the cost of shipping as a percentage of the value of the good that you're shipping? Are you shipping something that you're going to sell for $10, or something you're going to sell for $1,000? That obviously has an impact on how much you can afford to pay for shipping to determine whether or not it's worth it to get there fast or take this slower route. On top of that, you have size. Obviously larger items, or bulky or heavy items, cost more to ship. So those are some of the most important things that you need to take into account.
O'Reilly: And this is definitely something that anybody who has gone to FedEx (NYSE:FDX) or the UPS (NYSE:UPS) Store or the post office and said, "I need something there tomorrow," and it's, like, $30 to send an envelope. It's because of the speed factor. So how did those factors that you just listed impact the cost to move something, and what are the best options for each?
Levine-Weinberg: We'll start with speed. Obviously, if you need something to get there fast, then you need to use air, especially if you're going long distance. If you're going within a few hundred miles, then the truck could get you there in one day. But if you're doing longer distances, the trade-off is really between the ship, rail, and air, and air is going to be several days or even weeks faster. So that's why people will use that. Obviously, air shipments are extremely expensive. To a large extent, this also will depend on how bulky the item is, or how much you need to send at one time. Going back to your example of FedEx, if you're just sending an envelope, it will cost you $20 to $30 to get it there in a day. But it's only $20 to $30, and if it's something that really needs to be there, that's not the end of the world. If you're trying to ship a piano or something like that, then you're going to be paying a lot more than $30 to ship it by air.
O'Reilly: [laughs] Why is that the option you came up with?
Levine-Weinberg: [laughs] I'm just trying to come up with something particularly heavy.
O'Reilly: If you're shipping an elephant ... [laughs]
Levine-Weinberg: So, to start out, you have this speed and size. If you're trying to send a really small item, it can actually be cheaper to send it by air than by ship, because there's more handling involved in sending something by ship. So even though that would normally be much cheaper than air travel, it can actually be more expensive, because if it's containerized, you need to get it into a container boxed up with lots of other things. You need people to take it off, split up the shipment again, and get it to the final destination. In those unusual cases, air can actually be the cheapest as well as the fastest. But generally speaking, sending something by FedEx is going to cost a lot of money. Now, I should mention there are cases where you can actually justify sending large volumes of goods by air. One example of that was reported on pretty extensively a few years ago is why Apple uses air shipments for its iPhones, especially around product launches. It costs about $250,000, or at least it did back in 2013. It's probably a little less now, because fuel prices have come down. But about $250,000 to ship by air a plane full of iPhones --
O'Reilly: I'm picturing this right now, by the way.
Levine-Weinberg: -- from China back to Memphis, which is where FedEx has their big hub in the U.S. for shipment to all the Apple Stores and individual customers within the U.S. Now, that's a lot of money, but you can fit 450,000 iPhones onto this plane. So that's less than $1 a phone. And if you're talking about making people wait an extra three weeks to send a ship from China to the U.S., then this is a no-brainer. You're going to spend the extra $1 --
O'Reilly: Sorry to interrupt. You said 450,000 iPhones. At $800 apiece, that is $360 million worth of iPhones at retail.
Levine-Weinberg: Right. So, in that context, $250,000 shipping costs --
O'Reilly: Drop in the bucket.
Levine-Weinberg: -- it just doesn't matter.
O'Reilly: So, obviously, if I need to get a super-important contract to California today or tomorrow -- plane, automatically. If it's less urgent, what sort of distances are we talking about for the efficiency of one option over another to take hold?
Levine-Weinberg: For transporting something by road on a truck, the cost is linear and it goes up almost one to one with the distance. So the cost of sending something by truck 1,000 miles is about twice as much as sending it 500 miles. By contrast, for train and ship, there's a lot more cost involved at the beginning and the end of getting something onto the train or onto the ship, and then getting it off of the train or the ship. In most cases, except in very specialized circumstances, everything is going through a terminal, so at either end, you need to have trucks to get something from the pickup point to the terminal, and then from the terminal to the drop-off point. So the result of that is, for shorter distances, 300 to 500 miles or less, trucks are always the most efficient option. When you get a little longer than that, in that thousand-mile range, that's when trains are really at their best. And ships, when you get past 1,000 miles, can often be more efficient. That also depends a lot on geography. If you're looking at the United States, it actually makes sense to send trains all the way across the country, because to go by ship from New York to San Francisco, you have to go all the way down to the Panama Canal, you have to pay the canal fees, and it's quite a way out of the way. So in that case, you would usually want to send something, at least if it's on the smaller side, by train across the country, rather than taking a container ship.
O'Reilly: Got it. So, 300 to 500 miles for truck -- that makes sense. Really quick -- last week's show I did with Taylor Muckerman was about the rail sector. There's a reason that Warren Buffett bought Burlington Northern; there's a reason that Bill Gates owns a big chunk of Canadian Northern -- I think 25% or something. Why are railroads cash cows the way they are? And I pulled up the numbers for YRC Worldwide -- that's the trucking company; we all see their trucks. In a good year, their returns on equity -- and by "good year" I mean like last year -- its average, 10.8%. In a bad year, it dips to 1% to 2%. They actually went bankrupt in the last five or 10 years, a Chapter 11 reorganization, not a liquidation or anything. But why are railroads such cash cows? The shipping sector is replete with red-ink bankruptcies. What's the deal there?
Levine-Weinberg: Honestly, it's really all about tracks. For ships, you need the container ports, but often anyone can get in there, at least if it's not a really busy port, so there's a lot of competition. And in the rail sector, because of the fixed costs of getting into the rail business, if you actually want them to start a new railroad built on completely new tracks, it would be prohibitively expensive. The land and acquisition costs alone these days would be setting you back hundreds of billions of dollars to get into major metro areas. So you basically can't enter. As a result, you have half a dozen companies that control the vast majority of rail shipments in North America, at least the U.S. and Canada. That means there's a limited amount of competition. And that gives companies the opportunity to push prices up. And the biggest competition you have that would keep prices down is from truck and ship and air. But as we said, the air costs are a lot higher. The shipping is very circuitous. Even if you're just going from New York to San Francisco, it's circuitous. If you're trying to go to somewhere in the middle of the country, it's not even an option. And truck is also prohibitively expensive for these longer hauls. As a result, in that 1,000- to 2,000-mile range in the U.S., it's really just trains, and there's only a few companies that can do that for you. So that gives them a lot of pricing power and allows them to make a lot of money.
O'Reilly: So railroads are a double threat, then. You have lack of competition -- in fact, I hasten to say there's probably only one or two railroads in a given city that even service it.
Levine-Weinberg: Yeah, there's basically two railroads that do a lot of the north and south, and two railroads that do a lot of the east and west in the U.S.; two railroads in Canada. There's not a lot of options.
O'Reilly: So all these markets are a duopoly, which is just, draw your own conclusions. They're the only game in town if you're going from New York to Kansas or something.
Levine-Weinberg: Yeah, pretty much.
O'Reilly: Wow, OK. So, moving on. We talk about oil a lot here on this show, for obvious reasons. If I'm in the Permian Basin of West Texas or up there in South Dakota, and I strike oil, yay, me -- how am I going to get the oil to Houston?
Levine-Weinberg: Oil is definitely a very specialized market within shipping. As you mentioned before, pipelines are an option, and that's something that doesn't exist for most other goods. So you have pipelines, you have trucks with tanker cars on them, you have rail tanker cars, and lastly you have ships. If you're somewhere that's landlocked like the Permian Basin, then ship is out. So you're left with pipeline, road, and rail. Road, as is the case for other shipments, the prices go up very significantly as distance gets longer. So just going a few hundred miles could cost you about $20 a barrel.
O'Reilly: Which is huge.
Levine-Weinberg: When oil was over $100 a barrel, that was big, but it wasn't so big that it never made sense. It usually didn't make sense, but it was still possible to make that work in some specialized cases. Today, if the global market oil prices are $45 a barrel, you just can't pay $20 a barrel. So you have to either get it onto rail or into a pipeline. Pipeline obviously depends on where is the nearest pipeline? Getting that pipeline infrastructure into the right places is very important. Rail has often, at least in the last five to 10 years, tended to be the first option when you're just opening up a new area for drilling. But once a new find becomes big and is producing a lot of oil, then somebody is going to build a pipeline in there, or at least try to build another pipeline in there, because it's a lot cheaper.
O'Reilly: Right. That was the one standout negative in Burlington Northern's results that we saw last week, when Taylor and I were talking. Buffett bought Burlington Northern during the financial crisis and immediately became a huge part of operations. The balance sheet exploded, because that's a large fixed asset. And it was minting money with the surge in shale for three years, up until 2012. Then things started to go south in 2014 in particular, and nobody was shipping oil on it. It's making less money than it did three years ago. There was only one culprit, and it was that the oil sector wasn't going so great. What does it cost for these pipelines? What does a pipeline company charge you?
Levine-Weinberg: A general rule of thumb is that pipelines tend to be about $3 to $4 a barrel. That's what you're going to pay. And it will go up for longer distances, but not by that much. Obviously, pipelines, there's a high fixed cost of putting the pipeline in the ground, but the cost of actually operating it, the variable cost, is quite low. So that makes it the cheapest way of getting oil around on land. Shipping overseas is actually cheaper. You can get a barrel of oil from the Persian Gulf to the U.S. for something like $2 a barrel in shipping costs. So it costs less to go from somewhere like Iraq to the United States than it would cost to get something from North Dakota down a pipeline to Houston.
O'Reilly: Wow. And not only that, but you hear all these stories about people storing oil offshore in these ships just because it's cheaper than storing it in Houston or Cushing or something.
Levine-Weinberg: In part because there's been this rise in oil production in the U.S., you haven't had as much of this intercontinental shipping of oil. And as a result, there's too many oil tankers out there. They're so cheap to rent that you can actually just use them as floating storage.
O'Reilly: I cannot believe it's that cheap. I really can't. $2. Wow!
Levine-Weinberg: Yeah. The even more expensive option is rail. Rail is going to set you back at least $10 a barrel if you want to go from something like North Dakota, the Bakken, to New York. This is why BNSF is making so much money. If you look back four or five years ago, they were doing a lot of these shipments out of the Bakken formation, in that region, to Houston, to New York, replacing a lot of that overseas crude. It was still a lot more expensive, the shipping. It would be about $10 a barrel, compared to $1 to $2, but it worked out because the Bakken crude was selling at such a discount compared to world markets due to that transportation issue. So it's really good while it lasts, but the problem is, it's so expensive comparatively to ship crude by rail that it's always giving companies an incentive to not ship crude by rail, to find other ways, specifically to build pipelines. So I don't know that it's ever going to come back, at least in that particular area, to the way it was five years ago, because even if the oil market picks up again, they've built pipelines up in that area now, so more of that crude oil is going to be going by pipeline rather than going by rail in the future. I think if there's a next big boom for crude by rail, it's going to be someplace we don't know about yet, to be honest.
O'Reilly: That's a really good insight. Even with oil where it is right now, I think it was about six months ago, maybe even a year ago, Kinder Morgan got final approvals for a $4 billion pipeline expansion up in Canada for the tar sands. And this is not the cheapest oil to make, and they were getting it to the western coast just above Seattle. And it was like, wow, if they're doing that for this oil, what reason would rail have to be used there? Crazy. Very good. You get the last word, Adam. Anything cool that you want to share for investors looking at the transportation sector?
Levine-Weinberg: I think we've basically covered it. If you take it from the view from 30,000 feet, the cheapest way to move stuff around is usually by ship. If not, it's going to be by rail. After that, you have auto. The most expensive is by air. But what actually makes the most sense from an economic perspective really depends on other factors, such as how big your shipment is, which will impact the cost of the pricier methods like air shipping and how time sensitive your shipment is. If you really need to get there soon, then obviously air can be well worth the cost. And that's why companies like FedEx and UPS do as well as they do.
O'Reilly: Awesome. Thanks again for your time, Adam.
Levine-Weinberg: Thank you for having me.
O'Reilly: That is it for us, folks. Be sure to tune in tomorrow for the Technology show with Dylan Lewis. If you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at firstname.lastname@example.org. As always, people on this program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Adam Levine-Weinberg, I am Sean O'Reilly. Thanks for listening, and Fool on!
Adam Levine-Weinberg owns shares of Apple. Adam Levine-Weinberg has the following options: long January 2018 $90 calls on Apple, short January 2018 $140 calls on Apple, and short February 2018 $160 calls on Apple. Sean O'Reilly has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple and Kinder Morgan. The Motley Fool recommends FedEx. The Motley Fool has a disclosure policy.