January 7, 2015

By Marc Davis

If the U.S. price of bread soon goes up, blame it partially on Canada. Canadian grain exports to the U.S., including wheat – Canada’s biggest crop – have declined significantly in recent months as rail capacity is increasingly devoted to shipments of crude oil. The U.S. is the biggest importer of Canadian grains, followed by China.

Wheat exports to the U.S. from Canada plummeted this year by 36 percent over last year, down to 210,700 metric tons. The decline represents a six-year low in exports to the U.S. As a result, processors and millers of wheat in the U.S. must now rely more heavily on domestic supplies. The potential result: higher prices.

The Canadian government and simple economics are behind the falling volume of grain shipments to the U.S.

For Canadian railroads, shipping crude oil to the U.S. is just more profitable. Domestic grains are shipped by rail to the nation’s ports, mainly Vancouver in western Canada and to eastern port cities on the St. Lawrence, such as Montreal and Quebec City. From these locations, Canadian grain is shipped to foreign importers, despite the increased costs and the more distant destinations.

With less supplies of the lower-priced Canadian wheat in the U.S., wheat-based products could further increase in price. From October 1 to mid-December, 2014, U.S. wheat prices had already spiked 24 percent.

A Canadian government regulatory requirement imposed in March, 2014, is the second factor in declining wheat shipments to the U.S. A government-mandated rule, formulated to assure that rail capacity is available to wheat and other commodity growers, resulted in “unintended consequences,” said Mark Hemmes.

Hemmes is president and founding partner of Quorum Corporation, based in Edmonton, Canada. The company monitors the nation’s grain handling and transportation system for the Canadian government and reports quarterly and annually on its efficiency and its impact on producers, railways, grain companies and ports and other aspects of the industry.

“The regulatory rule forced railroads to carry a specified minimum amount of grain,” said Hemmes.

“Canadian farmers sell their commodities to grain companies and railroads,” he said. “They [railroads and grain firms] then decide where to ship, not the farmers. The shorter, nearby destinations are more profitable for shipment of grains.”

The result, according to Hemmes, is that most Canadian grain goes to domestic ports for export, not to distant destinations in the U.S. That was the unforeseen and unintended consequence of the government regulation.

“I can’t speak for the Canadian government as to why [it] made the regulation change, but it apparently saw the crisis,” Hemmes said.

The crisis he referred to was the increasing domination of rail capacity by the highly lucrative crude oil to the detriment of domestic grains. Farmers wanted the rule mandating more rail space for their grains as oil increasingly took over rail cars and grains were not shipped.

“Rail car turnaround cycles is also an element,” said Hemmes.  “Railcars used for shipment to the U.S. run a 28 to 35 day cycle. That means from loading, to transport time, to unloading and return to point of origination. That’s not the most efficient use of assets. The Canadian cycle [rail shipments from source to destination and back] usually runs 14 days. That’s far more efficient.”

Some analysts anticipate a widespread ripple effect.  Prices for wheat and others grains could increase and the cost of consumer products, which use those commodities, could also increase accordingly. But price elasticity will stretch only so far, so at a certain high cost level sales will flatten and may start to decline.

Hemmes declined to forecast future wheat prices. “I’m a logistics guy,” he said, “not a market forecaster. There are so many variables that go into determining prices.  Rail transportation capacity is just one of them.”

If the price of wheat and other commodities increase, the cost of farm acreage devoted to the growing of grains could also increase. Landlords may raise farmland rental prices based on the projected return per acre.

Weather is always the wild card in wheat prices, and this year’s excessive rainfall and below-average temperatures in Canada damaged fall wheat production. Milder weather in western Canada hurt yields of winter wheat.

Canadian wheat production this year will decline about ten million metric tons to 27.5 metric tons, down from last year’s record output of 37.5 million tons, according to data from Statistics Canada, an agency of the Canadian government.

The Canadian government is especially focused on examining the nation’s rail system this year, according to Hemmes. “Every fifteen years the government does a complete review and right now they’re in the midst of it,” he said. Part of the review process, says Hemmes, is to look at input from growers, shippers, and lobbyists.

“But there’s no anticipating what’ll be done or what will change,” Hemmes said.

Meanwhile, as rail space for wheat and other grains continues to remain scarce, Canadian farmers are reportedly using trucks to deliver their commodities to the U.S. while crude oil rides the rails.