Fredrik Eliasson – Executive Vice President and Chief Financial Officer
David Baggs - VP, Capital Markets and Investor Relations
CSX Corporation (CSX) Credit Suisse Global Industrials Conference 2013 December 4, 2013 9:00 AM ET
So we’re going to get started now with CSX. Today we have with us Fredrik Eliasson who is the EVP and Chief Financial Officer of CSX and he has served in this capacity since January 2012, primarily responsible for the management and oversight of all financial and strategic planning activities at CSX. And here with him today is David Baggs who is the VP of Capital Markets and Investor Relations at CSX and he’s been with the company for 25 years. Fredrik?
Thank you, Alison and good morning everybody. It’s a pleasure to be here. Before I get started as always, let me just quickly remind you about our forward-looking statements. Any projections or any outlook that I might share with you today should be taken in the full context of those statements.
The way that I have structured the presentation today is really around four key points. First of all a brief recap about our long term proven track record of success and ability to deliver for our shareholders despite a pretty difficult macro-economic environment over the last two years. Second, talk about a network that reaches all major eastern markets and connects not just population centers but also a significant portion of the manufacturing and natural resources in this country. Third, because of that market reach that we have and also this very rapid transition that we’re seeing in this new energy environment where our core business has declined quite significantly, we probably now have the most diversified portfolio business that we’ve ever had where 80% of our business now is intermodal and merchandise and our utility coal business is actually now down to less than 10% of our overall business. And then fourth, and as part of that 80%, we’ll talk a little bit about our intermodal business and how that platform and the strategies we put in place over the last few years are starting to really create some good and strong results for us and we think the opportunity that lies ahead of us for profitable organic growth is very, very large.
So let me start with a quick recap on Slide 4 in terms of our financial performance and as you can see on the left hand side, that because of the housing decline that started in 2006 because of the global financial recession and now there’s very rapid transition to a new energy environment, our volume performance between 2006 and 2012 was marked by a 13% decline or about 950,000 units of business that went away. If you look in the stack bar chart you can see that our merchandise business in the dark blue as a percentage of our overall portfolio is about the same. However, it has declined about 600,000 units in absolute terms between 2006 and 2012.
Our intermodal business on the other hand has grown about 300,000 units. It’s now up to about 38% of our overall volume last year. At the same time, as I said earlier, we saw a significant decline in our domestic coal business. It’s gone from 24% of our business to about 14% last year, about 900,000 unit decline out of that 950,000 in total decline. And then at the same time, our export coal business increased significantly from 2% to 6% as we continue to see this global secular trend where we believe the U.S producers will play a larger role in the global coal market going forward.
Despite these headwinds, we have been able to deliver for our shareholders. During this period of time, our operating income has increased about 60% for about an 8% CAGR. Our operating ratio has improved by 710 basis points and last year we had a record 70.6% operating ratio. And our earnings per share had almost doubled for a 12% CAGR during this period of time. We have done this by not focusing on the things that we control, but focusing on the things we can control. So we’re focusing on safety, service, productivity and testing price ceilings through our value pricing initiatives. In safety, last year we were the safest class one railroad. Our service was at record levels, both our internal measurements and the feedback from our customers indicated that. Productivity last year alone we were able to drive out almost $200 million of productivity and we continue to do inflation plus pricing.
This same story has continued here in 2013, both in terms of our focus on the things that we control, but also in terms of the headwinds in our coal business. Our coal business for the first three quarters of 2013 is down 9% to almost $0.25 billion. Despite that, we expect 2013 EPS to slightly exceed 2012 levels. This is all in the strength of the first three quarters as we’re expecting the fourth quarter to be more challenging because of headwinds both in incentive comp side and also both in real estate, both above the line and below the line because there are things that we are challenging -- because things that we are cycling year over year.
Also in the prior three quarters we’ve been benefiting from liquidated damages and we’ve indicated that for the fourth quarter we expect liquidated damages to be flat year over year. However, off the base that we see here in 2013, we’re still targeting 10% to 15% EPS growth for 2014 and 2015 and that two-year CAGR clearly has become more challenging because of some of the coal headwinds that we had seen here since we issued that guidance originally both on the domestic side in terms of the inventory overhang still being with us through at least the first half of 2014 and because of what we’re seeing in the export coal market which we’ll talk about more a little bit later in the presentation. In addition to that though, we still expect a high-60s operating ratio by 2015 and longer term we also remain focused on getting to the mid-60s operating ratio beyond that period.
So the key drivers in terms of our ability to deliver for our shareholders in the past and also deliver on this guidance is of course our network reach .our network reach as you can see on Slide 6 is 21,000 miles of track of privately funded highway in 23 states east of the Mississippi River. Our network such as two thirds of the U.S population it connects all of the mega regions east of the Mississippi River and also connects significant portion of our manufacturing and natural resources, not just domestically but also globally through the 70 ports that we serve.
As a result of that network reach, and also because of this new energy environment we find our self in, we now have the most diversified portfolio business that we’ve ever had. As you can see on the right hand side you can see that our intermodal business now accounts for about 40% of our overall volume. Our merchandize business is about 40% of our overall volume made up of industrial segments, agricultural segments and our housing and construction sectors and then the remaining 19% is our coal business out and as I said earlier, down significantly from where it was just a few years ago.
Now let’s take a look at what that portfolio business has done here so far in the fourth quarter, seven weeks into it. Overall volumes so far is up about 75 in the quarter to date and I would say that it’s relatively consistent with what we had expected going into the quarter. We knew we were going to obviously cycle superstorm Sandy and also get the full effect of the new crop that we are starting to move. If you look at the left hand side on Slide 7, you can see that our construction sector is up about 7% here in the fourth quarter to date, pretty similar to what we saw in the third quarter and significantly above the run rate for the first half of the year. Our industrial sector continued to do very well. Clearly it’s been driven this year by a lot of crude by rail road and frac sand growth, but we’re also seeing here in the fourth quarter sequential pickup in both the automotive and our metals business as well.
The agricultural sector as I mentioned before, we’re up 7% here as we’re starting to see the benefit of the new crop as we’re moving that. And then on intermodal side, also as I said before, clearly the volume up 11%, domestic up 14%, our international business up 8% at this point in the quarter and both benefitting from the fact that we’re cycling superstorm Sandy from last year. And then on the last two markets, our domestic coal business also consistent what we saw earlier in the year. Our domestic coal business is down 7% so far in the quarter as we continue to deal with inventory overhangs in the southeast predominantly. And then export coal is up 4% here, different from what we saw in the first half of the year where it was down double digits for both the first half and the third quarter.
So let me talk a little bit more about coal on the next couple of slides and let’s talk about export coal first of all. On the left hand side here on Slide 8 you can see what underlying commodity indexes have done, both in terms of our metallurgical coal which is the [inaudible] index and API2 which is the thermal coal index. and you can see that since the beginning of the second quarter it has declined significantly and has recovered somewhat both of these two indexes, but they’re still at relatively historically depressed levels. The good news though is as you saw earlier, our export volume is up about 4% so far in the fourth quarter and that’s really driven by our metallurgical coal franchise that is up 13% while our thermal coal is down about 7% during this period of time.
But while volume is up, we’re clearly expecting our revenue here in the fourth quarter from our export coal business to be down. We have made significant rate adjustments here over the last year or two years I should say to make sure we optimize our bottom line but also do what we can to help the U.S producers through this pretty difficult period of time. we will have a much better sense as we get through the next few weeks what our coal will look like for next year, especially on the thermal side as we finish up the contract negotiations for 2014 and we will be able to provide you full year guidance when we get to our fourth quarter earnings release. Still, this is going to be the second best year in CSX’s history in terms of volume for export coal. And we think that is a great proof point to the thesis that I talked about earlier that we do believe that the U.S producers have a larger role to play in the global coal market going forward as well.
If we turn to the domestic coal business on Slide 9, you can see on the left hand side the different regions and what the inventory days are right now in terms of days of burn at the utilities. If you look on the right hand side this is the way that we normally talk about our business. You can see at the top on the right hand side you can see the northern utility inventory levels and the red line indicates where it was last year and the yellow line indicates where it is right now. So we’re slightly below where we were last year in terms of days of burn at the utilities. We’re at about 66 according to the last public data that we have compared to 69 last year. That is still slightly above where the average was for 2006 and 2010 which is what we’re using as a target for our utility customers.
However, in the south we’re still significantly above that five year average. As you can see we’re at about 103 days right now. Now, that compares nicely with where we were last year which was about 138. So a significant improvement year over year, but they’re still well above where that average is which is about 70 days. Part of the reason for that is the last two summers has been abnormally mild. So we have not made as much progress as we had originally anticipated getting through this inventory overhang. However, we do -- and this is why we have indicated that we think the inventory overhang will be a drag on our coal volumes, utility coal volumes at least through mid-2014 at this point.
However, as we get through this inventory overhang, we do think that our utility portfolio is going to become more resilient. It’s clearly going to be smaller than what it was going into this new energy environment, but we also do think it’s going to become more resilient. If you look on the left hand side of Slide 10, you can see in the blue area what natural gas prices have done over the last two years and you can see that it has stabilized over the last year or so somewhere between $3.50 and $4. Overlaid on top of that graph, you can see the different coal basins that we draw the coal from for our utilities and you can see the beginning and difference points where economically they can compete. So Powder River Basin from $2.50 probably here in the east coast to $3 and Illinois Basin that is competitive with natural gas even if gas prices were around $3.50. And then you need to go closer up to $4.50, $5 for the northern App and central App to become competitive.
The good news is on the right hand side in that pie chart you can see that almost half of our business, 49% of our utility coal business now comes from these two regions, Powder River Basin and Illinois Basin that is now in the money so to speak. And that has increased 100% over just the last three years. About a quarter of our volume in 2010 was from those two regions. So and we’re expecting that growth to continue as we continue to see southern utilities especially making plans for changing their sourcing away from central App coal towards Illinois Basin coal to take advantage of the investments that they’ve made in scrubbers.
The other point that we’re trying to get across to our investors right now is to make sure they understand that if you look at our volume third quarter year to date, that if you think about the plants that I’ve announced that are going to shut down in 2015, volumes to those plants are down 25% year to date and 70% since 2008. The remaining plants so far that we know are going to stay open after 2015, coal volumes are actually up 1%. So because of this natural gas -- where the natural gas prices have been and as low as they’ve been, we believe a lot of the impact that we were expecting to feel in 2015 has really been pulled forward to the last few years. So we see relatively minimal impact in 2014 and 2015 from these plants shutting down as most of that has already occurred. So as I said earlier, as we get through the inventory overhang, we do think we’re going to come out of this transition with a more resilient portfolio on our utility coal side.
So let me talk a little bit more about the rest of our business, 80% of the business that has nothing to do with coal. And on Slide 11 let me just give you a high level recap of what we’ve been able to do since 2009. So very quietly because the focus has been on coal, we’ve been able to grow our merchandise/intermodal business by 80% of our volume at a CAGR of almost 6%, 5.8%. Now this has added significantly above what the economic output in this country has been during this period of time, whether you measure that as GDP or IDP. The key reason for that are the same reasons we’ve talked about now for almost a decade in terms of some of the strategic prove points of macro changes that we’re seeing, longer supply change, continued challenges by our trucking partners under investing in our highway systems and also frankly the benefits of the new energy environment that we found our self.
You couple that with a strong service product and this is what you get. So very quietly we’ve been able to grow our merchandise and intermodal business $2.5 billion since 2009. On the merchandise side, it has predominantly been our chemical business and of course our automotive business and in fact, we’ve been able to offset fully in merchandise the decline in the coal business during this period of time. But clearly the long term growth opportunity for us is our intermodal opportunity, especially on the domestic side which is just simply to move truck traffic off the highway system and use a rail based solution for their transportation needs.
Let me talk a little bit more about our intermodal business on the next couple of slides. So on the right hand side here, you can see what our volume has done over the last few years. You can see that in 2009 our intermodal line was about 1.9 million units and 2012 last year was 2.5. So we’ve grown about 32% during this period of time. On the left hand side you can see the mega regions that I talked about before and overlay that in the nice maroon color, you can see the existing terminals we have, 45 terminals of which eight are port terminals that very nicely overlays on top of the mega regions that are networked regions.
Our northwest Ohio terminal is something I’m going to talk about in a second. And then you can see in the more the pink color, you can see the different terminals that we are currently expanding. We are adding because of the growth that we have seen and the growth that we’re expecting about 500,000 units of this capacity this year alone between investments that we’re making in Atlanta, Columbus, Boston, Detroit, Louisville and Charlotte. And in addition to that, we’re also building a new terminal in Winter Haven outside of Orlando as part of our SunRail transaction. We’re filling in a white space up in Montreal, taking advantage of the growing NAFTA trade. And we’re also longer term expecting to build new terminals both in Pittsburg and in the Baltimore area.
In addition to terminal investments, we’re also spending money on double stack clearances. If you looked on the map at the green area, you can see where we are double stacked today and at this point we move about 90% of our volume today moves in double stack cleared lanes. With the national gateway initiative which you can see there in the yellow which is connected to mid-Atlantic port into the Ohio valley with a double stack network, once that is completed in 2015 or so, we expect to be in that mid-90s range at that point.
But the real game changer here in terms of investments we’ve made is our northwest Ohio facility. Let me just talk about corridor strategy versus the hub and spoke strategy. Traditionally what railroads are talking about when we talk about intermodal, we talk about corridor strategy. Really for us that is Chicago to New York, Chicago down to the southeast, New York down to the southeast. And really what that requires is that on each side of this corridor you need to have a very large population center to amass enough volume. You can then do pickup and drop-offs in two or three places along the way. Now what that does though is that it limits your ability to connect the dots. It limits your ability to serve different markets. So what we have been able to do as you can see on the left hand side with the northwest Ohio facility is to create an aggregation center, a hub and spoke system where we can very efficiently pull trains in and build new trains in a short of a period as four hours if needed. Usually it goes between six and 12 hours. That allows us to penetrate new markets, smaller mid-tier markets in a profitable way that we couldn’t do with a corridor network.
And in fact if you look on the second bullet here, you can see that we’ve been able to create 125 new lanes alone with this terminal driving 20% of overall volume growth that we’ve seen since that terminal opened in 2011. In addition to be able to connect more dots by the northwest Ohio facility is unique as well in that it has allowed us to bypass Chicago for a lot of our transcontinental traffic and free up local traffic capacity in Chicago, but also improve transit reliability and time from the west coast over to the east both to the tune of probably 24 to 48 hours. So it’s been a significant improvement all the way around and we really do think that our northwest Ohio terminal is a game changer to a very large degree.
So our strategy on intermodal space has really been a couple of different things. First of all you’ve got to have a very strong service product. Second, what we have done is of course invest in terminal capacity double stack clearance to make sure we have the right profitability and contribution to the bottom line. Third, we have of course created this hub and spoke system to be able to increase our market reach. We have made sure that we have the right channel partners, that we’re working with the right folks at the right price to make sure we drive profitable growth. And we’ve also added our H2R, our highway to rail initiative where we have a dedicated education force, frankly another sales force as we don’t sell the rack that goes out to the beneficial cargo owners either by themselves or jointly with our channel partners to educate them about the virtue of a rail based solution. We think this is a great strategy to drive profitable growth within our intermodal space.
Frankly, if you look at the results, I think they speak for themselves. If you look -- since 2006 through three quarters of 2013, you can see that overall American Trucking Association truck tonnage is up about 16% during this period of time, while our average week of domestic intermodal volume is up 71% during this period of time. That is executing against the strategies that we’ve said and laid out for ourselves. The good news is we think we’re in the very early innings of continuing to capture this opportunity that lies ahead of us.
If you look on Slide 15, we can see that we think there’s about 9 million loads out there that very nicely would be able to be overlaid on top of our network. 9 million loads is defined as going between population centers that we serve that traverses at least 550 miles in a drive in. and we think that our H2R initiative is the right vehicle for us to go after these beneficial cargo owners that not necessarily all of them understand what an intermodal product can do for them in terms of service and also cost savings. Clearly as we continue to capture this opportunity, we’re going to be putting capital in the ground to expand our facilities, but as part of our long term capital guidance of 16% to 17% of revenue and we think these investments are scalable with some of the technology and the wide span cranes that we’ve developed here over the last few years. We think this is by far as I said at the onset of this presentation is the largest growth opportunity we have and we don’t see any reason why for the foreseeable future we can’t grow our domestic intermodal business at a multiple of the overall economic output within this country.
So let me wrap up on the next slide. Clearly we have a proven track record of success as a management team and we’ve been able to drive strong financial growth and shareholder value despite the pretty difficult macro-economic environment. Very quietly over the last few years we’ve been able to grow our merchandise/intermodal business, 80% of our business that has nothing to do with coal at a $2.5 billion clip since 2009. We think our network is very well positioned to leverage the growth prospects from the diverse portfolio we now have, but clearly within that portfolio our intermodal business is the long term key growth driver for us and we think we now have developed a platform and a strategy to drive that growth for many years to come.
So thank you for your attention and Alison, I get to turn over to you for some questions.
Thank you very much. So I guess I’ll kick off where you left off in terms of intermodal. I think that there’s some misperception in the market about the margins on the business and I know that CSI has talked about the operating ratio on the business or operating margins as being in line with the corporate average. Could you maybe just talk a little bit about helping the market or investors bridge the historical thought that it’s more like an 85 ore business?
Sure. Frankly, if you go back to the last time we reported our intermodal business separately which was a few years back, frankly if you look at operating ratio back then, and that was before a lot of the double stack clearances, a lot of the additional pricing, I think we were in the low 80s, high 70s even. So we’ve been very visible about the fact that the way we think about intermodal business is to make sure that we think about bottom line profitability first. We are not letting traffic onto a network that doesn’t make sense economically. If I look at our portfolio businesses and I take out part of the business for different characteristics, our coal and our chemical business, if you look at everything else, our intermodal business when you look at long term economics where you include a lot of return for the investments that we’re making and a capital recovery charge, our intermodal business as a percentage margin is at par with the rest of our business.
And obviously that is because of our relentless focus on bottom line. It is because of investments that we made in double stack clearance is a large part of that, but also make sure that we drive efficiency density wherever we can .but I think the number one thing is you’ve got to be very disciplined because we could probably grow this business a lot faster than we are, but you do that at the expense of profitability. So we think we’re in the right sweet spot right now in terms of how we’re executing this and capturing this tremendous growth opportunity.
And as you build, you’re in the early innings of this so as you do build density albeit slowly and at a measured pace, it seems as if you’ll be able to improve margins further. And I guess whether or not it’s above the corporate average depends on how the rest of the business is doing, but conceivably intermodal margins could actually be better than the average.
I think that’s right and I just -- your characterization of a slow growth. We grew our intermodal business last year on the domestic side about 7%. We expect to grow at about a similar amount this year. So pretty significant growth well in excess of whatever economic output, but we’re doing it in the right way and you’re actually right. As we continue to build density, the margin should be improving and we’re measuring that on a monthly basis to make sure that we hold our team accountable for that. So you’re absolutely right. And one of the other things that I think is important to point out is that I’ve talked about long term economic margins.
That’s really my focus as a CFO to make sure that we not only look at the incremental margins, but we look at the long term economics. On the incremental margin side, this is an extremely attractive business because you’re loading on additional volume to an already very fixed network to a very large degree. And that is one of the reasons why despite having lost $0.75 billion in coal revenue over the last seven quarters, we’re able to do as well as we are in terms of producing on this growth last year and expecting to earn this growth this year as well. So the incremental margins are very attractive.
And on the 9 million addressable market, it’s pretty clear from the presentation what volumes are included in that. If you think about increased trade from Mexico and flowing up into either the southeast or the northeast in your territory. How much could that possibly add to that 9 million truckload figure?
We think that could help a lot and obviously at the end of the day having a network where two thirds of the U.S population lives drives that opportunity and we think we have good connectivity to the interchange partners that would help to drive that growth. So that is clearly part of the overall growth story, there’s no doubt. But the biggest piece itself though is the opportunity just to pull existing traffic that is moving today onto a rail based solution.
You mentioned this northwest Ohio hub, all this incremental business you gain from it. Who are you taking share away from?
We’re taking share off, as I showed on one of the slides it’s just the trucking industry as a whole. And I wouldn’t say necessarily that we’re taking share. What we’re doing in our mind is solving some of the strategic challenges that our trucking partners have. We are able to provide that long leg of the journey while the trucking partners can focus on the pickup and delivery. And so as I said earlier in the presentation, if you look at the trucking tonnage in this country, it’s up about 16%, 17% since 2006 while our volumes are up about 71%. So that’s who – we’re just taking traffic off the highway system and putting it onto a rail based solution.
The investments you’re making on the intermodal network, are they required to sustain the kind of intermodal growth you’ve talked about over the past several years? Are you taking it a step function higher or is it more of a profitability bend to it where maybe growth can be slower but you were talking incrementals could be very much more attractive. What blend of those is going on?
In terms of -- make sure I answer your question appropriately. In terms of capital, in the strategic part of our capital that we spend every year intermodal takes a large part of that. And we think that’s embedded in the 16% to 17% guidance that we have out there. And we have a lot of control points, both in terms of when we evaluate investments upfront, but also post audits afterwards to make sure that the investments that we’re making make sense economically. We have to make those investments in the terminal capacity predominant. I think as you saw double stack clearance investments are slowly but surely coming through and now it’s really about making sure the terminals have the capacity to handle the incremental growth that is there. We think with the technology we’re putting in place and also with the wide span cranes that we are implementing in several of our terminals that we can do this in a relatively efficient way without necessarily having to go out and expand the footprint on the facility which is a very difficult thing to do.
In addition to that, there will be some investments that we’ll make to make sure we’re filing white spaces. So Montreal is a good example of that where we have an opportunity to capture a whole new market that we haven’t been able to do before. now as part of all that, you’ve got to make sure you have the capacity, but in addition to that as we talked about before, the profitability of this business, as long as you’re disciplined, should continue to improve because you have a very fixed asset base that you’re now starting to fill in, but you’ve got to make sure that what you’re filling in makes sense economically. I hope that answers your question.
It does, and just one clarification. So you’re able to sustain the kind of volume growth that you’ve seen over the past few years in intermodal. Is that realistic or?
Yeah. Our expectation is that we have enough macro factors that is pulling traffic towards a rail based solution and looking at the opportunity set that is so large. Our overall intermodal business last year was 2.5 million units. Half of that was international. Half of that was domestic. That the opportunity set is so large that we should be able to sustain our domestic intermodal growth, that half of our intermodal business in that range %5 to 10% for the foreseeable future.
I guess I’ll switch to the topic of coal just to get one in there. I’m sure it’s not your favorite topic. I guess how do we think about where we are in terms of is the worst behind us? What is the market going to look like in your view after some of the EPA rigs shake out, the plant closures? Does CSX have a view on the size of the market? Is it 800 million tonnes, 900 million tonnes? And do we need to get through the next couple of years in order for your business to really start to resume the level of margin expansion you’ve seen in years prior?
So we do think that next year, 2014 will be another year where we will have coal headwinds. Next year though is more I think going to be on the export coal side than on the domestic coal side. Clear domestic will also be some headwinds because of the inventory overhang that we’re seeing, but the larger impact next year is going to be in the export market where we are going to cycle the price adjustments that we’ve done this year and we are still not clear how much of the thermal coal that we contracted really for in 2012 that is moving this year is going to be moving in 2014. I think those are the factors through 2014. Going back to the domestic business, I think that once you get through the inventory overhang, I think the two factors that I talked about in the presentation are critical to remember.
We’re going to have a smaller portfolio business on the utility side going forward, but it’s going to be more resilient and because of the fact that more and more of our coal is drawn from the Illinois Basin and the Powder River Basin. So it’s going to be competitive at the $3.50 range with natural gas. In addition to that, when we look at the impact of the 2015, while there’s some yet left to be felt, 70% decline since 2008 of the utilities that are going to close in 2015, it could easily be overshadowed by just simply getting through the inventory overhang. So we think ’14 will be another transition year to this new energy environment as we are dealing with the inventory overhang and resetting our export coal business portfolio, but after you get through there, we think things will pick up again and you’re not going to see that drag on our coal side any more.
As far as the mix on the domestic side, roughly half now is PRB and Illinois Basin. So I guess I have two questions on this. Where -- is there any regional differences in your utility customers that have switched to other sources? Is it more northern, is it more southern? And then in order to get the total portfolio to be competitive at roughly $3.50, where do those percentages need to move to?
Obviously we will see what happens here over the next couple of years. What we do know is that we have several utilities predominantly in the south that are planning on switching their sourcing after their contract expires with the producers over to Illinois Basin. So we do expect that that 50% will continue to grow over the next two or three years to what is left to be seen, but it should be a bigger and the fact that we have doubled our percentage of the overall portfolio from 25% and 50% in just three years coming from those two regions is a good indication that the momentum is still there and it is going to make our portfolio more resilient.
So maybe some of the southern utilities that are going to switch have confirmed through their coal that’s been sitting there?
And the contracts that are in place with the producers.
Any other questions in the audience? Just I guess one more on the export side. One of your customers recently mentioned I think at a conference or an earnings call that they had re-priced or had priced about 4 million tonnes of export thermal. It wasn’t really clear whether this is something that would be an additional step down in 2014 or if it’s something that’s already embedded in the 2013 or 4Q ‘13
Yeah. We are encouraged by what is happening in the thermal market even at these depressed levels. Look at just API2. But there’s no doubt that there will be pressure on our thermal volumes in 2014 because a lot of what we’re moving today was contracted in 2012 when API2 was at different points. But because of what we’re doing to try to help the U.S producers get through this difficult time and obviously to optimize our bottom line, and what they’re doing to drive our cost and their system, it seems that we can compete even at this historically depressed level which is a good sign. But I do think that there will be a negative next year in terms of our thermal coal lines and perhaps even in the met line, but we will see that and have a better sense of that and give you some visibility into that when we get to our fourth quarter earnings call.
And the met volumes are actually pretty strong quarter to date. Is that the high vol B that you’ve seen?
Yeah. part of that is the fact that our comps are easier year over year because fourth quarter last year was pretty weak, but also the fact that we are seeing the market respond to what we’re doing on the facing side as well as what the producers are doing. So as we said all along, there is a clear demand for the quality of coal that we can produce in the U.S, even at these low underlying commodity prices.
And switching to pricing, you have talked about moving some domestic contracts to fixed variable. Is that something that you think will be uniform going forward for your domestic business or is it for certain customers that that type of contract works for and others might stay to the similar structure that you had in place previously?
Yeah, and really it’s going to come down to the customer’s preference. We’re not going to try to push it onto a customer unless they are interested in participating in that sort of contract. There really are two reasons why we think the fixed variable contract makes sense. On one hand you can get rid of the liquidated damages conversation at the end of a contract because what happens is that they have a fixed payment each and every quarter regardless of whatever volume that they move. And then the variable portion is on top of that and what it allows them to do sometimes is to move up the dispatch chain by having that fixed cost into their fixed cost structure to speak. And it makes coal marginally more competitive through that process. So we think it’s a good thing, but we’re not going to push it onto our customers unless it’s something that they make sense. I think it’s about a quarter of our business now that is some of that contract and we will see here. We have some contracts coming up. We will see where we end up here at the end of the year, beginning of next year in terms of overall utility business in terms of how many customers likes it.
And I’ll sneak in one last question on a different topic. Fraction has been a pretty big topic for the rails over the last several quarters. So I was just wondering if you could remind us what percentage of your business that that represents and if you’re seeing increased movement towards the Marcellus or any other gap --
Sure. Our fraction business just a few years ago was relatively small because our reach into the Marcellus region is not as good as our competition. But as we move now over to Utica shale and more and more focused on the wet gas, we’ve seen a tremendous pickup in our frac sand business because the work that our sales team and marketing team has done in terms of making sure we have the right terminal infrastructure as well and working with the right producers. We were able to grow our fracturing business last year about 30%, this year over 40%. It’s going to be about a $60 million business for us this year alone and obviously grown tremendously and we expect it to continue to grow. And so we’re excited about that opportunity. And as I said earlier, as I stand here today and I look at what the new energy environment brings us in terms of frac sands, in terms of LPG, the fractionator has been built on us and of course crude by rail, moving forward now I actually think the new energy environment is a good thing for CSX. I couldn’t have said that two years ago, but looking here where we are today and I see the growth opportunities within those new energy markets, it’s pretty exciting frankly.
Any other questions? Okay, thank you very much.
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