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Railroad freight is a volume business. Shippers and receivers are unlikely to turn to the nation’s railroad carriers for those freight cars if their volumes are light. That is simple economics.
However, if a company is a high-volume shipper, then its management will consider owning or renting its own railcars.
If the company is shipper of chemicals or crude oil, the answer is simple. There are no railroads providing free rail tank cars. Therefore, the company’s management must choose between owning or leasing the tank cars needed to carry its products.
Other shippers of commodities from coal to grain can rely in large part on using railway pool equipment. If sufficient railcars are available, then leasing or buying railcars is optional.
Overall, more than 60 percent of North American freight cars are leased or owned by others – not by the railroads. It wasn’t that way 50 years ago, according to Progressive Railroading. The private source share shown in the pie chart includes some small private railroads, shippers, receivers and some railcar manufacturers with ownership.
Railroad companies like Canadian National Railway (NYSE: CNI) and Norfolk Southern Company (NYSE: NSC) own various railcar types like gondolas for steel and pipe, covered hopper cars for grain, and open top hopper cars for coal, ores and similar bulk commodities.
Railroad boxcars are another exception to the overall private car pattern. As of 2015, North American railroads owned more than 75 percent of all boxcars.
So why would a shipper lease or purchase a railway freight car? After all, leasing or owning adds to a shipper’s logistical burden.
The pros of leasing or owning railcars
Having greater control of the supply chain is likely to be the most critical reason a shipper would decide to own or lease its own railcars.
With railcar lease or ownership, shippers are not subject to the vagaries of supply and demand from other users of that railcar type. Shippers directly control available transport capacity by linking their car fleet directly with their production line.
Shippers also control their forward inventory movement. They can move commodities forward to holding yards closer to the next step in the production process, or to their own or customers’ factories or distribution centers.
Ownership or leasing also can reduce the demurrage charges assessed by railroads. Demurrage has been a major issue this year, with Surface Transportation Board hearings taking place in May.
The corollary on demurrage, however, is that private railcars cannot be randomly left at critical railroad yards or holding tracks. Instead, the railcars would have to be moved to private yards or storage tracks.
Another benefit is that private railcars act as portable storage units – if the final receiver unexpectedly can’t handle railcar delivery or unloading.
However, shippers should be beware. Railcar leasing is not a trip lease. Railcar leasing is a relatively long-term commitment to possession and use. Railcar leases are subject to negotiation of terms. But in a conventional business cycle, a railcar lease is for a seven-year period, plus or minus.
In contrast, owning a railway freight car is often a 30-year or longer capital commitment. Railway freight cars last much longer than semi-trailers or containers do. Actual rail car life often exceeds 40 years.
Finally, railroad rates are typically discounted if shippers provide their own railcars. Why? Because the railroad gets a better return on its balance sheet by not owning “your” cars.
The cons of leasing or owning railcars
Leasing or ownership comes with administrative burdens and financial issues.
Leasing and ownership both require a corporate fleet management function. Then there is the burden of overseeing the periodic car maintenance functions within prescribed federal safety rules and the terms of the negotiated lease.
There are financial and cash flow requirements. If a shipper is new to shipping by rail, its management must either decide to staff up or contract for expert help to negotiate the process. Fortunately, there are reputable service providers and consultants to help. There is even an annual forum that examines the complexity or leasing, owning and pricing.
There are also fleet sizing and purchase timing issues. For example, shippers want to avoid buying or leasing into a fleet size bubble.
Another key consideration is that these cars are very expensive. New railcars a decade ago cost about $90,000; they now fetch a 2019 price in the $140,000 range.
Be aware, that railway equipment contracts are strictly enforced. This is not like agreeing to a movement contract on a spot rate basis. Leasing and owning railcars is a serious legal and financial commitment. Enforcement of terms tends to favor the lessor – which may be a bank, a third-party or the railcar manufacturer.
Storing excess railcars when there is a downturn in the nation’s economy can be expensive as well. Leasing too much equipment can result in both ongoing monthly payments plus fees to private track owners or small railroad companies that “might” have space available to store railcars not needed. Parking fees often range from $100 to $450 or more per railcar per month.
Need to store railcars with undelivered commodities inside? That comes at a higher storage fee and sometimes also with regulatory inspection requirements.
Need to move the railcar from one storage spot to another? Then expect to pay both a car-miles and a switching fee to the railroad. Switching costs often are in the $300 and up range for both the empty and the loaded position switch.
The biggest uncertainty may be the risks of leasing or buying at the wrong time. For example, in March 2019, some car brokerage appraisers and experts warned “… there are just too many cars in the system.” It appears to have been an accurate assessment. Have investors listened and reacted?
Today, about 20 percent of the 1.67 million North American railroad car fleet as measured by the American Association of Railroads is technically in storage. That means almost 360,000 freight cars are not being used at this time. Due diligence suggests that over-supply risks are periodically much higher. A decade ago during the Great Recession, about 30 percent of the North American freight railcar fleet was estimated to be in storage.
Therefore, expert market intelligence and market timing are critical to making these private freight railcar asset decisions.
Conclusions
Owning and leasing a fleet of railcars when a company’s core competency is in manufacturing or something else is a tough decision.
Four decades ago, when so many railroads like the Penn Central and Milwaukee Road were in bankruptcy, private railcar leasing and ownership was an easier decision. Many railroads were simply incapable of meeting railcar supply demand back then. The rail industry’s 1970 era return on invested assets was only 2 percent and their costs to borrow were much higher.
Today, adding new private cars – or modernizing an aging railcar fleet – is more prevalent. But the process is a challenge. Often buying used equipment that was well-maintained by the previous users can be a better approach than buying new.
Older, well-maintained railcars at low-demand periods might be available at about $30,000 per railcar. How does a shipper make those choices?
There are responsible parties that specialize in such transactions. They can independently appraise both market value and mechanical condition of the railway cars.
These third parties can help shippers navigate the process of registering the equipment with multiple organizations. Soliciting financing is also a critical task. The good news is that there are many competing potential investors in the private railcar market.
Acknowledgements:
- Association of American Railroads
- Bascome Majors, Susquehanna Finacial Group, LLP
- Patrick Mazzanti, President, Railroad Appraisal Associates
