U.S. domestic coal production peaked in 2008.  The decline that followed was driven first by the politics of climate change and then by the shale gas revolution.  Our coal production takes place in three major coal-producing areas, ‘Appalachia’, the ‘Interior’ (Illinois, Indiana), and the Powder River Basin’s ‘Western Coal[1]’.  Substantially all moves by rail.  With the politics of pipelines delays, many thought crude by rail would take the place of lost coal volume.  But the real drivers for coal, crude by rail, and shale gas are the economics of energy[2] production and transportation.  The politics of exiting the Paris climate accord and curbing of environmental regulations will not change market forces.

Often viewed in isolation, energy commodities are connected by transportation economics.  Historically, the railroads have generated more revenue from coal than from any other single commodity.  Even with its decline, coal continues to represent a major share of rail tonnage and top line revenue[3].  Exports of coking coal, used to make steel, have been a traditional area of strength, and coal pricing has been supported by ongoing demand from China which imported 23.5% in the first six months of 2017[4].  At current prices U.S. steam coal exports are competitive in Asia (East Coast or Gulf Coast to India, California to China or North-East Asia[5]).  Amazingly, after our exit from the Paris Climate accord, steam coal exports to Europe have grown.  France’s nuclear regulator ordered safety checks on a number of the country’s reactors (almost 80% of France’s electricity comes from nuclear energy[6]) requiring the country to rely more on coal fired power.  While Germany is replacing its nuclear units with renewable energy (wind and solar) it has increased its use of coal as a backup to renewables (over 55% of German electricity generation comes from fossil fuels[7]).  Shale gas is more efficient and burns ‘cleaner’ but prices have been rising and power producers have responded by switching back to coal.  Meanwhile, environmentalists are arguing ‘fracking’ poses public health risks due to water table contamination, waste fluid air pollution, earthquakes, and unknown climate change impacts[8].  There is no question that domestic coal production is facing headwinds.  According to data from the American Association of Railroads, 22% of the country’s 220,000 coal gondolas were in storage this May and 26% of the 142,000 hoppers had not been used in the last 60 days[9].

History demonstrates energy commodity shifts take years to fully transition.  Wood gave way to coal in the 1800s.  Until the shale revolution ushered in a new era of plenty, the prospect of oil supply running out was a doomsday scenario.  Now coal is being squeezed by shale gas.  How rail traffic behaves in the years ahead will depend on energy pricing competitiveness.  Coal is becoming more competitive as natural gas prices increase (the U.S. is expected to become a net exporter of natural gas in 2018[10]).  Since the industry can expect fewer government regulations and a more supportive administration in Washington, the future role of coal in the U.S. energy mix is expected to stabilize.

Our investment strategy is to seek those exceptional or minority cases where we are confident of current cash flows and future values.  The answers are in the economics.  If you are looking for rail insight, call the Rail Experts.  Call RESIDCO.

[1] At 1.13 billion tons Wyoming accounted for 41% of U.S. coal production in 2016.  Association of American  Railroads.

[2] Department of Energy, August 2017 report: Shale Gas(economics) are to Blame for Coal Plant Closures.

[3] In 2016 coal accounted for 31.6%[3] of originated tonnage for U.S. Class I railroads, far more than any other commodity.

[4] Reuters, July 31, 2017, U.S. Coal Exports Surge.

[5] The Asian benchmark price for thermal coal (Australian port of Newcastle ended at $92.28 a ton on July 28, steady from $94.44 at the end of 2016, but almost double the $50.63 at the end of 2015.

[6] Institute for Energy Research, October 24, 2016.

[7] Ibid.

[8] As a result, New York, Maryland, and Vermont have banned fracking!

[9] The Blade Business Writer, Rail Unit Profits The Andersons, May, 28, 2017.

[10] U.S. Energy Information Administration, Natural gas prices in 2017 and 2018 are expected to be higher than 2016, January 23, 2017.

The Importance of Infrastructure

Infrastructure is one of the main factors of economic growth. This includes power, water, telecommunications, ports, roads, and rail. In a report by McKinsey Global Institute, the projected requirement for infrastructure investment is estimated to reach $57 trillion dollars from 2013-2030. This is to keep up with global GDP growth targets. According to PWC, globalization enabled free movement and distribution of goods around the world, while travel and people to people linkages enabled the movement of data and currency. Such massive activity is only possible through physical and digital infrastructure. Due to the expected shift in economic and demographic trends, there is an enormous need for boost infrastructure spending.

According to the Business Roundtable, statistics show the need for improvement in America’s infrastructure spending: the infrastructure quality of the U.S. currently ranks at no. 16 globally, behind France, Japan, and Germany. Among the world’s top 50 airports, the U.S. only has 4 included in the list; delays and congestion have amounted to $24 billion losses in 2012 alone. Around 25% of rails around the country is marked as “good” or “excellent.” Clearly, there is a lot of room for improvement. The U.S. economy would greatly benefit from massive infrastructure spending.

An article by the Council of Foreign Relations mentioned the current state of U.S. transportation infrastructure. Many highways and bridges in the U.S. will reach the end of their maximum expected lifespan, thus the need for adequate capital investment in order to conduct major repairs to these infrastructures. The last era where transportation infrastructure has benefited was during former President Eisenhower’s time until the 1980s. Afterward, spending on transportation infrastructure has significantly declined.

Short and Long-term Benefits of Infrastructure Investment

Infrastructure investment can have short-term and long-term economic benefits.  Building and construction efforts will result in a boost in employment; more jobs will be created. Long term gains involve sustained economic growth with greater benefit for the population, with better services and smoother flow of people, goods, and services associated with high-quality transportation, better roads, rail, airports, and seaports, among others.

Admittedly, transportation infrastructure requires a significant amount of capital investment, and traditional government funds may not be enough. This is where the private sector can come in. The Financial Times mentioned that some policy experts advocate for greater private sector involvement in infrastructure investments, mainly through public-private partnerships or PPPs. PPPs are projects done in long-term contracts, with direct cooperation between the public and private sector. Private capital can then fund infrastructure through municipal bonds. Ultimately, there are risks and returns to be considered but this may vary depending on the project involved. As mentioned in the article, a public-private sector partnership may result in lower costs in terms of technological or operational components or expertise, compared to a public sector-led initiative.

The bottom line is that there is a massive need for transportation infrastructure investment in the United States, and there is no better time to invest than now. Investing in transport infrastructure means investing in the future and ensuring long-term economic benefits for the country. This unique opportunity is sustainable and its effects are long lasting. As emphasized in the Business Roundtable report, the following benefits can be obtained with increased investments in the transportation infrastructure:

Increased GDP growth – investment in transportation infrastructure will generate more jobs; the maintenance and repair projects will further boost employment and create jobs that are permanent and well-paying, which can benefit the middle class, resulting in an increase in GDP growth.

Increased productivity – Efficient and modern infrastructure translates to greater productivity by improving safety, reducing labor costs, fuel expenditures, travel time and other unnecessary effects of uncertainty. Supply chains run more smoothly and the cost of doing business is lower.

Increased international competitiveness – High-quality infrastructure will attract foreign direct investments and encourage businesses to expand their operations.

Investing in Transportation Infrastructure

Investment in transportation infrastructure will result in highly sustainable, short- and long-term economic gains.  It is a win-win solution and a unique opportunity that businesses should take advantage of. Infrastructure plays a crucial role in providing employment opportunities, increasing productivity and boosting international competitiveness, and is a proven key factor in driving economic growth. To know more about investing in transportation infrastructure, call or visit RESIDCO for more details.

 

Aviation investment is driven by profitability and the prospect for future growth. Recent mergers have resulted in the number of major carriers in the U.S. decreasing from 10 to 4[1]. This consolidation has created an oligopoly and helped the remaining players[2] take a more balanced approach to capacity management. They now control 80% of the domestic market and a good portion of the international market. With better control of available seat capacity and a developing consensus that jet fuel pricing is going to stay low for the foreseeable future, the industry has become attractive to investors[3]. Add new sources of revenue like charging for baggage, premium seats, and early boarding, combined with fuel saving new engine and equipment technologies and you have double digit returns on invested capital. With high barriers to entry, pricing control, and management talent, the industry appears positioned for a bright future.

Operator fleeting decisions are based on mission, seat mile profits, operating cost, maintenance requirements, reliability, flexibility, and fleet commonality (for pilot substitution, training and spares inventory purposes). Earnings and profit making capability of equipment is valued. Newer aircraft have higher ownership acquisition cost but lower emissions, lower fuel cost, maintenance savings, and a better passenger experience; but, in the current fuel market, the efficiency gains of newer models do not offset their higher ownership cost. New equipment will be needed to serve market growth, but the economics of investing in mid-life aircraft remain.

Since demand is sensitive to the business cycle and equipment supply, investment horizons require the ability to identify appropriate market entry and exit opportunities. Long asset lives require knowledge throughout the investment term and skill to determine the impact of new technologies, exogenous market events, replacement demand, competing aircraft values and investment economics[4].

There are a lot of different kinds of planes. Which are the most profitable? What is the optimal time to enter and exit? Keys include age, seats, units sold and remaining in service, combined with an analysis of a carrier’s mission, market, models, engines, avionics, and fleet operations dynamics. Is the equipment market liquid, can equipment be traded, reconfigured or parted out? Knowledge of asset values and lease rates allow a connection of investment choices with outcomes and translation of these opportunities into action. It requires searching for the best opportunities, both here and abroad, and an experienced management team with a focused investment strategy.

With profitable experience and deep relationships, we effectively manage asset concentrations, credit exposures, and counterparty risks. For long-term strategies and an in depth understanding of the characteristics of aviation equipment combined with the ability to select and manage asset investment for better than average returns contact us directly.

RESIDCO, aviation and transport investment specialists.

[1] Consolidations include Delta and Northwest in 2008, United and Continental in 2010, Southwest and AirTran in 2011, and American and US Airways in 2013.

[2] American, Delta, United, and Southwest.

[3] Warren Buffet picks a company or industry based on his estimate of its success over the next 10 to 20 years. He’s recently invested in U.S. airlines. Why? The industry is enjoying strong finances and good control over capacity.

[4] United Airlines, for example, recently decided to refurbish all 21 of its B767 aircraft that had originally been slated for retirement. Delta extended the use of 15 of its B757s.

Government taxes to encourage (or discourage) a variety of economic activities. The rates set influence the market’s required before-tax rates of return for both individual and business investments. From a social standpoint, taxes are designed to finance public projects, redistribute wealth, and provide basic services. Since self-interest is basic to human nature this creates private incentives to engage in tax planning. Such planning has long earned the blessing of the U.S. Courts.

When you invest, whether you are an individual, or a business owner, the taxing authority is your silent and ‘uninvited investment partner’. Effective planning involves more than being aware of current marginal rates; it requires an evaluation of the longer term results of your decisions, not just for yourself but for all participants. Each party and counter party has their own current and future marginal tax rates. These future expected after tax cash flows affect current actions and decisions. Understanding this concept is important since it directly influences the prices at which assets are traded now, and, what future pricing might be.

Naturally, most taxpayers pay no more tax than they believe they must. And they spend their time and money to arrange affairs to keep their tax bite as ‘painless’ as possible. Remember, money spent on tax planning is ‘tax deductible’, and the tax savings generated are ‘tax exempt’ because they reduce taxes payable.

Are increased taxes good policy? In 1997, Bill Clinton agreed to lower capital gains rates to 20% based on economic literature suggesting the lower rate would yield more tax revenue. It did. Yet Hillary has proposed to nearly double the top tax rate on long term capital gains to 43.4% from 23.8%. Under current tax policy, ‘capital gains’ are taxed as ‘ordinary income’ if an investor has held an asset for less than a year. After 365 days the current top long term gains rate of 20% applies (plus the 3.8% Obama Care surtax on ‘unearned’ income). Hillary has suggested a ‘sliding scale’ approach requiring ‘capital gains’ tax rates during the first two years holding period of 43.4%, year three, 39.8%, and 35.8% in year four. Investments would have to be held for more than six years to qualify for the current 23.8%[1].

Economists generally will agree that a system of competitive markets is remarkably efficient. Remember Ronald Reagan was elected in 1980 with his message that government is ‘the problem’ and economic freedom was ‘the answer’. The dominant lesson of the Great Depression and the Great Recession is that when Government overspends, overtaxes, and over regulates, economic freedom is suppressed and economic growth is impacted[2]. How is transportation investment best and ethically encouraged? Transportation asset Investors with a sound investment strategy hold diversified asset positions intended to weather volatility on the way to their longer-term objectives. Working with a firm that has a history of excellence, expertise and ethics produces results.

Call the air and rail transportation experts. Call RESIDCO!

[1] National Center for Policy Analysis, Hillary Clinton’s Capital Gains Tax Proposal, Brief Analysis No. 825, April 14, 2016 by Pamela Villarreal.

[2] WSJ, “Why This Recovery is So Lousy”, August 4, 2016, Phil Gramm and Michael Solon.

The most important decision an investor makes is the composition of his or her investment portfolio. That is what ultimately acts to determine the level and potential variability of returns. Research shows dissimilar asset classes act to increase returns while reducing risk. From an investment perspective, an aircraft or railcar under lease represents a stable and recurring monthly cash flow immune to short term swings in the market throughout the industry cycle. Real assets create real options, cash flow certainty, and economic value.

The world’s economic growth has dropped from 4.9 percent a year from 1951 to 1973 to an average of 3.1 percent for the balance of the last century. And, since 2000, GDP growth in the U.S. has been persistently low, averaging 2 percent, with world economic growth similarly sluggish. What drives market expansion and economic growth? New technologies, productivity improvements, the ability to produce, the desire to buy, access to capital, demographics, and investment in education and capital equipment. Broad based economic growth ‘lifts all ships’ creating opportunities, raising living standards, expanding access to services and most importantly allowing each of us to chart our own future.

Sound volume growth prospects are a major reason to include commercial aircraft in your ‘real asset’ investment spectrum. International air traffic has been distinguished by high growth rates. Global air traffic (passenger) has grown at an annual average of 4% in the last decade (despite 9/11 and other external shocks)[1]. This growth reflects increased globalization and the international division of labor. Air transport cost has tended to fall as a result of increased competition, improved engine technologies, larger aircraft, and lower cost jet fuel. On the rail side, the roads are focused on the fundamentals of providing reliable service and controlling cost as crude oil and coal freight volumes have fallen (there are many examples of striving to solve investment challenges only to find efforts defeated by events occurring in a larger context).

Holding air and rail investment requires management by a specialist organization. Risk management is complex and depends on portfolio credit quality and desirability of individual aircraft and railcar types. It’s not merely a question of loan or lease to value, but the relative importance of the unit to the operator, which governs whether they are likely to continue to operate the collateral in bankruptcy. In weak markets, extending the period an airline or rail carrier continues to operate the aircraft or railcar provides a better result than selling into that weak market.

Today, fixed income yields are low and the volatility and dampened expectations in the equity markets argue that portfolio construction and manager selection are critical. The future is uncertain. How do you grow and protect value over an investment horizon’s duration? It comes down to two important investment related disciplines; managing risk, and managing volatility. With investment clarity and consistent focus ‘real asset’ managers do this well. Our firm has a history of excellence, expertise and ethics. Team with experienced investment managers. Call the air and rail transportation experts.

Call RESIDCO!

[1] Source, IATA.

Government taxes to encourage (or discourage) a variety of economic activities. The rates set influence the market’s required before-tax rates of return for both individual and business investments from a social standpoint, taxes are designed to finance public projects, redistribute wealth, and provide basic services. Since self-interest is basic to human nature this creates private incentives to engage in tax planning. Such planning has long earned the blessing of the U.S. Courts.

When you invest, whether you are an individual, or a business owner, the taxing authority is your silent and ‘uninvited investment partner’. Effective planning involves more than being aware of current marginal rates; it requires an evaluation of the longer term results of your decisions, not just for yourself but for all participants. Each party and counter party has their own current and future marginal tax rates. These future expected after tax cash flows affect current actions and decisions. Understanding this concept is important since it directly influences the prices at which assets are traded now, and, what future pricing might be.

Naturally, most taxpayers pay no more tax than they believe they must. And they spend their time and money to arrange affairs to keep their tax bite as ‘painless’ as possible. Remember, money spent on tax planning is ‘tax deductible’, and the tax savings generated are ‘tax exempt’ because they reduce taxes payable.

Are increased taxes good policy? In 1997, Bill Clinton agreed to lower capital gains rates to 20% based on economic literature suggesting the lower rate would yield more tax revenue. It did. Yet Hillary has proposed to nearly double the top tax rate on long term capital gains to 43.4% from 23.8%. Under current tax policy, ‘capital gains’ are taxed as ‘ordinary income’ if an investor has held an asset for less than a year. After 365 days the current top long term gains rate of 20% applies (plus the 3.8% Obama Care surtax on ‘unearned’ income). Hillary has suggested a ‘sliding scale’ approach requiring ‘capital gains’ tax rates during the first two years holding period of 43.4%, year three, 39.8%, and 35.8% in year four. Investments would have to be held for more than six years to qualify for the current 23.8%[1].

Economists generally will agree that a system of competitive markets is remarkably efficient. Remember Ronald Reagan was elected in 1980 with his message that government is ‘the problem’ and economic freedom was ‘the answer’. The dominant lesson of the Great Depression and the Great Recession is that when Government overspends, overtaxes, and over regulates, economic freedom is suppressed and economic growth is impacted[2]. How is transportation investment best and ethically encouraged? Transportation asset Investors with a sound investment strategy hold diversified asset positions intended to weather volatility on the way to their longer-term objectives. Working with a firm that has a history of excellence, expertise and ethics produces results.

Call the air and rail transportation experts. Call RESIDCO!

[1] National Center for Policy Analysis, Hillary Clinton’s Capital Gains Tax Proposal, Brief Analysis No. 825, April 14, 2016 by Pamela Villarreal.

[2] WSJ, “Why This Recovery is So Lousy”, August 4, 2016, Phil Gramm and Michael Solon.