Rates across all modes going higher as growing demand collides with taut supply

Freight rate increases have shown the whites of their eyes.

A monthly index of freight activity released today by audit and payment firm Cass Information Systems showed that October freight expenditures—the prices paid by shippers to move their goods—rose 6.4 percent over the same period in 2013 and gained 11.8 percent from December 2013.

Expenditures in October rose 0.1 percent from September's totals, as a dramatic decline in diesel fuel prices reduced the impact of fuel surcharges on carrier rate structures, Cass said.

The now-familiar culprit is a chronic supply shortage exacerbated by increasing congestion at several Gulf and West Coast ports, notably the Ports of Los Angeles and Long Beach, which handle about 40 percent of the nation's containerized ocean import traffic. Shipment activity in October fell 0.9 percent from September totals, reflecting the supply chain's continued problems getting goods through the ports and into U.S. commerce, as well as a decline in September for new orders of manufactured goods, according to the report.

However, the slack in orders is not expected to last. The Institute for Supply Management's (ISM) monthly report on business, released last week, reported new manufacturing orders rose in October by 5.8 percent over September, while order backlogs increased by 6 percent. The data foreshadows "strong factory shipments in the coming months," which should put further upward pressure on prices, according to the Cass report.

Shippers are trying to fight off the increases, but in most cases they have no choice due to widespread capacity shortages of rail, truck, and maritime equipment, as well as the labor needed to man them, the report said. "Expect rates to continue to move up more quickly in the coming months," the report predicted. Cass' databases are derived from the $23 billion in freight transactions that Cass processes annually on behalf of its shipper client base.

RAILS TO BENEFIT
William J. Greene, lead transportation analyst for Morgan Stanley & Co., said in a note today that the railroads would be the prime beneficiaries over the next two years of the supply tightness in all transport markets. Greene said he had been conservative about the outlook for rail rates in the belief that pricing growth was dependent on railroads fixing the myriad service problems that have plagued them all year. However, given the severe supply shortages across the modes and the funds and manpower the rails are dedicating to restoring their service levels, Greene said that rail pricing could accelerate sharply over the next two years. Rail operating margins could be fattened further if service levels improve, which Greene forecast will occur starting next spring.

Another tailwind for railroads starting in 2016 is that a large chunk of revenues are tied to multiyear contracts with an average duration of three years. Each year, about one-third of all multiyear contract business comes up for renewal, meaning that two-thirds of contract business not repriced during 2015 will be at below-market rates in 2016, Greene said. "Thus, contracts renewed in 2016 should see rate increases that exceed 2015 renewals," Greene said in a research note.

Overall, shipping demand will continue to exceed supply as the U.S. transportation network sags under the weight of capacity constraints and increased volumes, according to Greene. "As such, we expect enhanced pricing power across transportation modes to follow," he wrote.

If there is some relief for shippers, it could come in the form of October data on North American heavy-duty truck "net orders" released last week by consultancy FTR. The firm said net orders—the number of new orders minus order cancellations—hit 45,795 units, the second-highest order month ever recorded, and a stunning 76-percent increase over October 2013. FTR called the increase "phenomenal."

"The huge amount of orders was driven by several very large fleets placing orders to be built throughout 2015," said Don Ake, FTR's vice president of commercial vehicles, in a statement. "This is the result of the industry operating near full capacity and fleets having confidence that freight growth will remain strong for the entire year in 2015. They want to lock in their orders now to guarantee future deliveries."

For almost a decade, new equipment has been used to replace aging trucks rather than to expand fleet sizes. Now, given the increase in shipping demand and the taut supply conditions, shippers can only hope that there will be more trucks on the road, thus delivering more capacity while keeping rate increases somewhat in check. However, unless an influx of qualified drivers materializes to operate the additional rigs, those hopes may be built on quicksand.