The business environment for truckload carriers promises to remain special at least through 2010, notwithstanding the ebbs and flows of the US economy, Thom Albrecht, managing director of the investment banking house of Stephens Inc, told a general session of the Truckload Carriers Association annual convention in Kissimmee, Florida, March 12 to 15, 2006.
Albrecht was joined in his presentation by Ed Mortimer, director, transportation infrastructure for the US Chamber of Commerce, and by Wayne Harburn, global head of commodities for ABN AMRO, an international banking firm.
Not every quarter will produce the results truckload carriers experienced in the fourth quarter 2005 nor will every year be as great as 2004, Albrecht said. For those carriers with financial backing and management skills, the next several years show great potential. For instance, a mandate for electronic onboard recorders is only a matter of time and when mandated, those recorders will help level the playing field for carriers who are operating correctly. “Carriers who are not playing by the rules should fear onboard recorders,” he said. “In addition, equipping fleets with recorders could squeeze the profits of marginal operators.”
One of the variables in the coming requirement for onboard recorders will be the fleet threshold at which the devices must be implemented. Some safety advocates want recorders in all fleets with more than five trucks; other are willing to exempt fleets with fewer than 20 trucks, Albrecht said. Recorders should actually make life better for fleets that already operate carefully within the rules. Those fleets will have access to much better data about hours of service compliance and many other safety factors, he said.
Reduced truckload capacity
The new hours of service regulations have taken some capacity out of the truckload market, possibly as much as 1% to 2%, Albrecht said. The rules haven't removed equipment from the national fleet; they have required more trucks to move the same amount of freight.
The next several years will produce a cascade of used equipment in the market, Albrecht said. As carriers buy ahead of time to avoid early exposure to engines designed to meet the next round of EPA regulations in 2010, they will be trading trucks from 2004 and 2005 equipped with engines from the 2002 emission regulation cycle. Fleets buying equipment, typically those with less than 100 trucks, probably will get their first experience with the 2002 engines at that time, he said. That poses real potential problems for those fleets. “We all know that the 2002 engines suffered a fuel economy reduction of 4% to 5% when introduced,” he said. “What we don't know is whether or not fuel economy will remain stable or degrade even farther by the time engines have logged 400,000 to 500,000 miles.”
A cascading effect of more complex engines in more expensive trucks into the market could result in a corresponding cascade of fleet consolidation, Albrecht said. Some carriers simply will not be able to cope with the new financial reality.
Truckload carriers will continue to build new capacity, possibly in the range of 5% to 6% in 2006, up from a capacity increase of 4% in 2004 to 2005, Albrecht said. This follows a period when capacity growth was fairly flat, but at least carriers avoided the temptation to indulge in unhealthy growth rates, he said.
Continued rate increases
The outlook for rates among truckload carriers indicates an increase of 4% to 6% for 2006, excluding fuel surcharges, Albrecht said. By late 2007, rate increases will probably slow almost to match the rate of inflation — probably in the 3% to 4% range.
In the past, both shippers and carriers have held to the premise that trucking is a fragmented business. That is no longer quite true, Albrecht said. Big carriers now have a substantially higher market share than at any time in the past. Among truckload carriers, the top 250 carriers control between 50% and 55% of the total market. Stories about rapid growth often come out of small carriers, but the reality is that they don't have enough market share to matter, he said.
The average operating ratio for carriers, both public and private, is hovering just under 95, Albrecht said. When only public carriers are considered, average operating ratio drops to 90.8. Those operating ratios are one of the most significant barriers to attracting new capital for carriers, he said. Currently, banks are willing to make loans, but as soon as any downturn appears, that willingness will disappear.
Margins must improve, because costs are sure to rise soon, Albrecht said. Some carriers who have started negotiations for truck purchases in 2007 are reporting average price increases of $15,000 per truck, he said.
Combined, 2006 and 2007 may present one of the most interesting trucking environments ever seen, Albrecht said. With the potential for added capacity resulting from the prebuying of tractors ahead of the new rules in 2007, the market may begin to look a little flat. However, that needs to be balanced against 2007, a year when truck sales will be down sharply, he said.
Track growth through inventory
Economic growth may work to keep truck sales a little higher than projected because capacity is already so tight. Growth will continue; although, some analysts say that growth could become excessive. It's really hard to judge how much growth is too much, Albrecht said. One good way to analyze growth is to track business inventory, and those figures suggest that 2006 will be a good year.
While the environment may be good, some changes have occurred that the transportation industry has been slow to notice, Albrecht said. Historically, business patterns in the first quarter of any year started poorly and slowly improved through March. More recent patterns show that retailers hold on to inventory for a buying rush that has developed after Christmas. The inventory corrections that once happened in January have now been pushed back into February. That change can be attributed to gift cards, which have become so popular with shoppers. Retailers report that 70% of the value of gift cards is spent within 30 days; so, they need to keep inventory on hand for shoppers seeking to redeem those cards, he said.
Although the economy continues to grow, that may not translate directly into expansion of trucking, Albrecht said. The industry is subject to great turmoil and reacts to factors other than general economic activity. Refrigerated carriers provide a good example. In the course of five years, seven of the top 15 refrigerated carriers failed. That chaos has created a terrific environment for the survivors, he said.
Better economy than reported
The general press seems to hold a negative view of the US economy, but the Chamber of Commerce has a more positive view, Mortimer said. For instance, unemployment is at 4.7%, close to an all time low. In one recent month, the economy created 240,000 jobs, and in 2005, the economy created 2.2 million new jobs. Job creation in 2006 should be about the same. For 2006, the Chamber of Commerce believes inflation will remain flat, probably somewhere just above 3%, while interest rates will rise, maybe close to 7%, he said.
Interest rates as a method for controlling inflation will rise in 2006, Mortimer said. The Federal Reserve will raise rates at least twice and possibly more. This picture may be a little cloudy, because it usually takes a couple of years to begin understanding the views of a new Fed chairman. The previous chairman left the economy in good shape, but it looks as though interest rates have several steady bumps up coming, he said.
Oil prices remain the unknown variable in the economy, Mortimer said. Political comments to the contrary, the national addiction to foreign oil will last well into the future. The new technologies that might wean the economy from imported oil stretch far into the future — possibly 20 years and beyond, he said.
Carriers need to plan for some extensive changes in the freight market. By 2015, the amount of freight moving around the country may double, Mortimer said. “We know that the nation will not double its highway capacity in that time frame, so trucking and railroads must find ways to work together more closely,” he said. “We need to get beyond the mutually exclusive picture of moving freight by truck or by rail, without mixing. The partnership between highway and rail carriers should continue to grow, because truckload carriers have become some of the best customers to railroads.”
Looming infrastructure needs
All of this activity takes place on aging infrastructure. This is the 50th anniversary of the Interstate Highway system, Mortimer said. The last highway bill was all about money but contained none of the vision that originally led to the Interstate system. “When it comes to financing, we all will pay more for revising and upgrading our infrastructure,” he said. “We can argue about how to pay, but we will pay whether in the form of higher taxes at the pump or in tolls. To solve some problems quickly in particularly congested areas, we will see more tolls on stretches of highway that have been free in the past. Some states are looking at truck-only lanes. Taxes at the pump will continue to be the main source of transportation infrastructure funding for at least the next 10 years, but tolls and vehicle/mile taxes will become more common. Those vehicle/mile taxes will probably start at 3.5 to four cents per mile.”
Decisions about oil pricing are made on a daily basis, Harburn said. Bankers must plan for potential changes in that market regardless of whether oil prices rise to $100 per barrel or fall to $30. Since 1998, the price of oil has increased 700%, a massive increase, he said.
“We tend to forget that oil is not just motor fuel,” Harburn said. “I recently heard the owner of a dry cleaner complaining that the price of the bags used to protect clean clothes had gone up four times, forgetting that the plastic used to make those bags started life as a derivative of crude oil. The impact on the economy from oil prices comes not just from its use as energy, but from almost every other product in manufacturing.”
Investors drive oil prices
The economic fundamentals determining the price of oil have changed immensely in the past five years, Harburn said. Five years ago, oil pricing originated almost exclusively with those people associated with the oil and gas industry, whether they actually worked for an oil company or for a banker supporting the oil industry. Those people basically set the direction for oil prices based on the value of West Texas Intermediate in North America or Brent North Sea Crude in Europe. “The change today is so much money in the market chasing too few investments,” he said. “Last year alone, more than $25 billion was put into oil futures as an investment. The investment community now plays a large role in dictating the daily price of oil.”
Pricing plays a dominant role in the availability of oil, Harburn said. “The stone age did not end, because we ran out of rocks, and the oil age will not end because we will run out of oil,” he said. “We will always have plenty of oil. The trick is getting it to a refinery and then getting the refined product to the places where it is needed. Remember, by itself, crude oil is useless.”
For the past four years or so, OPEC has played a much smaller role in setting the price of oil, Harburn said. In fact, the market has played OPEC more than OPEC has been able to play the market. Knowing that oil is a traded commodity, speculators usually try to sell off their positions prior to an OPEC meeting as a way to provoke OPEC into cutting production, causing higher prices. “Traders don't always behave responsibly with the good of the globe, much less the US economy, in mind when they make trading decisions,” he said. “OPEC, as an organization aimed at improving the financial position of member nations, has really had to do much recently to keep oil prices high.
“Maybe Shakespeare had things right when he portrayed bankers as not particularly nice people. Basically, we don't make anything, and in great parts of the world, what we do is considered blasphemy. Banks are there to make money and as long as the ratios are right, banks will be there to make loans.”
Little spare oil capacity
The idea that OPEC has a lot of spare capacity may not be correct at all, Harburn said. OPEC nations are pumping almost all the oil possible. If they have spare capacity, it is probably sour crude, which is not utilized easily in Western economies, because sour crude must be processed in very specific refineries with the capability to remove the excess sulfur content, he said. “In a world that wants cleaner fuels, OPEC influence has dropped,” Harburn said. “Five years ago, OPEC's level of influence might have been seven on a scale of one to 10, but today, that level is probably more likely to be four.”
The cash reserves of nations unfriendly to the West pose a much greater danger than terror activity against oil installations, Harburn said. In those instances where terror attacks have been tried, the terrorists have faced really savage welcomes. Particularly in Saudi, oil installations have a lot of people with a lot of guns, he said. As a result, the risk of terror attacks is no higher today than two or three years ago.
In contrast, some oil-producing nations have huge bank accounts, flush with cash built up over the past three years. Rather than talking about oil as a weapon, the West needs to view the possibility of money as a weapon, Harburn said. Iran, for instance, has reserve accounts approaching $50 billion that could be used for any purpose whatsoever, including support for its nuclear ambitions, he said.
Driver shortage raises rates
Possibly sarcastically, some carriers have said that the driver shortage has resulted in higher rates and wider profit margins. Industry analysts predict that trucking will require an additional 82,000 drivers annually between 2006 and 2010. However, demographic trends may make recruiting those drivers extremely difficult. The population of males between the ages of 20 and 34 is growing at less than 1%, and the number of women in the same age range is growing even more slowly.
Besides pulling more drivers out of a magician's hat, finding more drivers may become a real crisis, Albrecht said. Between 2004 and 2007, the number of both males and females in the age range of 20 to 44 actually declined. When that demographic group resumes expanding in 2008, it will be at a rate of less than one-tenth of gross domestic product growth, approximately three-tenths of 1% per year. “The result may be a redefinition of regional delivery,” he said. “Some shippers are beginning to look at transportation in two categories — trip segments under 250 miles and those between 250 and 450 miles. With the new hours of service, many drivers cannot run 500 to 550 miles a day as they could just a few years ago. The implication of the new definition of regional delivery is that more freight may attract new people to trucking, but under very different conditions than carriers have been used to.”
The industry has to convince a lot more people to choose trucking as a job, and it already has shown a poor success rate, Albrecht said. “I see nothing to suggest that the industry will become that much more successful in the next three to four years,” he said. “Certainly driver pay is going up, but it's still a terrible job, and until rates rise high enough to make much higher pay possible, it will remain horrible.”
Job dislocation won't help
Some carriers talk about recruiting laid-off autoworkers or construction workers as drivers, Albrecht said. Even if it happens, things won't change much. The commercial truck fleet in the US totals 10.4 million trucks of which 3.3 million are Class 8 trucks and tractors. Approximately 3% of the US labor force drives a Class 8 truck. “Let's assume that 100,000 autoworkers or construction workers find themselves in need of a different job,” he said. “If averages hold and 3% of those workers become truck drivers, the industry will have created 3,000 new drivers. If, with outrageous optimism, 50,000 laid-off workers agreed to become truck drivers, the total still would not be near 1% of the total number of drivers in the industry. The hard truth is that job dislocation will not solve the driver problem. It might help in a few select markets for short periods, but it is not a solution.”
Demographic trends do not favor an improved labor climate in the US as a whole, Mortimer said. As a result, the country needs to take a closer look at its immigration policy. “We have at least 11 million undocumented immigrants already working in the country,” he said. “We need to find a way to assimilate those workers, to get them moving toward citizenship and full integration into the economy.”
The second part of solving the labor puzzle involves education, Mortimer said. As long as a high school diploma is seen as the basic educational level for truck driving and many other jobs, the business and educational communities need to work harder to improve graduation rates.
Carriers also face difficulty finding new drivers and keeping the ones they have in a climate of increased security awareness, Mortimer said. The problem of finding workers with clean criminal backgrounds is growing. Education can help fill this role by working with young people to keep them from going down the wrong path from which they will find it increasingly difficult to work in a security-conscious nation, he said.
In addition to a driver shortage, carriers face a fuel crunch in 2007 with the advent of ultra low sulfur diesel in addition to new engine technology. Some analysts such as Albrecht say that carriers will buy new equipment ahead of the effective dates for the new equipment. Others such as Mortimer discount the prebuying phenomenon.
The Chamber of Commerce does not project a repeat of the big impact on truck sales from the new emission regulations that happened in 2002, Mortimer said. The industry is more prepared for the changes and will not react the same way again. However, trucks sales will be stronger prior to the introduction of the new engines than in the months immediately after they come on the market, he said. In 2002, the new engines frightened carriers into buying early. “We hope the industry is better prepared this time and that 2007 will not see the big drop in truck sales that happened in late 2002 and through 2003,” Mortimer said.
Constant changes in fuel specifications make trouble for financial markets, Harburn said. Oil trading needs a certain level of stability to make the futures markets work. Changes in fuel formulation make it almost impossible to trade in the future, he said.
At the top end of the scale, diesel prices seem to be less flexible than gasoline prices, Harburn said. This seems to indicate that diesel prices don't carry the same political clout of gasoline prices. When gas prices reach a given level, a great deal of pressure is brought to bear aimed at reducing those prices, he said.
Worldwide diesel demand
The supply of diesel worldwide is becoming tighter, Harburn said. The US, because it has not built a new refinery in more than 20 years, must buy both gasoline and diesel fuel on the open market, usually from Europe. Automakers in Europe are building more diesel power cars with the result that Europe has little surplus diesel to sell, he said. As a result, diesel prices do not subside as quickly as gasoline prices after a price spike.
Imposing ultra low sulfur diesel fuel on the US market has the potential for disaster, Albrecht said. As is typical of the federal government and EPA, no one considered the practical ramifications of mandating this new fuel. Ultra low sulfur diesel will cause both supply problems and pricing problems. The supply problem will quickly become apparent at truckstops. Even if plenty of fuel is available, truckstops will have no incentive to stock their tanks with ultra low sulfur diesel if only a small minority of the trucks on the highway need to use it, he said. “Truckstop operators are not going to install a separate set of tanks, and they are going to continue to sell conventional diesel fuel,” Albrecht said.
The first six months to a year will show a total mismatch between the number of trucks with '07 engines and availability of ultra low sulfur diesel, Albrecht said. The new fuel also will have an impact on the level of fuel surcharges carriers can collect, he said. Fuel surcharges are based on national average price as one of the main components. “If ultra low sulfur diesel costs 30 to 40 cents more than conventional fuel, carriers won't be getting their full surcharge,” Albrecht said.
The US has shown the benefits of free markets and democratic government to the world, and to the dismay of many a good part of the world is following the example, Mortimer said. In many parts of the world, the US is facing true competition for the first time. “Globalization fosters competition, and sometimes we may not be too happy with that result,” he said.
Another factor in US competitiveness revolves around demographic trends. The day is rapidly coming when almost two-thirds of the population will reach retirement age, Mortimer said. That will leave one-third behind to pay taxes to support in part or in total the retired two-thirds. One of the choices that the coming retirement forces is whether or not to allow enough immigration to fill the labor pool or continue to outsource a lot of products and services, he said.