THE ENVIRONMENTAL PROTECTION AGENCY (EPA) is mandating, as part of its stringent 2007 emissions policy, a 50% reduction in the NOx (nitrogen oxides) standard and a 90% reduction in the PM (particulate matter) standard.
How demanding is this, especially in light of how far the industry has come since 1990 in emissions improvements?
Peter Nesvold, transportation analyst for Bear Stearns, compares it to Major League Baseball's unofficial shrinking strike zone.
Assembling “an All-Star lineup of trucking industry sluggers,” he moderated a panel that analyzed the outlook in an all-day Heavy Duty Dialogue, “2007-2010 — How Bad/Good Could It Be?”
“The shrinking strike zone in baseball has put the pitcher at a growing disadvantage,” Nesvold said. “Who's facing a tougher strike zone? Major-league pitchers or the trucking industry?”
Nesvold that that “just for fun,” he created a one-for-one relationship between soot (PM) and strikeouts, and Nox and ERA. Then he applied that to the statistics of some of baseball's top pitchers. Using the EPA's 1998 standards, Roger Clemens' numbers that year wouldn't have been a 2.65 ERA with 271 strikeouts; they'd have been a 3.98 ERA with 45 strikeouts. Using '07 standards, Billy Wagner's numbers from 2005 wouldn't have been a 1.35 ERA with 130 strikeouts; they'd have been 40.50 ERA with two strikeouts.
“By 2007, the EPA will have lowered the soot standard by 98% and the NOx standard by 96% from 1990s levels,” Nesvold said. “In baseball terms, that'd be a strike zone of less than 1" wide and 1" high.”
So what does the shrinking strike zone mean for the truck industry? He said the expected implications include: an increased upfront cost ($7,000 to $10,000); over 2% fuel degradation; increased maintenance costs; potential initial shortages of ULSD; strong used equipment demand; a 50% reduction in builds in the first half of 2007.
Nesvold said North American Class 8 retail sales are forecast to increase 4% in 2006 to 339,425, but will fall 34% in 2007 to 223,075. In 2008, they are expected to increase 28% to 286,600, with a 12% increase the following year to 322,175.
EPA Mandates and Class 8 Demand
Partner/senior analyst, ACT Research
He said demand will be bolstered ahead of the emissions mandates and delay the demand in the aftermath.
“But the mandates appear to be lining up in all the wrong places in the economic cycle, and that compounds the problem,” he said. “Why pre-buy? There appears to be no downside.”
He said these factors are weighed in determining Class 8 demand: the economy is generating new freight to haul; trucker profits are strong; the used equipment supply/demand balance; credit is available; a higher new purchase price, added complexity, and a bad experience in 2002 add to demand ahead of EPA 2007.
The current Class 8 market indicators: a big order rebound in December following several months of below-expectations activity related to the soft economy activity in the second half of 2005; backlogs are moving higher; per-day build is at record levels (360,000 annual rate); empty slots impact the build, but not the build rate in the November-January period; retail sales are strong, but below record levels; inventory volume and ratio are up year-to-year.
“We expect the industry to run out of pre-mandate build spots by mid-2006,” he said. “At the end of December, there were around 200,000 pre-mandated build spots open. As occurred in 2002, we anticipate the industry will experience strong sales orders until the spots are filled.
That will be followed by a collapse in orders in the third quarter of 2006, and then a rise to something around replacement levels.
“We expect GDP growth of over 4% in the first half of the year, but falling below 3% by the end of the year as home-equity dollars and Katrina combine to be less prevalent in the economy. Consumer spending should be strong in the first half of the year. Business investment should be strong in 2006 and could pull back in 2007.”
Addressing truckload carriers, he said that regardless of their size, for-hire truckers in business today understand their operating costs. The freight environment is strong, carriers are reporting improved freight volumes, shippers indicate an ongoing tight truckload capacity, and double-digit freight rate gains continued in the third quarter.
“But there are rising costs,” he said. “Fuel was up 60 cents over 2005. At 6 mpg, that's 10 cents per mile. At 120,000 miles, that's 20,000 gallons per truck. Thank goodness for fuel surcharges. At 1% or 2% degradation in fuel economy, if you're using 20,000 gallons per year, every 1% is 200 more gallons of fuel per year. At $2.50 per gallon, that's $500 per year per truck.”
He said fleet fiscal discipline and the driver shortage eliminate overcapacity and improve profitability, and drivers, not equipment, are the true measure of capacity.
What will the velocity of the US economy be in late 2006/early 2007? He said a lot of late-model equipment will be in service by the end of 2006, thanks to strong Class 8 sales in the 2004-2006 period. New and used truck inventory volumes will be at uncomfortably high levels in early 2007, and new inventories will be entirely of pre-mandate units.
“Consumer and government spending both appear vulnerable,” he said. “While economic downturns are never welcome, they are less desirable following a large buyout of equipment. Even with economic unknowns, a case can certainly be made for a correction forecast of anywhere between 180,000 and 230,000 in 2007. By the end of 2006, there will be nearly one million new Class 8 units that will have been cycled into fleets the previous three years. That's a lot of fresh iron in fleets if the economy heads south. At the end of 2006, there will be a lot of new and used equipment on dealer lots. All of the new Class 8 inventory will be pre-mandate spec'd. That's another issue to contend with if the economy is soft.”
LTL Market Outlook
CEO, Martin Labbe Associates
He said GDP grew by 3.2% last quarter and will grow 3.3% this year, the Fed will increase interest rates 50 basis points by the end of the year, fuel prices will decline slightly and remain in $2.50 range for regular nationwide, and traffic congestion will increase.
He estimated that annual miles will increase by 10% per year for Class 6 and 7 and 3% for the Class 8 tractor (first owner), and 8% for Class 3-5.
“Time is more important than miles operated,” he said.
He said general freight growth is expected to be faster than overall freight. There will be a move to more frequent shipments “as we try to get inventory sales ratios to stay where they are, although it's a very serious problem.” He expects more labor-intensive freight, with congestion driving major changes in distribution.
“In 2015, you can go from North Carolina to New England, and that's gridlock, it's not slowing-down traffic,” he said. “You can't add truckload carriers.”
He said that in 1982, 70% of travel was un-congested and 12% was severely or extremely congested. In 2003, 33% of travel was un-congested and 40% was severely or extremely congested. He said 85 areas in the country account for 3.7 billion lost hours, 2.3 billion gallons of fuel, and $6.3 billion of extra cost.
He said that in the past, LTL lost share to small package carriers and truckload carriers, experienced more competition from regional carriers, and made a major move to quicker delivery times.
Currently, LTL has stopped volume loss to small package carriers, is gaining volume from truckload carriers, working with and acquiring regional carriers, and moving to provide next-day delivery.
In the future, LTL will provide local delivery for highway trains, share freight with truckload carriers, engage in more frequent acquisition of regional carriers, and be the fastest-growing sector in trucking.
“We're not shipping freight by rail, we're not shipping freight by air, we're not shipping freight by barge,” he said. “It's going to go by truck. So you're going to go from Chicago to Baltimore, and the truckload carrier is going to move to a distribution point, drop off the trailer, pick up another one, head back to Chicago and maximize the hours.”
How does it happen? Through freight staging centers, guaranteed time-of-day pick-up and delivery, and on-the-fly repositioning of equipment, because the equipment in place won't do the job that they ask, “simply because it's not very efficient for the driver to maximize his time.”
“Carriers are more forward-thinking now than ever. These individuals, for the most part, are survivors. They keep going, and going forward. But they have to be much smarter now. We're actually seeing carriers hiring other carriers in certain locations. Future growth depends on maximizing useful hours per day.”
Analysis TL & Owner-Operator
Commercial Motor Vehicle Consulting
He said that with TL company-owned tractors, the average trade cycle is four years. With 314,500 units, the annual replacement demand is 78,900 tractors.
With owner-operators (tractors acquired new), the trade cycle is five years. With 108,200 units, the annual replacement demand is 21,600 units.
On the truckload carriers' balance sheets, profitability is driven by truck utilization (revenue miles) and profit margins. Truck utilization is high, with freight volumes exceeding freight capacity. A low supply of available drivers has limited capacity expansion. The imbalance is slowly decreasing as truck sales trend upward.
“Right now, expect traffic to remain strong in the first half of 2006 because they're replenishing vehicles,” he said.
He said TL carriers have pricing power, with tight freight capacity, a change in TL freight rates in 2005 (general freight 5.9%, specialized 5.8%). Profit margins are high and carriers are passing along rising costs to shippers.
He said carriers have the financial resources to support a pre-buy. Why pre-buy? Because there is an expected increase in Class 8 truck prices in 2007. International announced that Class 8 prices are expected to increase from $7,000 to $10,000 in 2007, depending on the engine. CMVC predicts price increases of $4,500 to $7,500 due to competitive pressure among truckmakers.
He also said decreases in fuel economy are expected. Increases in truck utilization do not reduce fuel expenses per load, which remain a large share of total operating costs: Knight Transportation, 28.1%; Celadon, 23.9%; Swift Transportation, 19.9%; and Werner Enterprises, 17.9%.
Decreases in fuel economy are resulting in increases in operating costs. With a 5% reduction in fuel economy, a reduction in mpg from 6 to 5.7, and 100 miles driven annually, the increase in costs at $2 per gallon would be $1,754 annually and $7,016 over the lifetime (four years); at $2.25, the figures would be $1,973.25 and $7,893; at $2.50, $2,192.50 and $8,770.
“That's a major increase in operating expenses,” he said.
Options for TL carriers and owner-operators: pre-buy; pull forward replacement demand into 2006 from 2007; extend truck trade cycle; acquire used trucks; and maintain normal trade cycle and purchase behavior.
“If they extend trucks' trade cycles or acquire used trucks, particularly for TL carriers, the probability of going from a new truck to a used truck is low,” he said. “High- mileage applications require the attributes of new trucks. A lot of carriers are on four-year trade cycles, so they're not set up to handle a large increase in maintenance expenses. It's uneconomical to operate older trucks.”
He said a survey of owner-operators in the fourth quarter of 2005 showed that 18% expect to pre-buy, 30% were thinking about rebuilding engines to extend vehicle life, 17% would extend the trade cycle, 16% will purchase a truck in 2007, 15% are undecided, and 3.4% will switch to purchasing a used truck.
Heavy Truck Market Outlook ‘06-‘10
President, MacKay & Co
He said the economy will continue to grow, but at a slower pace.
“We are less than bullish about 2007,” he said. “We think there are some clouds that could turn out to be genuine causes for concern.”
In giving his heavy truck forecast for Truckable Economic Activity (TEA) versus the operating universe, he said:
The operating universe declined only twice in the last 35 years — the recessions of 1982 and 1991 (1% or less).
The operating universe remained flat only once in the last 35 years — the 2001 recession.
The no-growth replacement floor was 140,00 units/year (2001).
The largest recent increase in operating universe was 6% in 1999.
In forecasting TEA v Class 8 sales, he said:
There will be wild fluctuations.
A 12% TEA increase equaled a 60% increase in sales (1984).
A 3% TEA decline equaled a 44% decrease in sales (1975).
When there were regulations and recession in the same year, sales were down 44% in 1975 and 46% between 2001 and 2003.