A paper analysing how US railroads can manage the risks associated with the loss of lucrative coal transport as the global energy market changes won the annual Cambridge-McKinsey Risk Prize, run by the Cambridge Centre for Risk Studies in conjunction with McKinsey & Company.
The winning paper – entitled ‘I Think I Can, I Think I Can’: Can US Railroads Navigate the Decline of the Domestic Coal Industry? – was written by Steven Cooney, an Executive MBA graduate of Cambridge Judge (EMBA 2015) and a serving military officer with the US Marine Corps.
The prize was announced on 23 June at Cambridge Judge Business School by Dr Sven Heiligtag, Principal of McKinsey & Company, at the 2017 Risk Summit of the Cambridge Centre for Risk Studies.
Honourable mentions went to two degree candidates at Cambridge Judge: Master of Finance (MFin) candidate Ashish Srivastava (MFin 2016) and MBA candidate Stuart Barr (MBA 2016).
“Rail firms need to more actively consider the future of the coal industry in their enterprise risk management systems and make investment and disinvestment decisions accordingly,” says the winning paper.
Specifically, the paper said that railroads need to analyse the cost of production at the coal mines they service and estimate future production levels at various price points; and they need to evaluate the likelihood that individual power generators are likely to switch from coal to alternative power sources, or shut down.
“By combining those two analyses the firms will be able to understand how a drop in coal demand would impact their current clients, both producers and consumers,” says the paper. “This will allow individual firms to assess to viability of their current footprint and develop contingency plans for different levels of coal demand. It will also identify opportunities for mergers and acquisitions and partnerships, as changes in the competitive landscape will present opportunities as well as risks.”
Railroads transport about 70 per cent of US coal used for domestic power consumption, but coal-based electricity production fell by 46 per cent between 2006 and 2016, according to the US Department of Energy, as utilities shifted to cleaner forms of generation and natural gas prices declined due largely to shale gas production.
In 2015, five large US railroads involved in coal transportation – Union Pacific, Burlington Northern Santa Fe, CSX, Norfolk Southern and Kansas City Southern – generated $68.5 billion in revenues, of which $12.4 billion was directly attributable to coal transportation, the paper said.
Management of such large railroads face crucial decisions in the years ahead, and risk evaluation is a big part of such deliberations.
“A significant amount of railroad infrastructure, from trackage to train maintenance facilities, is oriented to supporting coal transportation,” the paper says. “If the coal industry continues to decline or collapses, divesting these assets in a timely manner would be financially prudent and prevent the firms from having to be burdened with unproductive assets.
“However if railroads divest too soon it would result in a loss of quality revenue that would likely be quickly picked up by a competitor. Given the magnitude of these firms, the assets in question will certainly be measured in the billions of dollars per firm.”
The honourable mention paper by MFin candidate Ashish Srivastava, who works for the Reserve Bank of India, the country’s central bank, looks at systemic liquidity risk from the perspective of developing economies. Entitled Systemic Liquidity Risk: A Macroeconomic Evaluation, it uses relevant macroeconomic data from the Indian financial system for the purpose of analysis, modelling and interpretation.
“To summarise, this paper shows that the structural and frictional liquidity risks shape the systemic liquidity risk through the channels of funding and market liquidity risk,” the paper says. “It is therefore quite useful both for the market participants and the central bank to keep a close watch on the interaction among these risk parameters so as to better understand and mitigate the manifestation of systemic liquidity risk.”
The honourable mention paper by MBA candidate Stuart Barr, who for many years was music director and album producer for singer Dame Shirley Bassey (of Goldfinger fame), takes a look at the “upside” of risk – in contrast to a focus on risk’s downside in many academic papers.
In the paper – entitled When Jeopardy Is a Risk Worth Taking – he examines the decision by Dame Shirley to perform live rather than miming at the 2013 Academy Awards, which allowed the “adrenaline-driven emotional enhancement and spontaneity” that such live performance can deliver.
“Because the Oscars aims for the best possible show, it must allow artistes everything they need to create their best possible performances,” the paper says. “Therefore, the producer must understand that to maximise the artistic calibre of the Oscars, artistes such as Bassey need to take risks.”
Our transportation system underlies all of modern life, playing a vital role in everything from getting us our morning cup of coffee to moving us to our jobs to bringing yesterday’s Amazon order to our door. But it’s something we tend to take for granted until things go wrong — heavy traffic, air travel delays or roadway collapses. And because we’ve failed to invest in keeping our system robust, those events happen more and more often. Meanwhile, transportation is undergoing major shifts — with new technologies and upgraded methods.
It’s the business side, and it’s the human side of it. There’s a cast of thousands behind that cup of coffee as well — the people at the port, the truckers who pick it up at the port, people who maintain the highway that the truckers drive on, and the drivers on that highway that are financing that roadbed, and on and on. It’s a chain of interconnectivity that really is reaching a crossroads because, in some ways, we can’t afford to maintain what we have, and yet the technology is evolving, changing, growing and making more demands on what we have.
The technology is developing, yet there are so many issues in the transportation end of it, the construction end of it, the supply chain end of everything. This has almost become — even though the government has kind of pushed it off in some respects — a 24/7 365 process.
The head of UPS in the Los Angeles area, Noel Massie, is an amazing guy. Here’s a company that moves over 15 million deliveries to our doorsteps every day. He’s a leader in the delivery space, and he’s tearing his hair out — every time traffic delays the average UPS route a minute, that minute costs the company $12.5 million. And they’re adding minutes all the time. It’s the hidden cost of e-commerce. You click on “buy it now,” and you think, “Hey, this is convenient. Amazon is going to deliver me a package by tomorrow, or maybe the same day.” What none of us really get is that we’re creating a truck trip every time we do that. And it’s accelerating. It’s making more traffic. E-commerce is a hidden contributor to traffic. And we’re so in love with it, but we’re not really in love with paying for expanding the capacity of our transportation system to handle those trucks.
The delivery companies around the world are lusting after drones, but not little ones — big ones, 747-sized drones. That’s where they see unmanned aircraft as the next disruption and provider of efficiency, lower costs — obviously, because they’re eliminating humans — and also more safety.
Half the cars on the road at rush hour aren’t driving to work. They’re elective trips for something that’s not job-related. Which means if you can get people to defer those trips, to do them earlier or later, and there are ways to do that, we can eliminate traffic without a single bulldozer blade.
With some changes in belief, in structure, in philosophy, companies and people could save massive amounts of money that really could affect the economy in a variety of different ways.
Just as increased traffic congestion is a cost, taking it away creates savings. We lost about $160 billion to the economy in 2015 just from traffic delays and congestion and the wasted fuel they cause. So yes, there’s a huge payoff. One idea is that you could have major employers, public and private sector, in a metropolitan area like Los Angeles, cooperate and stagger starting times for their workforce. It could be a voluntary program; there could be tax incentives to encourage it. But the effect would be to have commuters entering the driving space at different times rather than all at the peak rush hour times. If even 10% of the commuting population in a large city defers their commute by half an hour, it could reduce congestion almost magically.
We are proponents of the work-from-home philosophy. We’re seeing declining amounts of people carpooling over the years. So that would be an alternative. The other thing that cities around the world like London have demonstrated successfully is congestion pricing. You could replace the gasoline tax — eliminate it, it’s a regressive tax — and replace it with congestion pricing. It’s a toll that goes up at rush hour and down at off-peak hours, just like we price electricity. That, too, has been highly successful, because it eliminates that 50% of rush hour drivers who don’t really need to be there.
There are traffic apps, crowd-sourcing ones like Waze that amass data in real time and allow you to change the way you go places and avoid traffic. That’s been highly effective. And of course, companies with large fleets are using their own proprietary systems — FedEx and UPS — to do the same thing. So data on the personal level has been having a big impact. Free apps, for goodness sakes: Who would have thought that such a thing could make driving more efficient for us? But it certainly has.
The rise of the smartphone has also empowered ride-sharing, which is a huge disruptor. And when you combine that with the evolving technology of driverless vehicles, that’s a new paradigm for how we use and deploy cars — and whether or not we even want to own them in the future. We may just buy car time like we buy phone minutes, once driverless technology is mature.
The U.S. is schizophrenic on rail. We lead the world in our ability to move goods by rail but we are woefully behind in our ability to move people on rail. We’ve invested massively in the one and taken away investment in the other.
If you want to look at an effective rail system, America’s freight rail is pretty much the one you want to seek out and copy. And if you want to look at poor choices on our passenger traffic, then you could also look at how we’ve allowed our rail capacity to decay, particularly in the Northeast Corridor.
There’s infrastructure in that corridor that dates back practically to the Civil War, tunnels that are 100 years old. And it’s just one of many areas where we have lost the ability to maintain what we have. There’s a $3.6 trillion backlog in repairs to our transportation infrastructure. It’s enormous.
We can’t be governed by old thinking. A lot of the investments that we’re making — and they’re incredibly expensive ones like adding lanes to freeways like the 405 — really aren’t achieving what we want to achieve, which is to make traffic move better and more efficiently. We need to rethink what we’re investing in. And it’s not all about the ribbon-cutting moments. Some of the things are much simpler and yet could have a much higher payoff.
We’re continually seeing larger container ships bringing goods to our ports. In one sense, that’s welcome, because that’s bigger efficiency, it creates jobs. They’re a manmade wonder. But on the other hand when you have ships arriving that carry enough goods to stock 10 Walmart superstores all at once coming off on trucks, where are those trucks going to go? There’s no room on the roads for them. It’s like a tidal wave every time one of these big ships hits the shore, and creates huge concerns for smog, for traffic. If we’re going to have this outsourced-goods economy continue, we need to create the right infrastructure to handle it.
Many of these companies are making changes, yet there are still a lot of companies that probably are saying “If it ain’t broke, don’t fix it.” Not understanding that it is broken and it needs to be fixed.
There’s something like 60,000 bridges — just to name one category — that need repair around the country. One of them went out on a major freeway out in California, the Interstate 10, a major goods corridor freeway — a little tiny bridge that washed out in a storm. If it had been maintained properly it wouldn’t have washed out. Every day that was closed, it cost the trucking and goods-moving industry $2.5 million. That’s just one bridge out of 60,000, so you can see what allowing our infrastructure to decay can do to the economy. It is a massive risk that just grows.
Anywhere you look you’re going to find it — in every state, in every city. It’s a struggle. In the last century we’ve had two big infrastructure investments in this country. There was the Franklin Roosevelt era, when all the great public works that we still rely on — the Hoover Dam and the Golden Gate Bridge and so forth — were erected. All parts of the transportation infrastructure. And then there was the Interstate highway construction under the Eisenhower administration.
If you take away those two big building booms and investments by the government, huge investments, the U.S. has invested much less in terms of its gross domestic product in transportation than almost any other developed nation in the world. And we’re not keeping up.
When you think about the push for driverless cars … companies, like Apple and Google, that are trying to bring this technology forward, are really at the edge of a major tipping point. Yet in some respects, they still battle old conventional wisdom from the 1950s and 1960s. And that’s the problem. Whenever you try to integrate something new and disruptive in an old system — I mean, the car that we drive today is a fancied-up version of what was invented 100 years ago — trying to integrate those new ideas is really the difficult part. Once you get a majority of, let’s say, driverless vehicles on the road, then things get easy. But it’s that early mix that is proving problematic. That technology, once it’s mature, would save tens of thousands of lives every year and create enormous efficiencies.
The idea of car ownership and human drivers in those cars is something that’s going to go away. It’s going to be like the horse. Driving is going to be recreation, it’s not going to be what we depend upon. It’s going to happen in the goods-movement sector first, because the trucking companies are champing at the bit. But we have to prepare for the negative impact of that, which is a decline in an important source of employment. We can’t forsake the people who are at the heart of our goods movement industry now whose jobs would be at risk from driverless technology. So that’s one challenge.
The next one is to use that technology not just to have a million cars on the roads shuttling people around, but to solve the problem of getting people to take the train and other big pieces of mass transit, because it can solve that first mile, last mile problem. Solve the inconvenience of getting to the train station. The driverless car comes and drops you off. It’s all part of the same app that you would tap to get a trip to get you where you want to go.
So the technology and the change that it could bring could solve most of the negative sides of our transportation system, but it’s going to take time, and it’s going to take a change in mindset, which is the third thing. Are we willing to take our hands off the steering wheel? Because we all think we’re better drivers than we really are.