The cost of Rome burning - Transportation

To come up with a cost estimate, we consider three areas - the costing formula, performance and rail car allocation. The assumptions and methodologies we used are laid out below. The estimates are summarized in Tables 1a. and 1b. It should be noted that some of the costs that we calculate are costs only to the farmers, while others represent costs to the entire system. The costs identified with the costing formula, for instance, are typically costs only to farmers; what is a cost to farmers is a benefit to other players in the system, largely the railways. In contrast, the costs identified with performance and rail car allocation are costs to the entire system. Some of these costs will be borne by farmers and some will be borne by other system players.

Costing

The current formula used to determine annual rail shipping rates was developed in 1992. The problem with using a 16-year old formula is that it has not been altered to reflect the efficiency gains that have been made in the system - branchline closures, elevator consolidation, and 50-100 car loading spots. Several groups, including the Canadian Federation of Agriculture, have been urging Transport Canada to undertake a full costing review, but to date the government has not committed to doing so. Rail rates are expected to increase eight percent in the upcoming crop year, which according to the railways, reflects the increase in fuel and labour costs.

Until the formula is revised farmers are overpaying on freight charges. A study commissioned by the Canadian Wheat Board estimated the overpricing of rail rates to be in the range of $6.15 per tonne. If we apply this overage to all the grain tonnage shipped in a crop year, the current formula is costing farmers $173 million per year.

For an upper bound estimate of the rail costing issue we consider the impact of higher than cost freight rates on all grain produced in western Canada, which is about 50 million tonnes per year. The upper bound cost is $307 million per year. This upper bound cost could be even higher if we included the 25 percent contribution to capital allowance that is built into the 1992 costing formula.

Performance

The grain handling system in Western Canada has consolidated to become more efficient (see Quorum Report). Since 1992, primary elevators have decreased from 1,500 to 331. Twenty-two percent of all primary elevators have 100-car plus loading spots. However, cycle times and grain movement do not reflect these efficiency gains. Poor rail service forces farmers to store more grain on farms for longer periods of time.

For instance, despite a drought reduced wheat crop in 2007, only a portion of this crop has yet been shipped. While most of this wheat will be shipped prior to harvest in Canada in 2008, the lack of rail performance and the slow progress in shipment means that the opportunity to sell this crop at much higher prices is gone and it now must be priced against much lower priced new crop in the United States. Minneapolis DNS wheat prices have fallen from a peak of $860/tonne in February to about $360/tonne today.  While this problem is particularly costly this year, it will be a problem in most years as markets are typically lower priced over the summer months when the U.S. new crop is available for sale. The inability to move grain could be even more costly with a particularly large crop that would cause grain to be carried forward into a new crop year delaying the sale of stocks for a two-year period.

We estimate poor rail performance to cost the system somewhere between $256 and $512 million per year. In the lower bound cost estimate we assume the lack of rail capacity investment results in 8 millions tonnes of grain being sold at a price reduced by $32 per tonne, which is a typical price decline due to summer inversion in the wheat market. For the upper bound, we estimate that the price reduction is $64 per tonne or two years of carry on 8 million tonnes.

Car Allocation

The Canadian Wheat Board began using the car tendering process in 2000 to determine rail car allocation. The system has worked effectively and has generated transportation savings, which are returned to the farmers through the pool accounts. It also allowed the marketing system to procure and ship grain specific to customers' orders, which gave the Canadian system the ability to respond to customer requirements in an efficient and competitive manner. On February 1, 2008, the railways simultaneously moved to a new system that ignores rail car orders and delivers 100 cars every two weeks, to elevators the railways choose, regardless of where grain for sales requirements are located (see CWB News Release). By not following rail car orders there is a risk that the wrong grain will be shipped to port at the wrong time, causing congestion, delays, demurrage penalties and damage to Canada's reputation as a reliable supplier. This new system will also make the handling system less competitive as railways arbitrarily allocate cars rather than using competitive bids to determine which grain handler receives cars. In our upper bound of cost calculations we estimate that the lack of the responsiveness of the marketing system will lower farm gate prices by $8 per tonne because of a loss in reputation as a reliable supplier. In the lower bound estimate we assume that the change in car allocation has no impact on producer returns.

Table 1a. Lower Bound Canadian Agriculture Rail Transportation Costs, 2008

² CWB News Release. February 12, 2008. "CN Rail throws grain shipping into disarray." Available online at: http://www.cwb.ca/public/en/newsroom/releases/2008/021208.jsp

Further Reading:

Canadian Federation of Agriculture. Backgrounder. "Farmers bear brunt of excessive railway profits." Available online at: http://www.cfa-fca.ca/pages/index.php?main_id=426

Government of Saskatchewan. News Release. June 30, 1999. "Study reveals railway not sharing gains in productivity." Available online at: http://www.gov.sk.ca/news?newsId=59c5e3e7-8ee2-4c18-8fd3-9da3932029c6

This blog entry was co-authored by Murray Fulton and Richard Gray. To read additional Illative Blog entries or to leave comments on this entry, please visit www.illativeblog.ca. The Illative Blog is an initiative by the Knowledge Impact in Society (KIS) Project based out of the University of Saskatchewan. Email correspondence can be sent to kis.project@usask.ca