Finding Value In Midlife Air and Rail Equipment
Not so long ago the typical freight railcar had a new cost below $50,000. Today, a newly built freight railcar is in the $100,000 to $150,000 range. Both rail and aero assets present long-term investment opportunities. Railcars have up to a fifty-year interchange life. The economic useful life of an aircraft or aircraft engine is the period over which it is expected to be physically and economically feasible to operate in its intended role.1
What ends the life of the equipment is economics (when the cost of operating exceeds the cost of replacing). On average, the life of an aircraft, from purchase to retirement is between 20 to 36 years (Boeing and Airbus build their airframes to last 40 years: 51,000 flight hours and 75,000 pressurization cycles).
Today’s oversupplied secondary markets present opportunities to find value in midlife units. Finding those values requires the ability to identify well-maintained units with remaining service life while evaluating expected service alternatives. It’s the current spread between cost delivered new and secondary market cost that presents these investment opportunities.
The Boeing 757 is an example. Eastern Air Lines placed the original 757-200 in service on January 1, 1983. The last 757 was delivered in 2005. The modern narrowbody alternatives are more fuel-efficient, but the 757 is still active. When COVID appeared over 80% of the world’s 757s were grounded. Before COVID more airfreight was carried in the cargo holds of passenger aircraft than in dedicated freighters. With fewer passenger aircraft flying the parked 757s present the optimal narrow body for freighter conversion. To ensure dedicated freighter aircraft capacity, Atlas Air, the largest operator of 747 cargo aircraft in the world, recently announced it purchased three 747-400 aircraft that were previously leased and reached an agreement with lessors to take ownership of five more aircraft at the end of their existing lease terms next year.
Given the useful economic life of existing railcar equipment and the inflation in new railcar pricing (steel prices are up 215% since March 2020), it makes economic sense to evaluate opportunities to pursue existing rail equipment rather than new ones. Freight rail volumes are being influenced by several challenges, overreliance on global supply chains, the lack of microchips for autos, and the Delta variant, which is upending factory production in Asia. Among all rail traffic categories, Class One’s earned $5.97 billion from grain in 2020 (third behind intermodal and chemicals). But grain exports are down. Hurricane Ida flooded and damaged grain terminals along the Gulf Coast just weeks before the start of the Midwest harvest. More than 50 bulk vessels were lined up along the lower Mississippi in early September waiting to dock and load. On August 29th an all-time high of 47 container ships were at anchor off the ports of Los Angeles and Long Beach due to lack of berth space.
The strain on global supply chains is evident and Class Ones are hampered by capacity constraints resulting from COVID and the implementation of Precision Scheduled Railroading. With Thanksgiving and the Holidays expect port congestion and labor and capacity shortages at docks, warehouses, and trucking firms to continue.
The economics of logistics and transport investment are complex, but business cycles repeat. Volatility creates opportunity. Leverage our track record of transitioning equipment to its best and highest use. Times are excellent for midlife equipment investment strategies.
To model the equipment markets and manage risk, Call RESIDCO.
1 That’s the International Society of Transport Aircraft Traders’ (“ISTAT”) definition. ‘Longevity’ depends on market need and maintenance expense. Well cared for aircraft can have an almost unlimited life (but only with respect to safety and airworthiness: think the DC-3 aircraft that were in service in the late 1930’s and still fly today).
Rail and air transportation plays a central role in our nation’s economy. The government’s fiscal decisions, monetary policies, and administrative agency rulings influence the outcomes and the economics of transportation investment opportunities. The Surface Transportation Board’s unanimous ruling that the Canadian National hasn’t demonstrated its use of a voting trust would be consistent with the “public interest” follows the President’s recent Executive Order to “address overconcentration, monopolization, and unfair competition in the American economy.”
Government action and the rules and regulations implemented by its many Administrative Agencies1 have attempted to address both economic and social goals. Traditional ‘economic’ regulation focused on markets and economic variables and dates back to 1887 when Congress created the Interstate Commerce Commission to address the concerns of dissatisfied shippers. Railroads were then required by law to charge rates that were ‘reasonable and just,’ (the ICC was disbanded in 1995 and replaced with the Surface Transportation Board). In 1938 Congress created the Civil Aeronautics Board and directed the Board to place ‘public interest’ ahead of profits.
Regulatory reform (‘deregulation’) began in the 1980s, notably in the air and railroad industries.
Rail was significantly deregulated with the 1980 Staggers Act. That Act reduced federal regulatory controls over the roads who then went on to abandon unproductive routes, reduce labor cost, and increase efficiency by offering freight discounts to ‘bulk’ unit trains (e.g., grain and coal). By 1988 the competition released by deregulation had produced lower prices in most commodity classifications (while not increasing prices in others). The D.C. Circuit has recognized that the statutory language of 49 U.S.C. Section 10101 2 mandates deregulation of the entire railroad industry to the maximum extent possible in conformity with national rail transportation policy.3 Similarly, the Airline Deregulation Act of 1978 (supported by both Democrats and Republicans during the Carter Administration) specified the Civil Aeronautics Board (“CAB”) would be dismantled (eventually completed in January 1985).
After the CAB no longer had the power to price and set routes, competition forced air travel prices to fall, and U.S. airline passenger volumes increased dramatically. Deregulation gave railroads the freedom to negotiate contract rates and make operational improvements. The roads improved the efficiency of their networks, tailored rates to shippers’ traffic, abandoned low-density lines, and (as a result of merger activity) eliminated the duplicate track. Precision Scheduled Railroading is an example of operational freedom that the Roads are implementing today in an attempt to provide faster, more reliable service.
Tension exists between the business of pursuing ‘economic’ goals and the politics of pursuing ‘social’ goals. Governments may set ‘policy’, but business investment is driven by economics. Politicians do not face the same ‘market’ discipline. Other than elections, accountability mechanisms for political decisions are not in place. Markets may not always function perfectly, but unintended consequences often follow government attempts to produce desired ‘social’ results.
Identifying effective investment strategies in this environment requires an ability to integrate today’s politics into your investment thinking. Call RESIDCO.
1 In a 2015 Senate Judiciary Committee hearing, Chairman Chuck Grassley (R-IA) noted: “The Federal Register indicates there are over 430 departments, agencies, and sub-agencies in the federal government.”
2 Title 49 – Transportation – Interstate Commerce – “National Transportation Policy.”
3 Brae Corp. v. United States, 740 F.2d 1023, at 1043 (D.C. Cir. 1984); also Ass’n of Am. R.Rs. v. Surface Transp. Bd., 237 F.3d 676, (D.C. Cir. 2001).
New railcar orders rose 80% to 6,227 in the first quarter of 2021 from the fourth quarter of 2020 as rail freight volumes improved. Lease rates are showing improvement (but remain “soft”1). Greenbrier: “We’re seeing a broad-based need across all sectors and all businesses. Shippers are pursuing larger, higher-capacity railcars as a means to optimize rail shipments while reducing their carbon footprint by using rail.” Canadian National earlier had placed an order for 1,000 new-generation, high-capacity grain hopper cars (Trinity built) as their grain shipments have achieved 14 straight months of record growth amid record high grain prices. Trinity: “We see positive carload trends for railcar types representing over 50% of the North American fleet.” Railcars are continuing to come out of storage as average scrap pricing has increased: forty-seven thousand railcars are expected to be scrapped in 2021 with the age of scrapped cars declining to 36 years from 43 years in 20162.
Class Ones are reporting record operating ratios3. “We are even more confident about growth for the balance of this year,” Norfolk Sothern’s CEO Jim Squires told investors and analysts on the railroad’s earnings call on July 28th. For the second quarter, Union Pacific set records for operating income, net income, and earnings per share, and an all-time record operating ratio.
The pandemic revealed the geopolitical risk of over-dependence on foreign production. China’s reluctance to approve the return of Boeing’s 737 Max to service reveals their focus on local certification of the C919 (by this year-end) and demonstrates their ambition to become a global power (Boeing has not placed any new aircraft orders there since 2017). China’s coerced joint ventures and industrial technology theft is moving it toward a new kind of predominance among Asian low labor cost countries, growing in sectors that are far less exposed to labor cost competition – particularly high-tech production that demands sophistication and reliability as well as cost efficiency. As China absorbs U.S. technology it plans to replace foreign corporations with domestic ones.
A more belligerent China now boasts an increasingly skilled labor force, growing middle class, strategic raw materials, highly developed manufacturing capabilities, and plans to further invest $1.4 trillion in advanced manufacturing and automation by 2025. With its high labor costs, US manufacturing will be forced to improve productivity and increase the efficiency of its workforce to effectively compete (of particular concern is 25 percent of the US manufacturing labor force is now age 55 or older). National security concerns and ongoing tensions have created this need to reduce dependence on manufactured imports. Smart strategies include building strong transportation links with Mexico and Canada that will develop competitive advantages.
Rail and air transport investment requires the ability to anticipate major changes, understand served markets, shipper logistics patterns, modal alternatives, and consumer behaviors. The U.S. economy grew at an annual rate of 6.5% in the second quarter and economists expect the third quarter to be better. For investment policy, portfolio composition, and asset management, look beyond the pandemic to position your rail and aero investments. Call RESIDCO.
1 GATX, CFO Tom Ellman, first-quarter 2021 earnings call, April 20th: “non-energy tank car lease rates remain down 15 to 25%, with freight car lease rates down more”.
2 CIT internal estimates as of June 1, 2021, MARS July Lake Geneva Summer Presentation.
3 NS 58.3%, CSX 43.4% (excluding one-time expense credits adjusted to 55.1%), Union Pacific 55.1%.
The U.S. economy is opening up. Forty-seven percent of the U.S. population has been fully vaccinated. Most states have lifted restrictions. Over the last year, Congress has passed $4 trillion in fiscal stimulus. The updated Congressional Budget Office forecast expects GDP growth to reach 7.4% in 2021. The recovery is exceeding expectations and may turn out to be the strongest U.S. economic growth since 1951. Boeing’s CEO, David Calhoun has called the recovery “more robust than I ever imagined.” But the snapback in demand is stressing global supply chains, creating bottlenecks, and causing price spikes. Low vaccination rates across Asia are resulting in manufacturing and supply chain disruptions, driving transport, storage, and inventory costs to near-record highs. In June the Fed raised its annual domestic inflation forecast to 3.4% from 2.4% in March.
As China pursues its heavily subsidized Comac C919 the U.S. and European Union have agreed to suspend their seventeen-year trade dispute over government subsidies to Boeing Co. and Airbus SE.1 The tariff elimination follows the U.S. led G7 preliminary effort to overhaul international tax rules to achieve a global minimum tax. With 130 countries in agreement, each country’s government will now seek to pass2 the right to tax profits where customers purchase not where the business has a physical presence.
June TSA traffic climbed above 2.1 million per day, almost double the traffic in March. Road trips and a return of domestic air travel have driven U.S. crude to $75 a barrel (a first since 2018). But U.S. shale producers are unlikely to increase output as they have pledged to hold production flat this year and cap growth in 2022 at 5% using higher prices to strengthen their balance sheets and return capital to investors.
The domestic aviation recovery is driving orders for the newest, fuel-efficient narrow body aircraft (fuel accounts for a third of airline operating expense). United moved to lock in lower pricing with the largest combined aircraft order in its history: 50 Boeing 737 MAX-8, 150 Boeing 737 MAX-10, and 70 Airbus A321neo (the MAX burns around 15% less fuel). While MAX retail pricing is $125 million, large orders are usually sold for half their list price (or lower). Of the worldwide passenger jet fleet, 29% or over 7,000 units remain in storage. Current appraisals by international advisory firm Ishka, show a 15-year-old 737 20% less expensive this April than in January 2020 (a wide-body 777-300ER, 45% less expensive). The availability of these aircraft presents competitive opportunities.
Rail carload and intermodal volumes again saw annual gains for the week ended June 26. Nine of the ten carload commodity groups the AAR tracks posted annual gains, including coal. Efforts to switch to renewables remain in their early stages and many now recognize coal provides ‘base load’ protection critical for maintaining grid reliability.
Midlife assets: economics and an experienced specialist management team drive successful investment results. Get answers to your questions. Think long term. Call RESIDCO.
1. The Boeing-Airbus dispute started in 2004 when the U.S. filed a complaint with the WTO, claiming the EU’s subsidies for Airbus put Boeing at a disadvantage. Both now recognize the Chinese Communist Party threat.
2. 130 Countries. But no agreement with Ireland, Hungary, Estonia, Nigeria, Kenya, Peru and Sri Lanka who argue low tax rates attract foreign investment. The new tax rules are to apply to large global business with profit margins of at least 10% and global sales of at least 20 Billion euros.
It was only fourteen months ago that Covid-19 appeared shutting down economies and disrupting international traffic. Last fall’s elections led to a new Administration and a continuation of tariffs on Chinese products1. First tariffs, then the pandemic. Both have significantly disrupted domestic and global aviation transportation. Those disruptions, and “Precision Scheduled Railroading” have also changed the dynamics of rail equipment investment.
What remains is a recognition that transportation networks form the backbone of trade and economic growth. With one in every three Americans fully vaccinated we are now entering a post-pandemic world. The Fed’s willingness to finance deficit spending is driving a return of domestic demand. U.S. GDP increased at an annualized rate of 6.4% in the first quarter of 2021 compared to the fourth quarter of 2020. At the end of the first quarter of 2021, U.S. GDP ended up less than 1% below its peak reached in late 2019. The April consumer price index rose 4.2% at an annual rate. The Atlanta Fed’s GDPNow prediction for second-quarter growth is 11%. The speed of the recovery is leading to supply chain shortages and increasing commodity and component costs. Bridgewater Associates’ Ray Dalio pointed out the current Administration’s economic agenda risks injecting too much money into the economy which will accelerate price increases as consumers spend to get what they want.
The lack of international passenger traffic ‘belly space’ has increased interest in passenger-to-freighter conversions. Larger passenger aircraft (the widebodies – A380s, A340s, and Boeing 747s) have been retired early. The acceleration of e-commerce, caused by the pandemic, is driving growing air cargo demand even for smaller freighters (from express parcel carriers FedEx, DHL, UPS, and Amazon). Boeing at its biennial World Air Cargo Forecast expects the air cargo market will grow at a 4% annual rate over the next 20 years. That requires a freighter fleet 60% larger than today. Current pricing of these older ‘retired’ ex-passenger jets allow economic cargo conversions. Even aircraft long-retired are returning to service (Georgian start-up Geo-Sky has re-activated a 1987-built 747-200 converted freighter – last operated in 2012).
The rail traffic recovery from the pandemic continues. U.S. carloads of grain, food, lumber, paper, scrap metal, and several other categories were higher in April 2021 than in either April 2020 or April 2019. Total carloads averaged 237,960 per week in April 2021, the most since November 2019. April’s intermodal weekly average loadings are the largest for any month in history. Intermodal is being driven by increased consumer spending triggered by the additional $1.9 trillion fiscal stimulus the ‘American Rescue Plan Act of 2021’ (signed March 11) is injecting into the domestic economy. Consumer spending rose 21.1% in March from February. That is the biggest percentage increase since 1959. As of May 1, 2021 railcars is storage continued to decline (365,379 freight cars down from 409,289 units at the start of this year).
The economies of the world depend on efficient transport. A transportation investor’s challenge is to maximize after-tax returns net of all non-tax costs over an asset’s expected market life. Long-duration assets are influenced by economic uncertainty. Uncertainty breeds opportunity. As demand begins to outstrip supply finding solutions for practical investment is challenging. Work with the professionals. Call RESIDCO.
Glenn P. Davis, 312-635-3161
1 Tariffs began in the first year of the Trump Administration, four years ago.
The March weekly average of total rail carloads (231,232) was up 4.1% over March 2020 (total carloads for the last two weeks of March were up 7.3% over comparable weeks of 2020). Intermodal volume was up 24% over March 2020, that’s the biggest monthly gain ever. Following a 25.6% gain in the fourth quarter of 2020, the first quarter grain carloads were up 22.1%; the last two quarters of grain carloadings are the largest quarterly percentage gains on record. Industrial products (an aggregate of seven rail traffic categories representing the industrial economy) rose 1.1% in March, their first monthly gain since January 2019.
First-quarter U.S. GDP growth (to be released April 29) is expected to be 6% annualized, the fastest growth of any quarter since 2003. Additional ‘infrastructure’ spending is to be proposed by Congress (in addition to the $2 Trillion ‘stimulus’ just passed). A review of regional Federal Reserve Bank data shows manufacturing factory activity reported up. The Purchasing Managers Index (“PMI”) rose to 64.7% in March 2021, its highest level since 1983. Seven of the 10 sub-indexes set modern-day records. The Bureau of Labor Statistics announced on April 2 that a preliminary 916,000 net new jobs were created in March, the most in seven months (the official unemployment rate fell to 6%). The Conference Board’s index of Consumer Confidence rose to 109.7, its highest point since the pandemic began. For the ninth consecutive month railcars in storage continued to decrease (as of April 1st, 378,241 freight cars or 22.9% of the 1.651 million North American freight car fleet remain in storage).
Vaccinations have significantly slowed the spread of the virus, but factors that determine the timing of an aviation recovery are complicated by coronavirus variants and a slow rollout of vaccinations across the European Union. Infections have surged in France and French President Emmanuel Macron announced a nationwide four-week lockdown starting April 3rd. Italy also extended its partial shutdown until April 30th. Last year, air carriers were able to cut operating costs by 45.8%, but revenues dropped 60.9%. The result? The global aviation industry reported $118 Billion in net losses in 2020.
Aviation performance is expected to show improvement this year. Carriers with large domestic markets (North America and Asia) are performing better than other regions. Cargo operations are sustaining the major’s international networks. U.S. domestic demand has been increasing steadily as summer approaches. More than 1 million Americans have been flying each day for nearly a month. United reports Americans are traveling in the greatest numbers in more than a year, “Every day the numbers are better and better.” Delta is ending its block on middle seats. And, as a revenue-building strategy, major carriers are experimenting with point-to-point flights from smaller cities to suddenly popular leisure destinations.
Others are preparing for post-pandemic growth (Canadian Pacific, Kansas City Southern, AerCap/GECAS). As the domestic recovery becomes apparent and interest rates remain low, adapt your rail and aero investment strategies. Today’s decisions will put you in a stronger position for tomorrow. To identify targets and stay ahead of your competition, you will need critical market information. Call RESIDCO.
Glenn P. Davis, 312-635-3161
Once approved by the Surface Transportation Board, the combination of the Canadian Pacific and Kansas City Southern (the two smallest Class One Railroads by revenues1) can be expected to drive a modal shift from truck to rail. The combined “Canadian Pacific Kansas City”, or CPKC, will remain the smallest Class One. After the combination, a single rail transportation network will stretch across the North American continent and deep into Mexico.
The KCS connects the Gulf Coast Mexican ports of Veracruz and Tampico and the Pacific port of Lazaro Cardenas to Laredo, Texas. KCS has lines running north from Texas through Kansas City to Illinois and southeast to the U.S. Gulf Coast ports of Brownsville, Corpus Christi, Port Arthur, New Orleans, Gulfport, and Mobile. On a revenue growth basis, the CP and Kansas City Southern have been the two best performing Class One railroads for the past three years. After the new U.S.-Mexico-Canada (“USMCA”) trade agreement came into force last year (July 1, 2020), KCS, with its operations in Mexico, (the “Kansas City Southern de Mexico”) became a natural acquisition target. That July, the Blackstone Group Inc. and Global Infrastructure Partners considered a takeover bid for the KCS, which when made, was rejected. It was a strong indication of the upside growth any subsequent consolidation would offer.
The current combination has no route overlap and will create direct competition with the trucking industry (and other Class Ones) in the U.S. Midwest (the Dallas to Chicago corridor) and into the South. “The combination will provide a transportation solution for manufacturers seeking to bring factories back to North America after the pandemic exposed the risks of relying on overseas supply chains.” Mexico is a crucial supplier of vehicles, auto parts, electronics and food, and a major customer of grain, fuel, and consumer goods. Trade across the three nations is expected to grow, and the CPKC is targeting $800 Million in revenue gains by 2025 from the following sources: intermodal, automotive, and dry bulk (cement and grain carload traffic). The combination does not reduce choice for rail shippers, rather it expands their market reach and opens alternative shipping lanes. The benefits of single-line service will shift trucks off U.S. highways, reducing truck congestion and carbon emissions in the Chicago to Dallas corridor. “Rail is four times more fuel-efficient than trucking. One train can keep more than 300 trucks off public roads and produce 75% less greenhouse gas”.
The question for rail equipment investors: “Will the combination results in reduced or increased rail equipment demand?”
Pro: The combination will create rail traffic growth by expanding rail shipper market reach, taking truck traffic off highways, and improving rail transportation alternatives for grain, autos, and auto parts, energy, and intermodal shipments. It will eliminate the need for interchange between two systems, allow a bypass of Chicago congestion via the CP route through Iowa and reduce carbon emissions in the City of Chicago. It may also reduce the need for public investment in highways and bridge repair.
Con: Securing approval from the Surface Transportation Board (industry concerns remain over a loss of competition from previous rail mergers). The CPKC is positioning for post-pandemic rail growth. How to identify the impact on rail equipment demand from this combination?
1Kansas City revenues in 2020 were $2.6 Billion, CP revenues in 2020 $5.756 Billion.
Glenn P. Davis, 312-635-3161
Dr. Anthony Fauci has predicted, “it will be open season for vaccinations in the U.S. by April”. Supply boosts are expected to allow most people to get shots to protect against COVID-19 by then. Herd immunity could be achieved by late summer. With continuing low-interest rates and Fiscal stimulus provided by the CARES act (passed March 2020, authorizing $2.2 trillion), the 2020 COVID Economic Relief bill (signed December 2020, which authorized an additional $900 billion in spending), a possible third stimulus of $1.9 trillion, and a yet to be defined bipartisan ‘infrastructure’ spending package the economy is set for a comeback. As the vaccines roll out significant pent-up demand, caused by the pandemic lockdowns, will lead to a recovery in the second half of 2021.
Rail traffic is often used as a measure of broad economic activity. This January ten out of twenty carload categories had higher volumes than in January 2020. Intermodal volume and carloads of chemicals (on a weekly average basis) were higher than ever before. Chemical carloads were up 4.4% year over year in January, their biggest percentage gain in 10 months. Intermodal containers and trailers set new all-time records, up 12.1% over January 2020 (the fourth straight double-digit monthly percentage gain). Volumes are up at West Coast ports (Long Beach, Los Angeles, Oakland, and Seattle/Tacoma) and East Coast ports (Savannah, Virginia, and Charleston). Carloads of grain were higher than any month since October 2007 (the January year over year carload gain was 40%, the largest year over year monthly percentage gain for grain for U.S. railroads on record). And carloads of primary metal products, lumber, paper, and iron and steel scrap were higher than they’ve been since the pandemic began. The traffic category which most closely correlates with GDP is “industrial products” which is an aggregate of seven different carload categories representing a cross-section of U.S. industry1. Iron and steel scrap were up 5%, the most for any month since January 2015. U.S. plus Canadian carloads of lumber were up 8.9%, the most for any month since May 2019, and the fifth straight year-over-year monthly increase.
Over 90% of U.S. coal consumption is for electricity generation, and coal’s share of electricity generation (at 19%) remains behind natural gas (41%) and nuclear (20%). Equipment oversupply continues in both the Rail (24% of the fleet in storage, 396,867 railcars) and Aviation markets (a significant fleet surplus is expected through late 2022). International passenger aviation will wait for travel restrictions to be lifted. Airfreight demand is so strong experts predict the market will be back to pre-pandemic levels by the end of March.
With the highest probability scenarios priced in, knowledgeable investors anticipate unforeseen circumstances. As the economy recovers, fleet plans will change and aircraft that have been written down will again generate cash. Opportunities lie in those out of favor assets that offer strategic returns. A focused asset manager can identify secondary market transactions that combine current revenue generation with remarketing/resale opportunities.
Invest productively. Call RESIDCO.
Glenn P. Davis, 312-635-3161
1 “Industrial Products” include chemicals, paper, metal products, autos & parts, crushed stone, sand & gravel, metallic ores and stone and glass products.
Energy is a universal and necessary requirement for both rail and commercial aviation. Diesel-powered locomotives pull freight on all nonelectrified railways around the world. Gas-powered turbines made intercontinental passenger flight efficient and affordable. Because many believe fossil-fuel energy unfavorably impacts the environment, there is a growing belief that climate risk must be considered in evaluating transportation portfolio investment opportunities.
On his first day in office, Biden signed an executive order revoking the Keystone XL pipeline permit, signaling climate as a priority. His order effectively shut down a 12-year cross border project that would have carried 830,000 barrels a day of Canadian heavy oil-sand crude to U.S. refiners on the Gulf Coast (U.S. refiners purchase 98% of Canada’s oil exports). According to the Canadian Government, Canada’s proven oil reserves are third in the world behind Venezuela and Saudi Arabia. Canadian producers have limited and costly options for getting their oil to buyers. It trades at a significant discount to the West Texas Intermediate benchmark to cover rail transportation costs. The cheaper Canadian crude makes it one of the most profitable for U.S. refiners. Without the Keystone pipeline, the Burlington Northern Railroad will continue to carry crude as it moves rail tank cars to the Gulf Coast. Railcars are recognized as a more ‘sustainable’ form of investment, whether in terms of CO2 emissions or energy consumption per load when compared to other forms of transport1.
Aviation’s share of global carbon emissions is significantly below that of cars and trucks. But at high altitudes exhaust contrails form heat-trapping cirrus clouds. Can carbon-neutral flight be achieved? Boeing committed on January 22nd to ensure all its new commercial aircraft are capable and certified to use 100% ‘sustainable2 aviation fuel’ by 2030 (existing regulations allow aircraft to use a blend of 50% sustainable and 50% conventional jet fuel). Airbus has announced plans to design aircraft that rely on a turbofan design that includes a modified gas-turbine engine running on hydrogen rather than jet fuel (the hydrogen would be stored in tanks located behind the plane’s rear pressure bulkhead). Rolls-Royce committed to using its technological capabilities to play a leading role in enabling aviation, rail, and power generation to reach net-zero carbon by 2050. GE is researching advanced electric propulsion and fuels to achieve carbon-neutral flight. Last December United Airlines pledged to go ‘100 percent carbon neutral’ by 2050 by using carbon removal ‘direct air-carbon-capture technology’ that would remove an equivalent amount of carbon produced by its aircraft and thus allow its planes to fly on fossil fuels forever. Boeing’s 787 and Airbus’s A350 already emit significantly less carbon than the older jets they are replacing by using lighter materials and more efficient engines.
Climate isn’t the only thing changing. General Motors announced on January 28th it will end the sale of ‘all’ gasoline and diesel-powered passenger cars and light sports utility vehicles and will only produce electric-powered cars and SUVs starting in 2035. Transitioning to carbon-free transportation will be difficult to accomplish, even if vigorously pursued. The risks include shifts in policy, technology, and existing equipment valuations. For insight into opportunities that will be created during this challenge call RESIDCO.
Glenn Davis, 312-635-3161 davis@residco.com
1 “Railcars are a sustainable mode of transportation and play an important role in the industrial supply chain by transporting our country’s most important products across the North American continent in an environmentally-friendly manner.” Trinity Industries.
2 Sustainable aviation fuel reduces CO2 emissions up to 80%.
During his campaign, Biden promised “a second great railroad revolution” to ensure America has the cleanest, safest, and fastest rail system in the world for both passengers and freight. That commitment is part of a pledged $2 Trillion investment in infrastructure, transit, power, electric vehicles, charging stations, and ‘green’ buildings with the goal of net-zero emissions by 2050. With a 50-50 Senate1, the Democrats fall short of the 60 votes needed to overcome a Republican filibuster. To pass their spending initiatives Democrats must select either a) the tax-driven ‘reconciliation’ process which requires a Senate majority to pass2, b) do away with the filibuster, or c) consider working across the aisle.
The markets have priced in significant additional stimulus in the first quarter of 2021, beyond December’s $900 Billion Covid fiscal package (which brought the total current fiscal stimulus since February 2020 to $3.5 trillion). Current stimulus spending is more a share of GDP than the entire response to the ‘07-‘09 recession (and it has been spent in less than two years). With the Fed promising to keep interest rates low until inflation reaches 2% and unemployment drops to pre-pandemic levels, the case for a robust recovery is widely expected. Economists at Goldman raised their 2021 forecast for U.S. economic growth to 6.4% reflecting their expectations of additional Federal Stimulus early in the new Administration. Biden’s $4 Trillion in tax increases on corporations and households earning more than $400K will come later after the fiscal stimulus and a successful inoculation campaign unlock consumer demand.
Congress will shift its focus to climate change and social equity issues, the Biden Administration to constructive international cooperation. Past Democratic Administrations shackled economic growth with excessive anti-business regulations. Expect Congress to use the Congressional Review Act, which allows the Senate and House to overturn regulations finalized in the 60 legislative days prior to the Inauguration, using a fast-track process that only requires a simple majority vote. Already, to ensure global consistency, the Environmental Protection Agency set its first-ever climate standards for commercial airlines and large business jets (December 28th). The new rules are meant to prevent U.S. jets from being shut out of international markets. They create efficiency standards to limit carbon-dioxide and nitrous-oxide emissions from new commercial airliners starting in 2028 (OEMs will have to apply the limits to any new designs starting this year).
On January 26, the U.S. will implement Covid-19 negative testing requirements for all arriving international travelers. The number of arriving international passengers has risen sixfold from June to November. With demand returning, hard asset investment will work as a hedge against a jump in inflation that will come as central banks print money and sharply expand their balance sheets.
2021 will be an improving year, much better than previously thought. Opportunities are to be found as the over-supply of railcars continues and thirty percent of the commercial aircraft fleet remains parked. Long term transportation investment demands analysis of market demand and supply, and effective decision making informed by expected changes in value and cash flows. See beyond conventional thinking to identify secondary market trends and equipment opportunities before they are recognized by most market participants. Call RESIDCO.
Glenn P. Davis, 312-635-3161 davis@residco.com
1 The last 50-50 Senate was in 2001.
2 Republicans used ‘reconciliation’ to pass the Tax Cuts and Jobs Act.
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