Hyperloop Blog Series (Part 2 of 3): The Social, Environmental and Economic Forces Driving Enthusiasm for Innovative Infrastructure
Part 2: Hyperloop Economics
In this 3-part blog series we address (1) the social and environmental drivers of innovative transportation solutions such as Hyperloop and charging roadways, (2) the economic factors driving investment in and enthusiasm for Hyperloop, and (3) the current obstacles that will need to be overcome in order for the construction industry to help improve the commercial viability of innovative transportation infrastructure solutions.
Sustainability is one of Precision’s core values and we are dedicated to furthering cutting-edge solutions for the built environment. We see innovative infrastructure solutions as an opportunity for our company to make a difference in the health and well-being of the planet and our fellow citizens of the world.
Part 2: Hyperloop Economics – The Forces at Play
In Part 1 of this blog series we discussed the societal and environmental factors that are driving the development of innovative transportation solutions. In this installment, we will focus on the economic forces driving investment in new transportation technologies around the globe.
Hyperloop is a global phenomenon, with feasibility studies currently in process for projects valued at over $200B (see Fig. 2.5 for a partial list). Inductive charging streets are also being tested in at least three countries at present. While inductive charging roadways require some additional infrastructure spending and provide straightforward benefits to consumers and the environment, Hyperloop offers a completely new approach to transport and is more complicated to understand. We will therefore commit the majority of this installment to developing an understanding of the underlying economic issues driving global investments in Hyperloop technology.
Because the potential market for Hyperloop is so geographically broad, we must start by establishing the appropriate macroeconomic context in which to view it. In order to outline the financial incentives driving global investment in Hyperloop technologies, we will start by providing an analysis of the economic drivers for ground-based modes of freight transport in the US and later expand to a more global view. This means starting with a close look at the domestic market for freight transportation via rail and long-haul trucking.
US Ground-based Freight Transport Market
Last year in the United States, the rail and long-haul trucking industries combined for $248B in total revenue. As the country’s recovery from the Great Recession has progressed over recent years, both industries have benefited from increases in (i) industrial production, and (ii) general trade volume. Lower operating costs due to depressed crude oil prices also contributed to increased profitability for both industries in 2016. Historically, one of the main drivers of growth for both of these industries (and freight transport in general) has been the Total Value of US Trade, which has been increasing since 2009 and is expected to experience a compound annual growth rate of 4.97% over the next five years (see Fig 2.1).
Long-distance freight trucking is the most widely used mode of freight transportation in the US, largely due to the flexibility it offers clients in terms of order size and timing of shipments/deliveries. However, the industry is expected to experience increased competition from rail transportation as fuel prices start to climb and consumers continue to grow increasingly concerned about environmental sustainability. According to research from IBISWorld, the long-distance freight trucking industry is expected to experience a 2.0% annual compound growth rate over the next five years while rail transportation is expected to grow by 3.4% annually over the same time period. Rail transportation is considered to be in a “growth” stage while long-haul trucking is considered a “mature” industry.
The US Department of Transportation estimates that, by tonnage, the rail transportation industry will grow 88% by 2035 (compared to 2002 levels), which will lead to increased strains on infrastructure and capacity in the relatively near future. Rail transportation has some important competitive advantages over long-haul trucking in that it usually represents the most cost-effective, convenient, and fuel-efficient option for large shipments. Modern trains can transport one ton of freight coast-to-coast on just 7 gallons of fuel while trucks typically require about 27 gallons per ton. This will translate into massive advantages for rail (in terms of both environmental footprint and cost structure) as the expected rise in fuel prices (compared to 2016 levels) drives trucking costs higher in the coming years.
Fig 2.1 – Total Value of US Trade
Source: IBISWorld Industry Reports – 2016
While trucking does benefit from the flexibility offered by the US’ vast highway network, road shipments are typically slower and more expensive than rail (per ton-mile). Small owner-operators dominate the long-haul trucking industry while larger trucking companies tend to focus on regional markets. Conversely, due to the industry’s high barriers to entry, rail transport in the US is dominated by 4 large operators with ownership of (and control over) infrastructure in their respective territories, which significantly limits competition within the industry. This results in large average profit margins of around 30% for rail operators while long-haul trucking operators average only 6-7% due to intense competition and a general lack of pricing power. The following chart illustrates the relative cost structures of these two industries.
Fig. 2.2 – Cost Structure Comparison: Rail v. Trucking
Source: IBISWorld Industry Reports, 2016
Due to intense competition, low profit margins and limited access to capital, trucking is likely to experience significant M&A activity in the coming years as the more well-capitalized regional firms take advantage of opportunities to upgrade to more fuel-efficient electric and hybrid vehicles sooner, thereby increasing profitability and pricing advantages over smaller owner-operators. In general, rail is expected to eat into trucking’s market share for longer distances as fuel prices increase and the trucking industry consolidates over time. Incremental improvements to fuel efficiency from technological innovations such as inductive charging streets should also provide advantages to regional trucking operators long before widespread access is available to long-haul truckers on the broader interstate highway system.
However, the rail industry has its own issues to contend with. As industrial production, trade volume and population growth lead to increased demand for rail’s relatively speedy and fuel-efficient services, capacity constraints will eventually hinder the industry’s growth. The rail industry faces a significant challenge in managing existing infrastructure and investment to meet this anticipated demand. On average, freight rail operators reinvest 40% of their annual revenues in equipment and infrastructure improvements. According to the American Association of Railroads, operators have spent $525 billion to improve the freight rail network over the past 35 years ($15B per year on average). The fact that these expenses don’t show up in the chart above (because they’re usually capitalized) does not reduce their impact on the real profitability and free cash flow of rail operators.
It therefore stands to reason that railroad operators would be interested in pursuing strategies to reduce infrastructure expenditures and operating costs over the long term. It just so happens that Hyperloop stands to provide massive upgrades in each of these categories. The cost to build Hyperloop infrastructure is estimated to be significantly less than that of high-speed rail. And because Hyperloop provides a closed system where vehicles make very little contact with the track (if any), maintenance costs are expected to be significantly less than for traditional rail infrastructure. On top of that, Hyperloop systems may not require fossil fuels at all and the systems will be largely autonomous – meaning significantly reduced operating costs and environmental footprint. With these issues in mind (plus the fact that rail operators already own the land and rights of way that will be needed to construct Hyperloop infrastructure), it is easy to understand why several large rail and logistics firms have begun investing heavily in Hyperloop ventures.
On February 17, 2017, the Dutch railway company Nederlandse Spoorwegen (or Dutch Railways) spearheaded a €600,000 investment in a new Dutch start-up called Hardt, which is an outgrowth of TU Delft’s winning pod development team from SpaceX’s competition in January. DHL was an early backer of the Delft team and is also expected to invest in Hardt. Dutch Railways wants to integrate the technologies developed by Hardt to make its trains and systems as energy efficient as possible, with a spokesperson recently saying, “As a major consumer of electricity, anything that can help us drive trains more efficiently is pure profit.” As previously stated, increased energy efficiency is just one of the benefits of Hyperloop systems as compared to existing modes of ground-based transport.
The profit potential of Hyperloop technologies is certainly not lost on world leaders in the transport and logistics industries. The case of Virgin Hyperloop One, with over $200 million of reported equity funding to date, is particularly illustrative of this point. DP World, the UAE’s largest port and infrastructure operator, is an early investor with two seats on the board of Virgin Hyperloop One. Summa Group, the largest holding company of Russian transport and logistics infrastructure (and an early investor in Uber and Uber China) is also a major investor and board member of the company. SNCF, a major European rail operator, and Zhen Fund, Sequoia Capital’s Chinese affiliate, are also early Virgin Hyperloop One investors. As we will discuss in this blog series, Hyperloop is much more than an interesting new idea and its potential to completely revolutionize the world’s transport and logistics industries has not gone unnoticed by the major players.
Hyperloop is currently projected to offer lower upfront infrastructure costs (estimates range from about equal to high-speed rail down to 1/3 the cost) in addition to reduced operating and maintenance expenses. Hyperloop pods will travel 2-3x faster than high-speed trains and will be powered by electricity (most, if not all of which, will come from renewables). The fact that Hyperloop will be a closed system also eliminates the threat of delays and maintenance issues due to weather.
Global Market for Hyperloop
These economic and environmental principles also apply when evaluating Hyperloop’s viability from a more global perspective. The main difference, which serves to bolster the case for Hyperloop even more, is the rest of the world’s relative preference for passenger rail. While Americans outside of Amtrak’s Northeast corridor justifiably view passenger rail as slow and unreliable, such is not the case in many other parts of the world, where high-speed rail transport is often preferable to air travel for shorter trips. While passenger rail travel currently represents an insignificant portion (less than 4%) of the total rail industry in the US, Hyperloop is likely to revolutionize the way Americans think about passenger transport options in the future. But in places like Europe, where passenger rail is already popular, rail operators and governments will be motivated by the same issues we have highlighted for US freight rail operators.
Another key difference between the US and international markets for Hyperloop lies in government enthusiasm for (and financing of) rail projects. Governments around the world have been investing heavily in rail for decades (either outright or via subsidies) due to concerns about road congestion and rising CO2 emissions. Rail subsidies are largest in Europe (averaging €73 billion per year) and China (averaging $130 billion per year), while the US has relatively small subsidies for passenger rail ($1.4B annually to Amtrak) and does not subsidize freight rail at all. Railway-centric government policies are intended to channel population growth and development toward dense city agglomerations and along main railway arteries. These forward-thinking strategies stand in stark contrast to US policies, which tend to favor highway expansion, which leads to suburban sprawl, increased vehicle dependency, and greater carbon emissions. In fact, European development economists argue that the existence of modern rail infrastructure is a significant indicator of a country’s economic advancement.
Fig 2.3 – Rail Investment by Country
Source: Arrigo & Di Foggia – Public Expenditure on Railways in Europe, 2014
Globally, the main driver of growth for the logistics and transport industries is world trade volume; which is forecast to experience an average compound growth rate of 4.1% over the next five years. Due to population growth and the increasingly global nature of many industries, world trade growth is largely inevitable over the long term, despite recent trends toward more nationalistic political views in many western countries. As global economic and population growth continue, the incentives for cheaper, faster, more efficient and more environmentally sustainable transport solutions will also grow.
Fig. 2.4 – Total Value of World Trade
Source: IBISWorld Industry Reports, 2016
Due to the various economic, demographic and environmental factors we have highlighted, several governments and prominent investors around the world are actively working to bring Hyperloop to their respective countries. Additionally, South Korea (through the Korean Railroad Research Institute) is developing its own “Hypertube” concept with a publicized goal of providing passenger transport between Seoul and Busan in 30 minutes or less. In the 1990’s the Swiss government took over the rights to the “Swissmetro” technology (an early version of the Hyperloop concept) after the private company behind it was unable to secure the necessary funding to bring the concept to market. The government is rumored to be considering funding for further development of the project, no official announcements have been made at the time of this writing.
Fig. 2.5 – Partial List of Hyperloop Feasibility Studies in Process (costs converted to $US)
KPMG, in conjunction with Hyperloop One (now Virgin Hyperloop One) and both the Finnish and Swedish national governments, recently released its “pre-feasibility study” for the three segments of the proposed Hyperloop route from Helsinki to Stockholm via the Aland Islands. The proposed route would involve three types of technical solutions for track construction: tunneling and trenching through hillsides, mounting above ground on pylons, and tunneling under the Baltic Sea. The preliminary findings from the study are exciting (see Fig. 2.6 below). While more detailed analyses are forthcoming, in its initial review KPMG determined a total cost per mile of $65M compared to the current average of $193M per mile for California’s high-speed rail project. At one third the infrastructure cost of high-speed rail, and with somewhat conservative estimates for ridership and ticket prices, the project looks very promising indeed. If Elon Musk’s new venture, The Boring Company, is successful in delivering faster and less expensive tunneling technologies, infrastructure costs could be reduced even further.
Fig. 2.6 – Helsinki to Stockholm Hyperloop Pre-feasibility Study Findings ($ thousands)
Source: KPMG Pre-feasibility Analysis, May 2016
Where do we go from here?
It is clear from our analysis that there is an incredible amount of worldwide enthusiasm surrounding the Hyperloop concept and that the underlying economics are compelling enough to justify the hype. But in order for large-scale Hyperloop infrastructure projects to be considered commercially viable, the construction industry will need to make great strides in terms of its speed, productivity, and cost-effectiveness. In the third and final installment of this blog series, we will examine the headwinds facing the construction industry as well as the forces driving innovation within it.
 US Rail Transportation; IBISWorld Industry Reports, 2016