Higher oil prices could drive rail traffic
A spike in oil prices due to Iran's threats could divert traffic from trucks, but higher fuel costs would pressure railroad margins.
Energy analysts have stated that Iranian action could lead to an increase of 50% or more in the price of oil. Rising fuel prices could help fuel-efficient railroads, such as Norfolk Southern Corporation (NSC), CSX Corporation (CSX), and Union Pacific Corporation (UNP) as traffic would be diverted away from trucking. However, it could also put pressure on rail companies' margins as fuel represents a major portion of their operating costs.
As manufacturers look to reduce costs and fuel prices skyrocket, we expect that they will look to more fuel-efficient methods of transporting goods than trucks. According to a study by the Federal Railroad Administration published in 2009, rail fuel efficiency ranged from 156 to 512 ton-miles per gallon, compared to truck fuel efficiency of 68 to 133 ton-miles per gallon.
As rail carriers develop intermodal facilities -- which entail shipping using more than one method of transportation -- and improve their networks, we believe that they will be able to take a sizable portion of freight off the roads. Last year saw pressures building on the trucking industry as intermodal showed continued growth for all Class 1 railroads.
The absence of pricing regulation in the rail industry helps railroads pass on some of their rising fuel costs to customers. The increase in fuel surcharge revenues, along with generally better industry pricing and modest growth in traffic volumes, helped railroads post strong results last year. For Norfolk Southern, fuel surcharge revenues increased by $179 million in the third quarter last year. But a potential spike in oil prices due to Iran's threats could pressure railroad margins as fuel contributes to higher operating costs.
We have a $91 price estimate for Norfolk Southern, implying a 20% premium to the current market price.
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The solid report comes a month after the retailer closed all of its Canadian operations.
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