CROSSTIES • JANUARY/FEBRUARY 2015 11

BY RTA FORECAST TEAMThe U.S. economy is performing relativelywell, with an increasing GDP growth rate out-look (S&P). The job market is improving aswell, and is up by 2.1 percent in 2014, thehighest growth rate in 15 years (Federal Re-serve Bank of St. Louis website). Furthermore,real median household income is finally in-creasing (1.2 percent as of November 2014),after a huge decline during and after the mostrecent recession (The Economist Jan. 3, 2015,p. 21).

This shows the economic expansion, whichbegan in mid-2011, is benefiting ordinaryhouseholds. In addition to this, the rapid andunexpected reduction in the price of gasolineand other fuels has released extra spendingpower…another boon for the U.S. consumer.

However, falling crude oil prices create aheadwind in other quarters. As reported byReuters on Jan. 21, three major oil companiesannounced current or future layoffs. BakerHughes has so far cut 1,000 jobs, while Hal-liburton and Schlumberger announced futurejob cuts of 7,000 and 9,000, respectively.

Many small shale drillers are scaling backdevelopment of new wells, and the falling revenue for some leveraged companies may be detrimental as is the case of WBH EnergyPartners filing for chapter 11 bankruptcy as reported by CNBC on Jan. 12. U.S. oil produc-ing states have also been affected. Alaska’sgovernment contemplates a 50 percent cut onCAPEX, mainly roads and bridges.

Furthermore, decreased oil revenue is expected to cause budget short falls inLouisiana. Texas has lost 2,300 oil and gas-production-related jobs to date (New YorkTimes, Dec. 27, 2014).

All of these events will have some negativeimpact on regional banks in these states andWall Street investors are trying to assess thedownside risk (Nathan Stovall, SNL Finan-cial). If affected in this way, banks could be

caught in a suddenwave of uncollec-table loans. This, inturn, would likelysqueeze creditavailable to smalland medium busi-nesses in thosesame states.

Looking BackIn recent years,there was a sub-stantial increase inU.S. oil productionresulting in an in-crease of crude oiltransported by railas well as suppliesfor oil fracking,such as sand anddrilling equipment.The 52nd weekly report by AAR shows in-creases of petroleum and petroleum productscarload shipments by 12.7 percent from 2013to 2014 and 11.6 percent increase of crushedstones, sand and gravel in the same period.

Based on these events, the Railway TieAssociation (RTA) published a tie forecast inthe September/October 2014 issue ofCrossties. That forecast was the result of alter-ing the econometric model to include frackingand crude by rail (CBR) wherever possible inthe model’s equations based on Department ofEnergy (EIA) U.S. oil production forecasts.The outcome was a model that predicted veryhigh tie demand especially in 2015 and 2016.Since then, tie purchases have not picked up;the latest 12-month-ended December pur-chases are 7.3 percent below year-ago levels.

Much of the drop in tie purchases is proba-bly due to limits on the supply side, whichhave been well chronicled. Nevertheless, thiscaused some head scratching and revisions to

the econometric model. One equation (Class 1purchases) was returned to its former state,with no CBR (crude by rail) variable present.Another equation was modified to include theeffects of pipelines on CBR volume. The resultof this second modification produced a betterfit with the historical data.

A second shock that created issues for theSeptember/October forecast took the form ofprecipitous declines in crude oil prices; WestTexas Intermediate fell from a peak of $107.95in June to $46.06 on Jan. 12, a drop of 57percent.

Table 1 shows the forecasted oil prices for2015 and 2016 that RTA worked with, as wellas the forecast revisions in the followingmonths.

So far, the precipitous price decline hasprompted oil companies to decommission agrowing number of rigs. For example, BakerHughes reports that the number of vertical rigsis down 9 percent in the last few months. �

C O V E R : M A R K E T O U T L O O K 2 0 1 5

The Good, The Bad& The Oily

Table 1

Table 2 - Base Case Forecast

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C O V E R : M A R K E T O U T L O O K 2 0 1 5

Rail shipments of drilling pipe, fracking sandand products related to new rig constructioncould decline in short order.

At this time, the Department of Energy’sforecasters expect U.S. crude production tocontinue growing through mid-2015, decline in

the second half, and then resume growth in2016: oil production in 2014 is expected to be 8.67 mb/d. An increase of 7.4 percent is expected in 2015, and further increase of 2.4percent is expected in 2016.

RTA’s econometric model utilizes forecastsfrom the Depart-ment of Energy,as well as fromStandard andPoor’s as inputsfor forward-look-ing tie purchases.Results are shownin Table 2.

This outlook issignificantlylower than RTA’sprevious forecastfor reasons men-

tioned above, but does return demand expecta-tions to the 2013 levels for 2015. The mostlikely downside risk to the forecast is thatcrude prices will remain lower for an extendedperiod of time, further disrupting shale and tarsands drilling activity, resulting in declines forCBR as well as shipments associated with newfracking endeavors.

As illustrated in Figure 1, the world GDPgrowth rate has been slowing down for sev-eral years and with it the demand for crudeoil. Furthermore, RTA found that the tradeweighted dollar index of major currencies has a strong negative correlation with oilprices as illustrated in Figure 2. The S&Pforecast expects the index to rise in 2015 and level off in 2016.

Since the level of oil production depends onthe crude price, for which there is a high levelof uncertainty, the RTA forecast team createdan adverse scenario for tie demand where theU.S. oil production in 2015 and 2016 does notincrease and is held flat at 8.67 mb/d.

For concerns stated above, this forecast isderived from lower CBR, fracking sand andother equipment shipments affecting not onlyshort lines but also Class 1 railroads. The re-sults follow in Table 3.

Upside potential could include a number offactors. Rail industry analyst Tony Hatchreports that domestic intermodal will achieveinvestable returns and that the big bet railroadshave made in the intermodal market will payoff with more balanced and sustainable growth.Hatch also suggests that there is an impendingboom expected for chemical and plastics pro-duction with U.S. exports forecasted to rise 45percent by 2020. This would arguably increaserail shipments and could buffer any downsideto reduced growth in CBR.

Finally, a change in Saudi oil output pol-icy, stabilizing crude prices at a higher levelthan today, plus a successful monetary stim-ulus in Europe would bolster overall railshipments. At this time, the RTA forecastteam sees no reasonable way to quantifythese factors to produce a model based onthem, but acknowledges that the possibilityfor upside to the base case forecast (Table 2) exists. �

Source: IMF, BEA, and S&P

Source: Federal Reserve Bank of St Louis, EIA, and BLS Trade weighted dollar index: EUR 34.29%, CAD29.97%, JPY 19.30%, GBP 9.43%, CHF, AUD, and SEK

Figure 1

Figure 2

Table 3 - Adverse Scenario Forecast