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Linking Farmers to Customers: an industry working paper
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March 8, 1999
Challenges and Opportunities
The grain handling and transportation system in Western Canada is undergoing
significant changes. High throughput elevators are being constructed across
the prairies in unprecedented numbers by both new entrants and long time
players in response to competitive pressures to maintain and enhance market
share.
At the same time, the economics and maintenance of branch lines is highly uncertain and must be addressed to ensure a sound investment environment for short line operators and producer car shippers.
On the marketing side, the trend has been towards an increasing number of customers who are purchasing grain in smaller quantities with more specific class, grade and protein requirements. In this changing environment, it is clear that the grain handling and transportation system must be able to respond to the needs of the customer in a low cost and efficient manner.
In conjunction with the industry, the CWB has made a number of significant changes reflecting this changing environment. The most significant of these was the implementation of the zone allocation system in November of 1998.
Looking forward, the Board's vision with respect to future changes in grain logistics is based on three overriding principles.
- The Board believes that, in grain handling and transportation, competition is the primary tool to be used in sectors where it results in the best possible returns to producers.
- The Board believes that regulation is required where competition will not be effective.
- The Board believes that there needs to be movement towards more commercial operating arrangements between the various players to ensure accountability in grain handling and transportation.
The key objective of the Board's plan is to establish an effective, low-cost transportation and handling system that meets the needs of farmers and customers.
Action Plan
Based on the above principles and objectives, the Board has developed an action plan that would strengthen the supply chain on two key fronts:
- Action items to create a more competitive and lower-cost grain transportation environment; and
- Action items to strengthen commercial contracts between the CWB, grain companies and the railways.
| Create A More Competitive and Lower-Cost Grain Transportation Environment |
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| Strengthen Commercial Contracts between the CWB, Grain Companies and the Railways |
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Summary
Implementation of this action plan would result in an efficient and low-cost system, a key objective for all industry participants. Grain freight rates would equal the best results of a competitive environment, competition in grain handling would
increase, and commercial accountability between all parties would be achieved.
In addition, implementation of this action plan would create a market environment in which many of the principles in Mr. Estey's report could be achieved. For example, recommendations which were supportive of short line operators and producer car
shippers could be realized. It would also ensure that shippers make optimum use of Canada's port alternatives, based on their economic competitiveness. This is particularly true for Prince Rupert, the St. Lawrence Seaway and Churchill.
Finally, this action plan would improve information flow within the industry because it establishes a framework for clearly defined relationships between industry participants and clearly defined information requirements. An improvement in
information dissemination would go a long way to improve the functioning of the transportation and handling system.
By strengthening the grain supply chain through the implementation of this action plan, Canada's grain handling and transportation system becomes the most effective way to link farmers to customers.
Background to the Action Plan
A More Competitive and Lower-Cost Grain Transportation Environment
Conduct a review of railway costs to ensure that the rates farmers pay are in line with the actual distance-related cost of transporting grain.
If there is sufficient competition in grain transportation farmers would only pay what it actually costs service providers to move their grain. Current freight rates, however, are out of line with costs. Each year the railways benefit by a two per
cent gain in productivity. This means lower costs for railways. However, these lower costs have not been reflected in lower freight rates for farmers. A truly competitive environment would see these benefits shared with farmers.
It has been six years since the last costing review. Next year, the cumulative benefit of productivity gains to the railways will be 14 per cent. On a total freight bill of $1.2 billion per year, that means that this year farmers are paying $168
million more in freight bills than they would be if there were regular costing reviews where productivity gains were reflected in lower rates. On an annual movement of 33 million tonnes, that translates into over $5 per tonne.
Therefore, if a costing review is completed for next year, it is likely that farmers would see at least a $5 per tonne drop in their freight rate.
The Board recognizes that it is important that all participants benefit by any innovative contributions they make that improve the working of the system. Based on this, beyond the first year costing review, future productivity grains should be
shared with other industry participants to ensure future ongoing industry investment.
Implement a cost-based, distance-related freight rate structure, which recognizes port parity, to replicate a freight rate structure that would result in a competitive environment.
In the absence of true competition, carriers are able to charge freight rates in excess of costs based upon what the market will bear. An example of this can be found in Montana. There Burlington Northern rates are set at levels that are three
times the cost of moving grain. This is a direct result of a lack of competition between railways and a lack of alternatives for shippers.
The same non-competitive situation that exists for grain shippers in Montana exists throughout western Canada. Even in situations where farmers can access more than one rail line by trucking, they would face non-competitive pricing by the railways.
As in the US, once one railway sets the tariff rate, the other railway would have no incentive to undercut that rate.
While the Board acknowledges the CP proposal to cap revenue earned from grain for a three year period, the Board is skeptical about what this proposal really means. The proposal is quite vague with respect to whether the cap includes bid cars and
other allocative mechanisms CP is considering. Furthermore, CP's proposal begs the question of why they cannot lower their rates below the maximum scale today, particularly given that CP has captured very significant productivity gains since the last
costing review in 1992. Finally, as an industry, we have to be looking beyond the three year period as deregulation of the rate structure would be difficult to reverse.
Looking across the border, one can see what non-regulated rates look like in a non-competitive environment like that which exists in most parts of the prairies. The statutory rate from Edmonton to Vancouver is Cdn $27.25 per tonne. The rate from
Shelby, Montana to Portland, Oregon, which is roughly the same distance as the Edmonton to Vancouver movement, is nearly twice that at Cdn $52.00 per tonne.
Closer to home, rates on commercial movement have tended to be much higher than the statutory rates for movements of similar distance. For example, the commercial rate from Moose Jaw, Saskatchewan, to Minneapolis, Minnesota is Cdn $49.33 per tonne.
By contrast, the statutory rate from Moose Jaw to Vancouver is Cdn $35.03 per tonne.
Given the absence of real alternatives to rail for grain movement from the prairies and the unwillingness of the railways to compete against each other on rates, removing the rate cap would result in long-term economic hardship for farmers.
A cost-based, distance-related freight rate structure, which recognizes port parity, would simulate freight rate setting in a competitive environment. Under this structure, the freight rate to Prince Rupert and Vancouver would no longer be based
solely on distance. The rate to Prince Rupert would come more in line with costs and more in line with Vancouver.
Examine opportunities for improved competitive railway access provisions.
Canadian railways operate on privately-owned tracks and, except under very controlled conditions, do not allow other operators to run on their system. Therefore, most stations and destinations can only be accessed by one railway. There are provisions
in the Canada Transportation Act (CTA) that are intended to allow a shipper to move tonnage from one rail line to another. However, in practice these provisions are not effective. As well, there are provisions which allow a railway to apply for
access to another rail line through joint running rights. Again, these provisions have not been effective, partly because they are limited to federally-regulated railways and more so because they rely on one railway's willingness to compete against
another.
Any recommendation for changes to the CTA relating to the methods of seeking access to other rail lines is a move in the right direction. It is important to note, however, that none of the recommendations proposed to date would effectively change the
competitive environment in the rail industry or justify a removal of the rate cap.
More work is needed to identify a workable model for improved railway competition. Within this context it must be recognized that a move to a system of publicly-controlled rail beds is not likely achievable, nor necessarily desirable given the power
structure of the current rail industry.
Change the CTA to encourage competition in rail transportation and strengthen shipper protection through improved Competitive Line Rate and Final Offer Arbitration provisions.
Competitive Line Rate (CLR) provisions in the CTA encourage competition between railways by giving shippers the ability to move their grain from one railway's line onto another. The legislation requires that the freight rate portion of a CLR must be
distance-based for export grain using the nearest interchange with a connecting carrier regardless of how the railway routes the traffic. As well, the legislation requires that any additional switching costs must be cost-based. These are two
important details within this provision and the wording in legislation must be strengthened to ensure that the railways conduct their business in accordance with the spirit of the legislation.
Competition in the rail sector could be further enhanced by strengthening the CLR provisions in the following areas:
- Remove the limitation that a shipper must have the cooperation of one of the non-local railways involved before pursuing a CLR application as this is a difficult requirement to meet in the absence of true competition between the railways.
- Streamline legislation to ensure that suitable and adequate interchange facilities are constructed at all locations where railway lines intersect, particularly in the absence of other interchange facilities within a certain radius. Require adequate maintenance of the infrastructure so that a healthy number of alternatives exist for interchanges between railways.
In addition to improved rail access which would increase railway competition, accountability and service, improved shipper protection as provided through Final Offer Arbitration (FOA) must be firmly set in legislation. As is intended with FOA, the
process must put shippers and carriers on an equal footing by requesting the simultaneous submission of each parties' final offer. As well, the process must be quick so that smaller shippers do not suffer unnecessary costs.
Maintain farmers' voice in transportation through an industry forum for capacity planning and high level car allocation. Grain movement is seasonal. Most shippers tend to want to move most of their grain during the winter months. The
CWB, for instance, usually tries to maximize movement during the October to March period because that is when prices tend to be the highest. Therefore, for some portion of every crop year, transportation capacity is constrained, meaning that there is
more demand for grain movement than there is supply of transportation services. Because of this, it is necessary to ration or allocate the available capacity.
In a non-rate regulated system, like in the US, this is achieved by variations in price through a bid car process. Those shippers who want to move their grain during the periods of peak demand must pay more than other shippers who must then wait for
the slower demand periods.
In Canada, grain transportation prices have been regulated by a maximum rate structure, because of concerns about the lack of competition between modes of transportation and between railways. Therefore, allocation is done through industry agreement
as established by CAPG. CAPG is an industry-funded organization consisting of representatives from the CWB, grain companies, railways and farmers. In times of constrained capacity, the CAPG allocates cars according to a set of transparent rules so
that all players are aware of their share of overall capacity.
CAPG also provides a forum for a very beneficial long term planning process that helps shippers and carriers alike to reduce uncertainty and therefore costs. It is interesting to note that many shippers in the US are trying to implement the same
system that has existed in Canada for several years.
None of the above means that the Car Allocation Policy Group absolutely must remain in its present form and function. However, it is vital that any changes to the current system include the retention of a forum for long-term planning and a forum in
which shippers' interests are incorporated in car allocation rules, as exists currently with CAPG. As well, the industry must not lose the ability to establish benchmarks for system performance that it has currently with CAPG. The CTA decision shows
that the CAPG planning process produces guidelines for which the railways and other industry participants can be held accountable. This is an important lever for farmers and grain marketers that they cannot afford to give up.
Ensure that branch lines are sold in economically-viable units to interested parties and that railways engage in sale price, rate sharing and service level negotiations in good faith. The intention of the rail line abandonment
provisions of the CTA is to make branch lines available for purchase by short line operators or communities. However, in practice this is often not realized because the portion of the system that has been made available for sale is often too short to
be economically viable. Ensuring that the railways make available adequate sections of track will give prospective buyers a chance to put together a sound business plan.
The sale of the physical asset, however, is only one aspect of establishing a short line railway. The prospective short line must still negotiate a freight sharing rate and level of service with the main line carrier who has the upper hand in
negotiation. The negotiated agreement must be valid for some period of time in order to attract investors and to provide a meaningful opportunity for the short line operator. Therefore, the CTA should be amended to reflect that the railways must
engage in sale price, rate sharing and service level negotiations in good faith.
Support federal government ownership of the hopper cars, or if the government decides to sell them, advocate producer ownership based on a sound business plan. The Board strongly supports federal government ownership of the hopper
car fleet. If the government decides to sell the cars, the Board advocates producer ownership of the hopper cars, primarily for grain use in Western Canada. Ownership of the hopper cars allows the ability to use car supply to affect railway service
and rates and will give farmers a voice in transportation.
Action Items to Strengthen Commercial Contracts between the CWB, Grain Companies and the Railways
The CWB's role in transportation is an important element in its ability fulfill its marketing mandate for farmers. That mandate is to market wheat and barley to get the most out of the market while minimizing costs to farmers.
The CWB's role in transportation includes a number of crucial activities:
- contracting with producers,
- negotiating the CWB's share of the total car supply,
- placing orders for grain movement with its agents.
- determining the routing, destination, grade and grain and, subject to the allocation rules with its agents, origination on CWB movement
- negotiating rail rates and service with the railways.
This role can be strengthened by instituting stronger commercial arrangements between the CWB and its agents.
Implement a financial incentive-disincentive system to enhance accountability for fulfilling CWB car orders. The CWB allocates its car orders to its agents, the grain companies, based on the Industry Rail Car Allocation Policy
(IRCAP). It outlines responsibilities and incentives for the allocation of CWB orders.
Under current car allocation policy, on a weekly basis grain companies are: (1) rewarded for accurately fulfilling CWB car orders by receiving incremental rail cars under performance allocation, and (2) penalized for poor car loading performance by
receiving fewer cars according to a car penalty schedule.
An incentive and penalty system based on physical cars encourages accurate loading performance because if the number of cars a grain company receives increases, the amount of CWB grain it can handle increases and the opportunity for it to earn more
revenue on throughput increases. Performance allocation is especially effective in this regard.
This system could be further improved by moving to a financial incentive-disincentive system. This could lead to improved accuracy of car loading and timeliness of shipments. More accurate car loading would result in improved railway and grain
company asset utilization and increased system throughput capacity as well as reduced costs.
Make the allocation of cars more responsive to companies' ability to service farmers.
Under the current IRCAP, the CWB allocates a portion of its orders to grain companies based on, among other factors, the proportion of CWB grain they have handled through their facilities. This handling calculation uses information from the previous
52 weeks, weighted heavily to the most recent weeks. One option would be to shorten the period of time that is used to calculate a grain company's share of CWB orders from 52 weeks to between 13 and 26 weeks. This would make the allocation system
more dynamic, reflecting the tonnage that the grain company is currently handling rather than what it has handled in the more distant past.
A second alternative is to base a grain company's share of CWB orders on the tonnage farmers have committed to its facilities through a contract sign-up. This would mean that instead of the grain company's allocation based on what it has handled, it
would be based on what it could handle as determined by the contracts signed at its facilities.
Both of these options would increase the level of competition between the grain companies, which would result in improved service to farmers. As well, increased competition between grain companies should result in enhanced system efficiency.
Implement terminal handling agreements to maximize the efficient use of terminal facilities, expedite vessel loading and meet supply replenishment requirements in a timely manner. Although bottlenecks can occur at different locations
on the supply chain in different years and for different reasons, a well functioning port operation is critical to an effective transportation system. The Canadian port system does a good job of not only handling a large amount of grain, but of
adding value to that grain through blending, cleaning, drying and positioning grain into sales position.
Accountability at the port could be improved would be through terminal handling agreements. These would be contracts between the CWB and the terminal operators which would clearly outline each parties' responsibility in the movement of grain and
performance incentives to enhance rail car unloading.
These agreements would result in increased capacity and greater terminal staff and resource planning. They would increase the ability of the CWB to manage its inventory and result in better contract fulfillment. It would result in improved car
unloading and vessel loading in port position, as well as enhanced terminal and CWB accountability. In negotiating such agreements, there would be a potential for increased competition among the terminal companies.
Continue to use tendering to source grain to meet certain customer requirements when it results in increased returns for farmers and improved efficiency. The CWB has used a tendering process to source grain in particular
circumstances. For example, the CWB has tendered for durum with certain protein levels for the Japanese market. There is a benefit to farmers in the CWB having this ability to tender for grain when it results in increased returns to the pool accounts
or when it enables the CWB to offer a unique service to customers.
Although it may be beneficial for the CWB to look at tendering as an alternate strategy for sourcing for grain and implement it in situations when it adds value to the pool account and increase efficiency, tendering for 100 per cent of its supplies
would result in increased costs and reduced return for farmers and negatively impact capacity. For these reasons, it is critical that the CWB have the option of sourcing grain through both tendering and non-tendering mechanisms to respond to a wide
range of customer and marketing needs.
Implement railway service agreements in rate-regulated corridors that reward performance based on some key benchmarks (e.g., loading and unloading levels, transit times, etc.). Efforts to negotiate agreements on rates are limited
under the current structure for two reasons. One is that the railways are currently charging the maximum rate so there is limited room for negotiation. The second is that the railways would be unwilling to sign a contract which would increase their
financial risk of nonperformance, without an increase in the opportunity for additional revenue.
Given these constraints, the CWB is interested in pursuing service agreements which guarantee tonnage and performance on the total railway service package including car supply and timely delivery to destination. Service agreements would clearly
outline the responsibilities of the shipper and the carrier, as well as the consequences of non-performance of either party.
Accountability on total railway service can be achieved if grain is treated like any other commodity in railway scheduling. That means, when a grain shipper places an order in the country, they should know, based on operating schedules, when that car
can be expected to be delivered at port. The railways are then held accountable for the total railway service package.
Railway service agreements are critical to the success of any system agreement between the CWB and the primary elevator companies or the terminal elevator companies. Railway service is the link between the two ends of the system. Furthermore, rail
service is the critical link in the marketing chain between producers and customers.
Service agreements would result in lower costs. Productivity sharing would ensure that these savings are shared between carriers, shippers and farmers. Better planning and more efficient use of resources as a result of service agreements would
translate into increased capacity for a given set of assets and therefore reduced costs. Service agreements would also clearly establish accountability for the CWB, grain companies and railways.
1 - Vercammen, J., M. Fulton and R. Gray. "The Economics of Western Grain Transportation & Handling." 1996 Van Vliet Publication Series, Department of Agricultural Economics, University of Saskatchewan.
2 - Terry Whiteside, US Wheat Associates, Keystone Agricultural Producers Annual Convention, January 1999.
3 - The rate is based on BN's tariff for a 52 car train at an exchange rate of 1.50.
4 - The rate is based on Canadian railway tariff for a 25 car train at an exchange rate of $1.50 and assuming 90 tonnes per car.
5 - This is supported in recent analysis by a group of University of Saskatchewan agricultural economists (Fulton, M., K. Baylis, H. Brooks, and R. Gray. "The Impact of Deregulation on the Export Basis in the Canadian Grain Handling and
Transportation System." December 1998.) and in a study commissioned by Saskatchewan Agriculture and Food (Travacon Research Ltd. "Grain Volumes and the Impact on Railway Profitability/Behaviour." September 1998.)
