CSX Corporation (CSX), Kansas City Southern (KSU): A Shifting Landscape

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CSX Corporation (NYSE:CSX)There’s a storm brewing in 2013, and it has major implications for U.S. rail infrastructure. Two important things are happening simultaneously: Agricultural production is gradually migrating to the north and west, and unconventional oil and gas production is generating more product than the existing takeaway capacity can handle. In both cases, rail is increasingly the preferred transport mode, but the current system may not be up to the looming challenge. My bet is that a whole lot of money will get thrown at this problem.

Shifting landscape
A new study came out on Sunday in the journal Nature Climate Change, depicting the shift over the last half-century of U.S. agricultural production to the north and west. The study, “Effects of climate change on US grain transport,” predicts acceleration in that trend as climate change continues to alter the regions where crops thrive. The authors expect that these changes will add strain to U.S. infrastructure, and that trains will displace barges as the primary mode of agricultural transportation. The study says rail transport must grow “from 8-14 percent due to the more northward shifts in crop mix and a reduction in proximity to the river system.”

In January of this year, the United Soybean Board published a report examining the U.S. railway system and its capacity to support future growth. “Maintaining a Track Record of Success” calls for rail infrastructure expansion to accommodate agricultural sector growth. Here, too, the report anticipates a gradual shift from trucking to rail, especially as rail is cheaper than trucking while producing far smaller quantities of greenhouse gases. The report notes that “the shifting economics of the coal and oil industry will all force additional adjustments in rail investment strategies.”

Last December, the Association of American Railroads published its “Moving Crude Petroleum by Rail” report. The authors explain:

Much of the recent increases in crude oil output has moved by rail from production areas, such as North Dakota, that are not adequately served by pipelines. As recently as 2008, U.S. Class I railroads originated just 9,500 carloads of crude oil. By 2011, this had jumped to 66,000 carloads, and in 2012 will exceed 200,000.

As long as we’re going down that track, we can hardly ignore the Keystone XL elephant in the room. In the rabid battle over whether Keystone gets built, one thing is clear: While Nero fiddles, Rome is laying rail. Many posit that if the pipeline fails to win Obama’s endorsement, the alternative will be to transport crude by rail. But at this point, with backlogs a mile deep and multiple new demand drivers, crude by rail is happening regardless.

Sarbjit Nahal, head of Thematic Investing Strategy at Bank of America Merrill Lynch, recently published an anvil-heavy tome guiding equity investors through strategies to capture the opportunities of the move toward energy efficiency. The report analyzes the energy-efficiency theme by economic sector, with transport far and away the most important — it already consumes half the world’s liquid fuel and is projected to guzzle 60% more by 2035. Given the limited scope for substitution out of oil in the next five years, Nahal predicts that one of the biggest beneficiaries will be rail.

Come on, ride that train…
So who sees an opportunity here? Let’s take a look at who’s where to get a better sense.

Source: U.S. Department of Transportation Federal Railroad Administration.

CSX Corporation (NYSE:CSX) and Kansas City Southern (NYSE:KSU) are all over the eastern seaboard, and they’re both getting skin in the game. CSX Corporation (NYSE:CSX) plans to spend $2.3 billion on wide-ranging expansion activities such as raising highway bridges, enlarging mountain tunnels, and clearing obstacles to make room for double-decker containers from the Midwest to the mid-Atlantic ports.

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