October 2008, TruckingInfo.com - Cover Story
A year ago, experts predicted we'd be turning the corner on the sluggish economy by now. They were wrong. Two things happened this year that economists didn't predict: a huge spike in oil and fuel prices that dug deep into the wallets of consumers and businesses alike; and a credit crunch, triggered by the housing crisis, that spread further than most people expected.
The credit crunch has gotten so bad, last month the government stepped in and took control of giant mortgage companies Fannie Mae and Freddie Mac. Wall Street giants Lehman Brothers and Merrill Lynch were filing for bankruptcy and sold to Bank of America, respectively, while the federal government bailed out AIG.
The economy, as measured by Real Gross Domestic Product, shrank 0.2 percent in the last quarter of 2007 and only posted a 0.9 percent gain in the first quarter of 2008. Second-quarter GDP was much better, but may not reflect a real turnaround. Most predictions call for at least two more quarters of sluggish economic growth.
The Fuel Factor
Obviously fuel costs - with diesel hitting record highs of over $5 in some areas of the country over the summer - has hit the trucking industry hard. Fleets are responding by cutting top speeds, using computer programs to analyze and improve routes and driver habits, and assessing fuel surcharges. All these things have helped the industry weather the high prices much better than during the last downturn and fuel price spike in the 2000-2001 timeframe.
But fuel surcharges only cover about 75 to 80 percent of fuel cost increases. Chock the rest up to empty miles, out-of-route miles, reefer fuel, the difference between actual miles and billed miles, and fuel used while idling, points out trucking consultant Lana Batts, former president of the Truckload Carriers Association.
"The final [thing] adding insult to injury is the shippers don't pay for 30 to 45 days after you've actually paid for the fuel," Batts says. "So that's what the problem has been - the delta between what I'm getting in my surcharge and what I'm actually paying in fuel increases. And it's a cash flow problem for most carriers. Which is why you see factoring on the rise. Most carriers that are in trouble, it's not because the shippers aren't paying, it's because they're paying late."
But fuel costs have impact far beyond the cost to fill your trucks' tanks.
"In the U.S., we consume somewhere around 200 billion gallons of gas and diesel every year," explains Kenny Vieth, ACT Research's heavy truck and trailer market analyst. "So that means every penny increase in [fuel] price is $2 billion that is diverted from consumer spending or from business investment." And consumer spending makes up about 70 percent of the economy.
The good news is, fuel and oil prices have dropped from their dramatic summer highs.
"With oil prices coming down, and the speculators out of the marketplace, I think it's going to give a chance for consumers to recover and for profitability to come up a little bit for businesses," Vieth says.
However, experts say we probably will never see oil drop back down to $30 or $50 a barrel. Most say a price around $100 a barrel is probably reasonable for the near and medium term. Our experts cited numbers ranging from about $85 to $120 a barrel would be supported by "fundamentals" such as supply and demand and the value of the dollar.
OPEC will likely not take further steep declines in the price of oil lying down. Last month, OPEC announced members would trim the amount of over-quota production in an effort to keep prices from falling further.
In the long term, watch out. Charles Maxwell, senior energy analyst with Weeden & Co., told Barron's that the price of oil today should be between $75 and $115, but that between 2010 and 2025, we may face "a lack of sufficient power to drive our economy on an upward course." He predicts prices of $300 a barrel (roughly $250 in today's dollars) by 2015.
This economic downturn started with the housing sector bust. "Whenever something grows much faster than fundamentals like supply and demand dictate, you're going to pay for it later," explains American Trucking Associations Chief Economist Bob Costello. "When home prices went up an average 15 percent a year from 2000 to 2005, that was unheard of. It was the biggest housing boom probably in history, certainly in a couple of generations - and now we're paying for it."
The housing bust has had major repercussions in the financial markets. During the housing boom, banks made loans to many people they shouldn't have. Now it has gone 180 degrees in the opposite direction. "Now there's people that should be able to get credit that can't," Costello says. "That's what we call a credit crunch." And it has extended well beyond mortgages to credit cards and other types of personal and business loans.
"The Federal Reserve can cut interest rates as low as they want," Costello says, "but if banks and other financial institutions don't want to lend money, it doesn't mean a hill of beans."
In an interview a couple of weeks before the government bailout of Fannie and Freddie and the developments with Wall Street's big investment banks, John Larkin, who heads up transportation research at Stifel, Nicolaus and Company, explained that, "As long as little banks are failing, and people are talking about the need for bailout of Fannie Mae and Freddie Mac, as long as there's a question about what's going to happen to [global investment bank] Lehman Brothers, I think people are very, very cautious with respect to extending credit. And without credit, it's difficult for the economy to grow."
There was hope that the early September federal bailout of Fannie Mae and Freddie Mac (which together hold or guarantee about half of the nation's home loans) would help address this problem, bringing mortgage rates down and injecting needed confidence into the financial market.
As we went to press, the Federal Reserve and central banks in other countries were working to pump billions of dollars into the world's banking system to help strengthen the financial markets and boost investor confidence. How the crisis on Wall Street will affect Main Street USA as we head into 2009 remains to be seen.
When trying to sort out what the economy is likely to do in the coming year, economists' jobs have been made more difficult by mixed messages from the usual economic indicators.
"It is a confusing time, because there seem to be a lot of contradictory data out there," says Ken Simonson, chief economist for the Associated General Contractors of America and a former ATA economist.
One of the biggest contradictions was the government's revision of second-quarter Gross Domestic Product growth from 1.9 percent to 3.3 percent. But our experts say that second-quarter GDP number is a bit misleading. For one thing, it partly reflects the economic stimulus checks from the government, a one-time boost. In addition, high exports and low imports boost the GDP number without really reflecting the bulk of the economy.
The weakness of the dollar compared to currencies abroad has helped bolster exports. That has made this downturn less painful than it otherwise would be, but not as painless as those second quarter GDP numbers seem to suggest.
"Now that we're not sending our money overseas, the GDP rises," explains Noel Perry, a consultant with Transport Fundamentals, Cornwall, Pa. "The question is, does that mean there's actually more freight moving?" The answer, most of our experts feel, is no. They also predict the growth of exports will slow along with the global economy.
Truck volumes are also making it hard to get a grasp on how things are going. The numbers "are very, very choppy," Costello says. "They look great one month and not very good the next, even week to week. That has been very reflective of this [economic] cycle."
Some parts of the trucking industry are doing better than others. For instance, companies hauling materials for export, like heavy construction equipment or coal or grain, are doing well. Energy-related freight, such as ethanol, or parts for wind farm equipment, is doing well. Fertilizer hauling is up because of the farm boom. In flatbeds, if you're hauling construction materials you're in the doldrums, but if you haul steel you're seeing a boom right now because higher transportation costs of cheap steel from China have suddenly made U.S. steel more attractive. Automotive freight, whether it's auto hauling or transporting parts to the assembly line, is in the toilet right now.
Private fleets are for the most part still in a growth mode, says Gary Petty, president of the National Private Truck Council.
"The rate of growth maybe isn't what it would have been had the markets grown [this year] as they did in 2005, but nonetheless, they're growing," he says. "[In] the benchmarking survey we did this year, two-thirds or more of our fleet members said they were growing."
In addition, numbers were looking up in the second quarter for many of the large publicly traded carriers. Companies such as Con-way Truckload, Knight Transportation and Celadon reported better numbers and commented that capacity was tightening. "We are encouraged and cautiously optimistic that the second quarter reflected a first step toward a more favorable relationship between freight tonnage and industry wide trucking capacity," said Kevin Knight, chairman and CEO of Knight Transportation, in the company's second-quarter earnings release.
The Coming Capacity Crunch
At least in the truckload portion of the business, capacity appears to be tightening. High fuel prices continue to take weaker trucking companies out of the market. At the same time, many large carriers have reduced fleet sizes. And some trucks have been taken out of the U.S. market entirely, sold to foreign buyers in Eastern Europe and Central and South America.
According to Donald Broughton with Avondale partners, just over 1,900 trucking companies with at least five trucks went out of business during the first half of this year, taking about 88,000 trucks off the road. Costello reports the truckload fleet shrank 2.6 percent in 2007 and another 1.3 percent the first half of 2008.
In addition to the number of smaller (and a few larger) companies exiting the playing field, Larkin points out, "some of the big truckload carriers [have decided] to downplay their traditional truckload business and move into non-traditional areas like regional, dedicated, intermodal, truck brokerage, those sorts of things. You've also seen the LTL industry lose some capacity as some carriers have downsized and some have gone out of business. So we may have seen the worst of the pricing, and it will improve a little more dramatically once the demand begins to come back again."
ATA's Costello, too, says that in general - not in every lane, not in every sector - supply is shrinking down to demand, especially on the truckload side. "So if freight were to just pick up a little bit, I think you would see much tighter conditions in the truckload market. You don't need a lot of growth for things to feel a lot better in the industry and to get financially healthier."
Adding to the capacity picture, many say, is the fact that we have exported a large number of trucks to places like Russia, Africa and South America. We've heard estimates of between 30,000 and 100,000 in 2007 and 2008, with most of our panel putting it around 40,000-50,000 in the past two years. That compares to exports of about 2,000 trucks a year during the downturn of 2000-2001 time frame.
"That's a huge number of trucks to pull out of the system," Batts says. "And they're gone, poof. Those trucks are not sitting on a used truck lot someplace waiting for a guy to grab the keys and think he can make a million bucks."
Two analysts who specialize in tracking commercial truck sales activity, however, are skeptical of just how much effect the exported trucks will really reduce the universe of commercial trucks in this country. Stu MacKay with MacKay and Company says the commercial truck universe has 2.7 million trucks in it. Eric Starks, president of FTR Associates, says R.L. Polk figures suggest there are 3.5 million Class 8 trucks registered. Compared to 3 million, more or less, 40,000 to 50,000 is a drop in the bucket.
Nevertheless, Starks does believe there are not as many trucks sitting this cycle as there were during the last downturn, whether it's due to exports or to the fact that "the industry's gotten a little savvier in right-sizing the market and didn't go as crazy as before."
"Capacity is coming out of the system, but that's mostly for the large over the road, for-hire fleets," he says. "That doesn't take into account the private guys and those guys doing shorter length of hauls that are parking those trucks. Our contention is the capacity is not gone; it's just temporarily parked, so it artificially props up the tightening of capacity. So they are able to push through some incremental rate increases, maybe 11/2, 2 percent in the second half for the large truckload guys."
When the economy starts coming back, there will still be trucks to take out of mothballs to put a damper on that tight-capacity scenario - at least at first. No one we spoke with had hard numbers, but MacKay says his company's monthly surveys of fleets indicate there are a lot of trucks parked. "So there's a fair amount of capacity to put back in place with what's already out there and sitting."
Once the economy really does pick up, though, most agree that there will be a capacity crunch - and the driver and owner-operator shortage will be "back with a vengeance," says ATA's Costello.
Desperately Seeking Drivers
As fleets have been shrinking the last year or two, they haven't been desperately trying to find quality drivers, Costello says. A year from now, he says, they will be. "It's not like in the last year and a half the demographics have suddenly improved in our benefit. Demographics are still going to work against us, and the fleets have to be prepared for that."
Larkin also talked about demographics and the coming driver shortage, pointing out that the industry's core drivers, who are in late 40s to late 50s, are getting close to retirement.
"If the FMCSA were to come in with more restrictive health standards, some of those very good truckers might not be able to continue," Larkin says. "You kind of wonder where from GenX and GenY you're going to find enough people to man all these trucks. You don't need a Stanford MBA, but you do need someone who can pass a drug test, who doesn't have a criminal record, who is responsible and physically capable of operating an 80,000-pound rig, and that's a pretty tough set of criteria to match up against for a job that is not seen as being terribly desirable."
Batts predicts that many fleets will want to expand their capacity rapidly by using owner-operators - and will find out they're not available. The slow economy, high fuel prices and slow-paying shippers have hit owner-operators even harder than the rest of the industry. There's no definitive source of owner-operator business failures, but common sense says a lot of them are out of business.
"Everyone you talk to who says they're going to make it through this, you ask how are they going to grow, they say they're going to use owner-operators," Batts says. "But where are you going to find them? It's not immaculate conception in owner-operators."
And it simply takes time to find drivers or owner-operators, Perry says, estimating it takes about a year and a half to expand the typical over-the-road fleet by 5 percent. "So it is probable we will get the type of shortages we did last time. And if like last time there's some kind of a shock (like changes in hours of service regulations last time), we could get to a tighter market than occurred last time. We could have an unprecedented situation in trucking in late 2010, 2011."
Too much of a capacity crunch could be not just a hindrance to growth for transportation, but also a hindrance to growth for the general economy, Starks says. If the down cycle goes on fairly long, he says, all transportation modes, not just trucking, will have problems adding capacity back fast enough to meet the needs of the rebounding economy.
Those who have the capacity will reap the rewards.
"The long run looks good," Batts says. "The issue is, how do you get to the long run?" LOOKING INTO A CRYSTAL BALL
Predictions call for at least two more quarters of very slow economic growth. The most optimistic of our panel see a recovery starting in the second quarter of 2009; the most pessimistic say it will be late in the year. Most say look for the beginnings of recovery mid-year at the best, and don't expect something more like normal 3-percent GDP growth until at least 2010 and maybe 2011.
Will we "officially" go into a recession? Most of our experts thought it unlikely. "Personally I don't think we're in a recession or going into one, but obviously if you've lost a job or are running a company that had to lay off workers, it certainly feels like a recession," says Ken Simonson, chief economist for the Associated General Contractors of America. "It is, I'm afraid, the beginning of a period of sluggish growth, so that the economy may not be adding jobs on balance for several more quarters. And personal income may be falling short of inflation at a consumer level."
They also questioned whether technically going into a recession really makes any difference. "From our standpoint, will it be defined as a recession or not is kind of academic," says Eric Starks, president of FTR Associates. "We're looking at at least two more quarters of very sluggish or no growth. If it is a recession, I don't think it's going to change the dynamics of what people and businesses are feeling. So in essence you will be a in a recession type of environment at least through the end of this year."
So once we get past the first quarter of 2009, what then? Our economic experts weigh in:
Bob Costello, Chief Economist, American Trucking Associations
"We don't see a sustained recovery in the U.S. economy until the second quarter of next year." However, Costello believes trucking may be pulling up out of its recession sooner.
"The last two recessions that the U.S. economy went through in the early '90s and 2001, trucking went into recession and was out of it in both instances before the U.S. economy ever went into recession," he says. This time, we've already gone through a freight recession - tonnage was down in both 2006 and 2007, but it's now growing at a moderate pace. "But I think volumes will still continue to be choppy."
The Freight Transportation Services Index from the U.S. Bureau of Transportation Statistics would seem to indicate things are looking up for transportation in general (it tracks for-hire trucking, rail, inland waterways, pipelines and air freight). For the first seven months of 2008, the freight index advanced 4.2 percent, its largest increase for the first seven months of the year since 2002. Compare this to 2007, when the index dropped 0.4 percent in the first seven months of the year.
At 112.9 in July, the freight TSI was up 4.5 percent since its recent low of 108.0 in September 2007 and almost hit its historic peak of 113.1 reached in November 2005.
The American Trucking Associations' advanced seasonally adjusted For-Hire Truck Tonnage Index fell 0.3 percent in July, the first month-to-month drop since April. But the seasonally adjusted index was 4.4 percent higher compared with July 2007, marking its ninth consecutive year-over-year increase. Year-to-date, the index was up 3.6 percent compared with the same period in 2007. Tonnage contracted 1.7 percent and 1.5 percent in 2006 and 2007, respectively.
"We think 2009 will be better than 2008 and significantly better than we've been seeing the last couple of years," Costello says.
Kenneth Kremar, Capital Goods and Freight Transportation, Global Insight
"We're looking for the consumer to be very, very cautious," Kremar says, predicting 1.5 percent GDP growth this year and 1 percent in 2009. "The housing market is still going to be very, very soft, so any traffic loads related to consumer spending or housing or even the light vehicle market are going to be lackluster. Corporate America is already cutting capital spending, and that is going to continue into the next year."
Kremar says the areas that are weak this year (residential construction, automotive, etc.) will continue to be weak next year. Plus non-residential construction, which has been doing okay, is expected to weaken.
By the second half of 2009, he predicts, some of these markets will have bottomed out, credit will have loosened up a bit, and some of the inflationary pressures will be easing. "You do get a little bit of improvement in the economy in the second half of next year, but we're not really talking about the economy getting strong again until very late 2009. Not until 2010 or 2011 will industries start to come back.
"So I think in a general sense, the trucking industry has probably got some rough road to face into the first half of 2009," Kremar says. "It will look better as you're leaving the year than it will as you begin the year, but overall it's going to be a very mixed bag this year and it will continue to be so in 2009."
John Larkin, Transportation Capital Markets Research, Stifel, Nicolaus and Company
"We're thinking we'll begin to see some evidence of recovery in the second quarter of next year," Larkin says. "By then a lot of the credit crisis issues will be behind us, the uncertainty of the election will be behind us, oil and energy prices will have stabilized; you might get another dose of fiscal policy stimulus of some sort."
Larkin believes the earliest we'll have a normal year as far as the economy goes is 2010. However, he says, "from a transportation point of view, the second half of 2009 could be very strong because you've lost so much capacity. Just a gradual improvement in demand will set up a favorable supply/demand relationship that could put the pricing power squarely back in the hands of carriers. Certainly a year from now things could look a lot better, even if we're just in the early stage of the [economic] recovery."
Nol Perry, Principal, Transport Fundamentals
"Looking forward, the signals for the near future are not very good from an economic standpoint," Perry says. The automotive industry is heading for its worst year since 1986, the housing market still may not have bottomed out, and employment is starting to slip - the Conference Board's Employment Trends Index continued its year-long decline in August, suggesting there is little likelihood of a turnaround in the job market anytime soon.
"The most likely case is the economy isn't going to recover till the middle of next year, so we'll have another extended period of slowness," he predicts. "For trucking, not much is going to change. We'll kind of bounce along at the bottom, and the guys who are running sharp fleets will pick up profitability a little bit."
The second most likely outcome, he says, is an outright recession. That's worth about 5 percent in volume, according to Perry. "If that happens, you'll have two things going on. First off, the capacity ratio would go down, you'd have another round of stress and some of the more visible fleets that are struggling might go under. And you'd also have some pretty high-profile bankruptcies among auto suppliers and retailers.
"Once we get out to this time next year, the prospect of recovery is much stronger," Perry says. "The question is, will it be at the middle or the end of the year?"
Gary Petty, President and CEO, National Private Truck Council
"I think some markets are going to get worse. It's going to be continued fallout of the housing industry; that obviously affects a lot of companies that are tied to that business. I think generally for trucking, even though the next year or two may be relatively down in terms of growth of truck sales, I think '09 is going to maybe be a bottom year for the economy overall," and 2010 we'll see a return to a more normal environment.
"I think '09 will see a shakeout of companies that are not competitive in this business, and it's going to have an impact on capacity," Petty says. "In a broader sense that's all the better, because in the ever-increasing standards of higher expectations, it's natural that the competitive standards would rise to those that are able to compete long term and the margin will get weeded out."
Ken Simonson, Chief Economist, Associated General Contractors of America
"I would expect real, inflation-adjusted GDP to grow at a 1 to 2 percent annual rate through most of 2009," Simonson says. "That's far below the historical average of 3 percent, but it's above the recession level traditionally defined as a negative change."
Simonson expects we will see several more months of very low housing sales, and even once sales begin to pick up, it will be six months or longer before home builders resume construction. He does see hope that we are near the bottom, because existing home sales and pending home sales seem to have stabilized. He is hopeful that a small gain in residential construction will show up in the last half of 2009. Non-residential construction did well in 2007, expanding 16 percent, but much of that was due to skyrocketing material costs, and he expects it to grow only 1 percent to 5 percent for 2009.
Looking beyond next year, Simonson notes that non-residential construction tends to lag the overall economy by as much as two years, so he doesn't expect strong growth in that sector until 2011.
Eric Starks, President, FTR Associates
"Our contention is it's either going to be similar going forward or it can deteriorate a little bit worse," Starks says. "Any kind of a turnaround, especially talking about the truck sector, really we're not looking for any kind of an uptick until the second half of 2009."
Orders for trailers have plummeted recently, he said, and orders for heavy trucks have stabilized at pretty low levels.
He predicts things to be down in the third quarter of this year and then sluggish into the fourth quarter. FTR is predicting 1.4-1.5 percent GDP growth for 2008 and about 1.6 percent for 2009. "That's substantially below trend growth, which is right around 3 percent. So that's definitely going to continue to feel like recessionary levels at least from a trucking standpoint."
Kenny Vieth, Partner, ACT Research
"We're thinking as we go into 2009, GDP somewhere in the 2 percent range would be a reasonable expectation," Vieth says. "With oil prices pulling back, and slower global economic activity, that should set the stage for a deceleration in inflationary pressures, which should eventually work themselves back to rising [disposable] income levels again."
Vieth also believes while exports will not grow as fast as they have, they will continue to benefit the economy.
"Business profits have been getting squeezed, but if we look at them excluding financial corporations they're not doing too awfully bad, so there still is the opportunity for modest increases in business investment."