Chill in ethanol industry may give railcar lessors a bad cold

Implications: The growth rate of the ethanol industry has slowed significantly in recent months as the price of corn pinched the profit margins of most firms and put some inefficient producers out of business.  With corn prices at $5.55/bu., reformulated gasoline (ethanol) prices must be above $2.00/gal just to break even, and prices last summer dipped as low as $1.50/gal. after a small surplus of ethanol developed. As uncertainties about costs, prices, and demand increase, producers are scaling back their plans for expansion.  Railcar lessors however, have already committed to buy, or have already taken delivery of enough railroad tank cars to move the previously projected production total of 10 million gallons 2008. Car surpluses are developing as lessees walk away from commitments, a rarely used and dangerous practice for most users in that industry.

Analysis:

Commitments by railcar lessees to take delivery and to begin payment on leases for railcars used to be almost as good as written contracts, and the latter were rarely broken. This was especially true among tank car lessees and lessors who populated a rather small community where reputations lasted for decades. With the boom in ethanol production, dozens of new players and companies have entered the rail car market and these newcomers are not playing by the traditional rules. Commitments by companies to lease new cars are being broken, and even lease contracts are being challenged as companies delay startups or cancel expansion projects.

 

Companies such as GATX Corp. (GTM), Trinity Industries (TRN), and The Andersons (ANDE) have made major commitments to this new industry and have built or have committed to build thousands of new tank cars. In late 2006, the existing capacity of the ethanol industry was 6 billion gallons per year and capacity expansions in excess of 7 billion gallons per year were expected to be installed by the end of 2008. To handle the increased production, there were 24,000 orders for ethanol tank cars backlogged for production in 2007 and 2008. Half of those cars have already been built, and already surpluses are arising as companies walk away from previous commitments. None of the builders and none of the leasing companies are saying that orders for new cars have been cancelled, but it would be wise if production schedules were at least extended beyond 2008 to let the industry production catch up. This would hurt the 2008 revenue and profits of the car builders (TRN, Union Tank, and American Railcar (ARII)), but it would give the market a chance to clean up the current surplus and it would keep production levels from plummeting in future years if a big a surplus arises after the 12,000 new ethanol cars are built this year.

 

In total, perhaps over 36,000 cars new ethanol cars will have been built between 2005 and the end of this year if current schedules are not reduced. Between 2005 and 2007, production increased from 4 billion to 6.4 billion gallons. It was recently thought that production in 2008 would be between 9 and 10 billion gallons. Based on production increases during the last quarter of 2007 it now appears that the output in 2008 will not even reach 9 billion gallons and will be lucky to exceed 8 billion gallons. That would mean a surplus of thousands of the tank cars and it would take years to absorb that fleet.