When we talk about the "bullwhip effect"—the magnification of order fluctuations at each upstream point in a supply chain—we usually are referring to a particular company's experience. But this phenomenon can also play out in a much larger theater. The relationship of the United States and China offers a clear example of how it applies on an international scale.
The bullwhip effect describes a phenomenon in which the impact of fluctuations in orders—and therefore in demand for parts and materials—becomes larger as demand works backward from the customer through to rawmaterial suppliers. It exhibits a "Hayekian" premise, named after Friedrich August von Hayek, the Nobel-prize winning economist who systematized the economics of capital structure, because it carefully considers the different stages of production, from higherorder, more capital-intensive goods to lowerorder goods that are closer to the consumer. Basically, this means that we should observe greater swings in production of the longerlived assets further back in the supply chain.
The bullwhip effect implies that inventories vary more than sales. In a macroeconomic setting, manufacturing sales will vary more than wholesale sales, which in turn will vary more than retail sales. As we move back through the supply chain, from consumer sales to more primary sectors of production such as manufacturing, we are moving further from the final consumer and into domains of greater variation. You can visualize it this way: retail is close to the bullwhip's handle (where action is initiated) and manufacturing is furthest away, down at the end of the whip.
This is easily observed when examining the relationships between manufacturing, wholesale, and retail sales during the past two recessions. (See Figure 1.) Both experimental and econometric evidence suggest that there are behavioral reasons for the bullwhip effect. Accordingly, a downturn in household consumption—even if it is premised on expectations rather than on economic fundamentals—is likely to translate into a larger downturn in manufacturing.
U.S. cutbacks dampen Chinese exports
Since the end of the Cold War, trade flows and the integration of global markets (globalization) have increased at a rapid pace. The entry of China into the World Trade Organization (WTO), along with a shift by India and some other developing countries toward market economies, has increased global trade and hence U.S. dependence on imports for domestic goods consumption. Meanwhile, China's industrial production reached historically high volumes and level of specialization. Anecdotal evidence indicated that certain regions of China were producing 70 to 80 percent of the global production of footwear, clothing, and other final consumer items.
These developments had a significant effect on U.S. supply chain dynamics and on the transportation sector in particular. In early 2003, U.S. imports recovered at an accelerated pace, along with Chinese exports, retail sales, and wholesale sales.
The rapid increase in imports from China had a direct influence on the U.S. domestic supply chain. The West Coast container ports were severely congested with Chinese imports from 2005 through 2007. Because imports were feeding into markets across the United States, they overheated the less-than-truckload (LTL) and intermodal rail systems. Government data, in fact, show that an import that enters the country on the West Coast has a larger impact on the U.S. transportation system than an import received in New York.
The tight relationship between the U.S. supply chain and China underlies a fundamental structural change in the U.S. economy. Harvard professor Niall Ferguson discusses this highly unusual relationship in his important book The Ascent of Money: A Financial History of the World. From the time of the Asian financial crisis in the early 1990s through the beginning of the recent global financial meltdown, there has been a symbiotic relationship between China and the United States, which Professor Ferguson has dubbed "Chimerica" (China + America). The Chinese were building up funds by means of currency interventions and purchases of U.S. debt instruments while Americans were piling on debt, expedited by the spectacular budget and trade deficits in the United States and easy monetary policy set by the Federal Reserve, especially during the critical years following the events of September 11, 2001. In essence, the Chinese were saving while Americans were consuming and spending.
Between the 2001 recession and the current "Great Recession," U.S. retail and wholesale sales growth was fueled by an import-heavy consumption boom. During that period, the level of imports and American retail sales started increasing at an accelerated pace, yet manufacturing sales hardly surpassed their pre2001 peak. When the U.S. economy started showing signs of weakness in the second half of 2007, many economists and industry analysts claimed that China had "decoupled" from the United States and would be less dependent on U.S. business.
However, the decline in Chinese exports in mid2008 proved the decoupling hypothesis to be false. When U.S. consumers curbed their spending during the global financial crisis, the impact on Chinese exports was highly significant. Thousands of mid-sized factories in China went out of business almost overnight, and millions of migrant workers headed back to their home villages. These and other data indicate that supply chain dynamics have become extremely volatile after a prolonged period of moderate volatility. They also make it clear that China remains tied to the U.S. economy; as long as it does so, it will feel the U.S. bullwhip effect.
Worries for "Chimerica"
During the first half of 2009, U.S. retail, wholesale, manufacturing, imports, and Chinese exports all began to rebound. (See Figure 2.) The strength of the Chinese economy also promoted the growth of U.S. exports. But that doesn't mean there is nothing to worry about. In fact, the key questions raised during the height of the Great Recession still await answers: Can Western countries still borrow money to fund their consumption imports, and if so, for how long? Will the world slip into a frenzy of protectionism? Will China become introverted and mimic its inward-looking past?
For now "Chimerica" will continue, as both nations stand to be net beneficiaries of this intricate economic relationship. However, as long as U.S. consumers and businesses continue to save more and reduce debt and the housing and non-residential investment markets remain depressed, U.S. supply chain dynamics are not expected to return to their 2006 peaks. Accordingly, supply chain professionals whose companies do business with China need to understand the bullwhip effect and be prepared to manage the effects of continued demand swings.
IHS Global Insight Inc. is a leading consulting company providing comprehensive economic information and forecasts on countries, regions, and industries with particular expertise in global trade and transportation. IHS Global Insight serves more than 3,800 clients in industry, finance, and government through offices in 13 countries covering North and South America, Europe, Africa, the Middle East, and Asia.
As we approach the final stretch of 2024, the rail industry is at a critical juncture, facing a convergence of long-standing challenges and emerging opportunities.
In recent years, the rail industry's story has been one of persistent headwinds: financial pressures, labor shortages, and heightened safety concerns following the East Palestine, Ohio, derailment, to name just a few. The shadows cast by these difficulties continue to loom large. These challenges, however, are symptoms of deeper, structural issues that have plagued the industry for over a decade.
Since the late 2000s, aggregate rail volumes have remained stubbornly stagnant. The initial gains from Precision Scheduled Railroading (PSR), once hailed as a revolutionary approach to operational efficiency, have largely been exhausted. The industry now grapples with this model's limitations, searching for new avenues to drive growth and profitability.
This pivotal moment demands a nuanced understanding of the sector's current state and potential trajectories.
The weight of history
In many ways, the root of today’s rail industry dilemma lies with coal. Coal was first used to generate electricity in the United States in 1882, and coal production, power plants, and railroads all grew together. In the 1970s, the development of the vast coal deposits of the Powder River Basin in Montana and Wyoming and their proximity to major rail lines fueled a massive nationwide railroad infrastructure investment cycle that lasted a decade. It was truly a bonanza.
In the early 2000s, however, advancements in hydraulic fracking and horizontal drilling led to a surge in natural gas production. As its prices fell, natural gas grew to be a titan competitor of coal for electricity generation. The impact of inexpensive and abundant natural gas has led to huge declines in coal production and coal’s share of electricity generation. According to the Energy Information Administration (EIA), coal’s share of U.S. electricity generation averaged 52% in the 1990s and fell to 16% in 2023. The natural gas share rose from 16% to 43% during that same time.
The impact on coal production, transportation, and consumption has been massive. In 2023, U.S. coal production was 577.5 million tons, representing a 51% decrease from 2008 volumes of 1.13 billion tons. During that same time, originated carloads of coal by U.S. Class I railroads peaked at 7.71 million in 2008 and plummeted to 3.43 million in 2023.
The short-term outlook is just as gloomy. According to the Association of American Railroads (AAR), coal carloads were down 17.1% from last year, the lowest January to June volume since the AAR began keeping records in 1988. Natural gas prices remain extremely low, and the cost of generating electricity from wind and solar farms has plunged. Coal’s share of U.S. electricity generation is expected to continue to decline in 2025. As a result, a significant amount of historical rail traffic will not return.
All factors considered, in the first half of 2024, U.S. railroads originated 4.17 million carloads, excluding coal and intermodal. That volume hasn’t changed much over the last 10 years, meaning that U.S. Class I’s have been unable to replace the diminished coal traffic with other carload traffic.
Filling the carload breach
Currently there are three AAR commodity segments that ship in enough volume to potentially offset the contracted coal volumes—grain, chemicals, and petroleum products. Of the three, do any provide a platform for volume growth?
Grain does offer some of the unit train economics of coal and represents about 12% of the first half of 2024 volume for U.S. railroads. However, for railroads, the grain market is divided into two very distinct sectors—domestic and international. Domestic grain demand has been relatively flat for the last 10 years, offering little opportunity for significant volume growth. The international market is quite different. While the United States is the world's largest grain exporter, volumes can swing wildly from year to year. The unpredictability of grain exports makes the entire segment risky as a growth strategy for Class I railroads.
The chemicals industry consists of thousands of producers throughout the United States, representing a material growth opportunity for Class I’s. The American Chemistry Council (ACC) reported that in 2022, 1.02 billion tons of chemicals were shipped in the United States at a cost of $79.0 billion. As a commodity segment, chemicals are the largest carload revenue source for U.S. Class I railroads. According to the ACC, rail represents 18% of total chemical tonnage while trucks led with 58%.
Like the chemicals segment, petroleum products represent a wide range of categories, including crude oil and refined products, including liquefied petroleum gases (LPGs), fuel oil, lubricating oils, aviation fuels, and other fuels. Together, they represent approximately 5% of U.S. rail-originating carload shipments.
A noteworthy structural opportunity that Class I’s can continue to nurture for growth in both the chemicals and petroleum products is south of the border. Today, Mexico’s ability to both produce and refine enough energy to meet its domestic needs is quite constrained, and that is reflected in the growth in imports from the United States. This export market represents a unique opportunity for Class I railroads.
Three things have driven this structural event. First, the Permian Basin in Texas and New Mexico creates a low-cost feedstock source for the world’s most sophisticated refining complex located in the U.S. Gulf Coast. Second, Mexico is a nearby market for both the feedstock and refining capacity. Finally, Mexico is facing a structural challenge in that its refining capacity has been operating below 50% for the last several years, and PEMEX, the Mexican state-owned petroleum company, is carrying massive debt. Railroads could serve as a vital link transporting feedstock.
The intermodal conundrum
Intermodal transport has long been considered the industry's golden ticket to growth, but in 2024, it presents a more complex picture. The segment saw a downturn in 2023, hitting its lowest volumes in three years. In June of this year, Class I railroads did report about an 8.7% volume growth in intermodal for the month over 2023. But even those numbers don't get them back to pre-pandemic levels.
However, we remain cautiously optimistic about intermodal’s long-term outlook. One way that Class I railroads could capture market share would be to target a significant volume of single-line traffic that travels between 700 and 1,500 miles and traverses only one railroad. That is a fairly sizable market for trucks right now, and if successfully converted to rail, it will add a significant amount of additional intermodal volume to the railroad’s portfolios.
To successfully compete, railroads will need to offer a compelling value proposition that can respond effectively to trucking’s current capacity surplus and low post-pandemic rates. This requires a delicate balance of pricing strategy, service reliability, and operational efficiency.
Path forward
Railroads have long faced criticism for their perceived inflexibility and reluctance to adapt to shipper needs. However, today's competitive landscape and changing customer expectations are driving rapid transformation in the industry. Class I railroads are actively working to enhance the customer experience, but they face significant challenges. To compete effectively with trucking, they must overcome deeply entrenched negative perceptions about rail shipping. This requires demonstrating unwavering commitment to their shippers and the markets they serve, as well as presenting comprehensive, forward-thinking strategies that showcase their long-term dedication to the industry.
For their part, shippers should reexamine the supply chain solutions they implemented to solve pandemic and post-pandemic challenges. They should take advantage of the current transportation market volatility to scrutinize the rates they currently pay and understand the trade-offs they can make in the marketplace to decrease overall transportation costs. Now's the time to start evaluating modal shifts. Railroads may be hungrier for traffic they didn't want to haul during the pandemic and post-pandemic years, and shippers can take advantage of a contracting truck market to inform their rail negotiations. In some cases, shippers may find that railroads have more appetite to commit to long-term contracts with fixed indices.
As we look to the future, railroads may never recover the bygone coal volumes, and their earnings profiles may be forever changed. Still, the industry's trajectory will be determined by its ability to address these interconnected challenges and opportunities brought about by the turbulence of being an integral part of the global economy. Success will require a multifaceted approach, and what worked for Class I’s in the past likely won’t help them be successful soon. All that said, it is a given that railroads will remain an integral part of North America’s industrial economy for a very long time.
Buoyed by a return to consistent decreases in fuel prices, business conditions in the trucking sector improved slightly in August but remain negative overall, according to a measure from transportation analysis group FTR.
FTR’s Trucking Conditions Index improved in August to -1.39 from the reading of -5.59 in July. The Bloomington, Indiana-based firm forecasts that its TCI readings will remain mostly negative-to-neutral through the beginning of 2025.
“Trucking is en route to more favorable conditions next year, but the road remains bumpy as both freight volume and capacity utilization are still soft, keeping rates weak. Our forecasts continue to show the truck freight market starting to favor carriers modestly before the second quarter of next year,” Avery Vise, FTR’s vice president of trucking, said in a release.
The TCI tracks the changes representing five major conditions in the U.S. truck market: freight volumes, freight rates, fleet capacity, fuel prices, and financing costs. Combined into a single index, a positive score represents good, optimistic conditions, and a negative score shows the opposite.
“ExxonMobil is uniquely placed to understand the biggest opportunities in improving energy supply chains, from more accurate sales and operations planning, increased agility in field operations, effective management of enormous transportation networks and adapting quickly to complex regulatory environments,” John Sicard, Kinaxis CEO, said in a release.
Specifically, Kinaxis and ExxonMobil said they will focus on a supply and demand planning solution for the complicated fuel commodities market which has no industry-wide standard and which relies heavily on spreadsheets and other manual methods. The solution will enable integrated refinery-to-customer planning with timely data for the most accurate supply/demand planning, balancing and signaling.
The benefits of that approach could include automated data visibility, improved inventory management and terminal replenishment, and enhanced supply scenario planning that are expected to enable arbitrage opportunities and decrease supply costs.
And in the chemicals and lubricants space, the companies are developing an advanced planning solution that provides manufacturing and logistics constraints management coupled with scenario modeling and evaluation.
“Last year, we brought together all ExxonMobil supply chain activities and expertise into one centralized organization, creating one of the largest supply chain operations in the world, and through this identified critical solution gaps to enable our businesses to capture additional value,” said Staale Gjervik, supply chain president, ExxonMobil Global Services Company. “Collaborating with Kinaxis, a leading supply chain technology provider, is instrumental in providing solutions for a large and complex business like ours.”
However, that trend is counterbalanced by economic uncertainty driven by geopolitics, which is prompting many companies to diversity their supply chains, Dun & Bradstreet said in its “Q4 2024 Global Business Optimism Insights” report, which was based on research conducted during the third quarter.
“While overall global business optimism has increased and inflation has abated, it’s important to recognize that geopolitics contribute to economic uncertainty,” Neeraj Sahai, president of Dun & Bradstreet International, said in a release. “Industry-specific regulatory risks and more stringent data requirements have emerged as the top concerns among a third of respondents. To mitigate these risks, businesses are considering diversifying their supply chains and markets to manage regulatory risk.”
According to the report, nearly four in five businesses are expressing increased optimism in domestic and export orders, capital expenditures, and financial risk due to a combination of easing financial pressures, shifts in monetary policies, robust regulatory frameworks, and higher participation in sustainability initiatives.
U.S. businesses recorded a nearly 9% rise in optimism, aided by falling inflation and expectations of further rate cuts. Similarly, business optimism in the U.K. and Spain showed notable recoveries as their respective central banks initiated monetary easing, rising by 13% and 9%, respectively. Emerging economies, such as Argentina and India, saw jumps in optimism levels due to declining inflation and increased domestic demand respectively.
"Businesses are increasingly confident as borrowing costs decline, boosting optimism for higher sales, stronger exports, and reduced financial risks," Arun Singh, Global Chief Economist at Dun & Bradstreet, said. "This confidence is driving capital investments, with easing supply chain pressures supporting growth in the year's final quarter."
The firms’ “GEP Global Supply Chain Volatility Index” tracks demand conditions, shortages, transportation costs, inventories, and backlogs based on a monthly survey of 27,000 businesses.
The rise in underutilized vendor capacity was driven by a deterioration in global demand. Factory purchasing activity was at its weakest in the year-to-date, with procurement trends in all major continents worsening in September and signaling gloomier prospects for economies heading into Q4, the report said.
According to the report, the slowing economy was seen across the major regions:
North America factory purchasing activity deteriorates more quickly in September, with demand at its weakest year-to-date, signaling a quickly slowing U.S. economy
Factory procurement activity in China fell for a third straight month, and devastation from Typhoon Yagi hit vendors feeding Southeast Asian markets like Vietnam
Europe's industrial recession deepens, leading to an even larger increase in supplier spare capacity
"September is the fourth straight month of declining demand and the third month running that the world's supply chains have spare capacity, as manufacturing becomes an increasing drag on the major economies," Jagadish Turimella, president of GEP, said in a release. "With the potential of a widening war in the Middle East impacting oil, and the possibility of more tariffs and trade barriers in the new year, manufacturers should prioritize agility and resilience in their procurement and supply chains."