In a recent issue of The Energy Strategist, I highlighted the extraordinarily low inventories of coal currently being held at the nation’s utilities. This is a big problem. As gas-fired power costs sky-rocket higher, you can bet that America’s fleet of coal-fired plants will be working flat-out to meet demand. Utilities will be scrambling to secure coal supplies and restock their dwindling coal yards. [...]

It may seem strange to some to recommend transportation stocks in an investment service focused on energy, but the fact is that substantially all the coal consumed in US power plants is transported by rail. Due to high coal demand, the railroads have garnered considerable pricing power in recent years, jacking up prices for hauling coal from producing basins to power plants. This trend has reversed a nearly 20-year era of flat or softening hauling rates.

For most goods, there are two main modes of transport within the US: rails or roads. But for bulk commodities like coal and grain, the rails are a more common and efficient choice, especially for longer haul journeys.

The rail business is pretty simple. Railroads are responsible for maintaining their own tracks--that means replacing rails and ties as well as upgrading rails to handle more traffic where necessary. This is a relatively high fixed cost for the firms. The railroads are also responsible for fueling their own trains. In almost all cases nowadays trains are powered by diesel fuel.

On the revenue side, train operators charge a set rate for hauling cargo. As you might expect, rates vary by commodity and by hauling distance. Another factor is service quality--if railroads are late with shipments, their rates are negatively affected.

For many years, railroads suffered from consistently declining and depressed rates. This meant the group generated very low returns on capital because to keep operating they still had to shell out for track repairs and maintenance on railroad cars. But this is no longer the case. In recent years rising demand for electricity has spelled greater demand for coal; to haul that coal, railroads have been able to consistently boost their rates.

And it’s not just the energy sector that’s been strong--an increase in imports from abroad has spelled growing demand for rail shipping services to move those goods around the country. The same is true for US exports--growing demand for US exports of agricultural products requires moving ever more grain from the nation’s heartland to ports along the coasts.

While it’s also true that higher diesel fuel prices spell rising costs for the railroads, this isn’t a big problem. The better railroad companies have partly hedged their diesel needs over the next year or so at much lower prices. To cover the balance of these rising costs, the railroads have tacked on fuel surcharges to their rates.

These fuel surcharges are important for two reasons. First, the surcharges defray most, if not all, of the impact of rising energy costs. And second, it serves to illustrate that the railroads now have pricing power over their customers. The rails can now demand a higher fee just to compensate for their rising costs. Such high surcharges would have had little chance of surviving a few years ago.

The railroad industry has proven to be a highly profitable theme of The Energy Strategist during the past six months. Long-time readers are well aware that the nation's railroads are absolutely key to shipping coal from mine-mouth to power plants. And due to a total lack of capacity on the nation's rails, hauling rates have been rising sharply in recent quarters. [...]

Railroad Infrastructure

There are many different types of railcars, some designed to carry coal, and others designed to haul cars or containers. As rails expand their capacity and try to increase their transport of coal, they will need more railcars. In fact, the industry is currently experiencing a shortage of several major types of railcar. And sometimes railroads don't want to buy railcars; instead they lease them for a fee. Obviously, this segment of the business also benefits from the shortage of cars.

Railcars, just like automobiles, wear over time. Parts like shocks, wheels and braking systems need repair and maintenance from time to time. The problem is that the harder you drive a railcar, the more maintenance and repair work it needs--harder use implies more wear and tear. [...]

This is one of the few times in the history of US markets when average ordinary investors may reap a windfall approaching that of the old Robber Barons. Grab onto the transportation sector of the energy boom and ride the wave to untold wealth.

© 2006 Elliott H. Gue
Editorial Archive

Transportation is just one of the five major themes I'm currently focusing on in THE ENERGY STRATEGIST. In fact, I'm convinced that energy is the #1 investment play of the next two decades… and any investor who misses out will deeply regret it. With furious global economic growth and a dwindling supply of the energy that's so absolutely critical to fuel that growth, you have the rare chance to participate in the mother of all squeeze plays...an opportunity to capitalize on an irreplaceable commodity that could give you multi-year gains of $10 and even $20 to $1.