It’s impossible to miss all the headlines these days about the crash in energy prices and the damage it is doing to the balance sheets of firms in the oil, gas and coal businesses. But the ripples from the price plunge extend beyond the coal miners and ExxonMobils of the world. A slew of industries tied to the energy world are also suffering, with little relief in sight.
Off the Rails
Few sectors of the economy benefited more from the surge in U.S. oil production than freight railroads and their suppliers. With so much new crude coming out of the ground (often in parts of the country not connected to oil pipeline systems), rail suddenly became a critical conduit for linking shale fields in the interior to the nation’s coastal refineries. Moving crude by rail costs more than moving it by pipeline, and derailments have sometimes led to catastrophic accidents. But oil trains can go where pipelines don’t, and they give refiners the flexibility to source crude from different suppliers as prices fluctuate.
Now, not so much. Slipping oil output in North Dakota means less demand for the rail tanker cars that were needed to haul crude from the Bakken Shale to market. Meanwhile, with new pipelines coming on line, less of the state’s output is traveling by rail. From a peak of more than 800,000 barrels per day hauled by rail in December 2014, producers in the Peace Garden State now rely on oil trains to haul slightly more than 500,000 barrels per day, according to statistics from the North Dakota Pipeline Authority. Nationwide, the number of railcars carrying crude and refined products has fallen from a peak of about 16,000 in mid-2014 to fewer than 13,000 today, according to the Association of American Railroads.
And it’s not just fewer tanker cars riding the rails. Less drilling means less need to haul drilling equipment, supplies and materials to job sites. Which helps explain why freight railroads in January saw a 10% year-over-year drop in shipments of crushed stone, gravel and sand, a category that includes the sand used by the oil and gas industry in hydraulic fracturing. (More on sand miners’ woes later.) Meanwhile, the huge drop in coal burned to generate electricity that we’ve noted in the past is also affecting railroads, which are moving far less coal than they did several years ago.
It all shows up on railroads’ bottom lines. Union Pacific, for instance, reported a 19% drop in operating income for the fourth quarter of 2015 compared with a year earlier. Even though UP hiked its freight rates, and even though cheap diesel fuel helped cut costs, the decline in freight volumes still dragged down earnings. Until the economy shows more pep and steams up demand for shipping of consumer goods to offset the weakness in commodities hauling, we don’t see much bounce for rail freight volumes.
Low oil and gas prices spell less drilling activity. And less drilling activity means less demand for a basic ingredient in fracking: Sand. Energy firms inject many tons of round grains of sand down their wells to prop open the cracks in energy-bearing shale and other rock layers that fracking opens up. The surge in drilling activity in recent years has been a boon for companies that mine the grades of sand that energy companies favor.
But now, with rig counts dropping and sand usage falling, those miners are under intense pressure. Hi-Crush Partners, a major frac sand producer based in Texas, is shedding workers and cutting other costs to cope with falling sand prices and demand. The company, organized as a master limited partnership, has nixed its dividend to conserve cash as its unit price has slumped from $40 last spring to about $5 today. My colleague, Jeff Kosnett, who edits Kiplinger’s Investing for Income, says that investing in sand producers is far too risky given the weakness in oil and gas prices and the stress that sand miners’ customers in the energy business are under now.
There is one bright spot for frac-sand, though: Energy firms are using more of the stuff in each well they drill because doing so results in more oil and gas output per well. That’s not enough to keep demand from falling right now, but eventually, when energy prices rebound and drilling activity perks up, it should bode well for the miners that can survive the current downturn.
The downturn in the price of oil, gas and many other commodities also hits makers of the machinery needed to dig the stuff out of the ground. Perhaps no company better illustrates this trend than Illinois-based Caterpillar, which saw revenues tumble by 15% in 2015 from the previous year. CEO Doug Oberhelman says that the company’s energy and transportation division, which includes the company’s sales of products to the energy industry, saw new orders drop by 90% last year.
Cat doesn’t see things turning around in 2016, either. The company projects that revenues will drop an additional 10% this year because of weak commodity prices that are weighing on its customers in the commodity world, and because of slowing growth in key emerging markets such as China. Other makers of earthmoving and mining equipment are probably sweating the same worries right now. Indeed, many emerging markets (think Brazil, Australia, South Africa, etc.) are geared heavily toward mining or energy production, or both. Don’t count on any of them to be ordering many bulldozers or backhoes anytime soon.