Tuesday, October 25, 2011
CWB defenders are using the economic benefit argument provided by the CWB that suggests that the single desk is responsible for $500 million in annual "benefit" to Western Canadian farmers. Unfortunately, the CWB has not released any details or calculations used to get this figure. Yet it’s being thrown around – in the media and in Parliament – as if it’s irrefutable.
Back in 2006, the CWB published on its website an analysis that showed the CWB provided a financial benefit of between $530 million and $655 million. I’m told the current estimate of $500 million used the same approach. A closer look at that analysis seems appropriate.
The CWB summarized its “benefit” as follows (details at the end of this article):
Value of CWB single desk marketing approach: $297 to $417 million
This is based on various CWB-commissioned studies that have been proven to be flawed in either their methodology or their assumptions. It can’t be said that the CWB doesn’t get these premiums but none of the studies used prove that it does.
Value of various logistics approaches: $169 million
The CWB reports that it provides value in its approach to managing logistics – tendering ($38 million), managing delivery system access ($115 million), terminal blending ($10 million), and producer cars ($6 million).
Tendering is the process of getting grain companies to compete. It is not a benefit of the single desk; rather in a backwards kind of way, it shows the high cost of the single desk. Think of it this way – if the CWB didn’t tender, the normal CWB system would cost farmers $38 million more on that grain than if grain companies were allowed to compete for it. Now imagine the savings if the CWB tendered the whole crop.
The CWB has “managing the delivery system” dead wrong. Through serious misunderstanding how the system works, the CWB has convinced itself that it adds value here; it doesn’t. The reality is that it comes at a hefty cost. And the only reason producer car loading appears to be attractive is because these CWB system costs are large.
Net interest earnings: $66.2 million
The CWB usually earns interest. The current net interest earning (2009-10) is $9.6 million.
Those arguing for the retention of the single desk use this $500 million “benefit” figure, but they also argue for a “cost benefit” analysis. Here’s what that would include:
Benefit: Any premiums need to be measured properly. This includes measurement against a crop year benchmark. The true measure of marketing “benefit” is not measured on whether the CWB captured higher prices than its competitors on a particular day; rather it is how it stacks up against the range of prices over the crop year. Data shows that the CWB has consistently returned lower than average crop year prices. Rather than put a hard number on it, let’s just say it’s pretty easy to see that returns of say $25 below the crop year average (its often larger) would cost farmers over $400 million annually (and that’s just comparing to crop year average prices).
Cost: The CWB reports its total marketing costs to the federally appointed Grain Monitor. In the last report it showed costs of $10.14 per tonne and $30.09 per tonne on wheat and durum respectively. This means a total cost of $291 million in costs that farmers pay now because of the single desk. (This is even higher when you factor in CWB barley.)
Benefit: As stated above, the CWB does not bring any benefit for farmers through its activities in logistics.
Cost: CWB handling costs (elevator tariffs) are higher than on non-CWB crops like canola. The difference, as reported to the Grain Monitor, is about $8.00 on wheat and $9.00 on durum. (This is in addition to the CWB marketing costs.) This means moving to a more competitive market could save farmers an additional $167 million annually.
Domestic feed barley: The way the CWB sells export feed barley has at times cost the barley farmer selling into the domestic market as much as $400 million in a year. Also, it is generally accepted that the CWB has often missed export sales of feed barley because of uncertainty of supply. A functioning open market would be able to respond to these opportunities.
Canola: Canola and other non-CWB grain prices are lower due to the single desk. Since farmers are not free to deliver wheat as they wish, they sell other crops for cash flow. This has been shown to generate pressure on the prices of these crops, particularly at harvest as farmers sell more than the market needs at the time. Cost estimates on canola alone are around $100 million annually.
There are many other issues that the CWB does not factor into its “benefit” analysis – but should be included in a cost benefit analysis. These include all those activities in which the CWB may engage resulting in costs or benefits for farmers. For example, demurrage and dispatch cost farmers money as does CWB speculative trading ($236 million in 2007-08). In comparison, when a grain company loses on these items due to mismanagement, there is no mechanism to pass those losses on to farmers.
A comprehensive analysis would also include the additional cost to farmers for being forced to store grain longer on the farm and the cost to the rural economy from lost processing opportunities.
All told, using readily accessible data and a sound understanding of how this business works, the cost of the CWB is well in excess of the $500 million in alleged “benefits”. A true cost benefit analysis would show that, even if the CWB got premiums, the costs – both real and “opportunity” – far outweigh the “benefits”.
Value of CWB single desk marketing approach for wheat: $146 - $255 million
The lower end is based on a benchmarking approach designed by Dr. Richard Gray and the CWB used only once; the higher end is based on a study done by the late Daryl Kraft, Hartley Furtan, and Ed Tyrchniewicz (KFT).
The benchmarking approach was badly flawed; for example, it did not consider CWB storage payments as a CWB system expense because there appeared to be no similar cost on the US side. Also, it assumed terminal costs in the US were the same as in Canada (they are lower).
KFT overstated the risk management cost of canola, making wheat look more attractive in comparison. They wrongfully assumed that the Canadian Grain Commission handling tariffs were the actual costs of handling (they are not; they are much higher than the actual costs or even what is charged.) Also, KFT assumed the CGC tariff on canola was the actual amount charged to handle canola (which it is not) and did not adequately include export sales basis levels. These mistakes made wheat look more attractive, adding to the net “benefit”.
Our analysis of these studies do not allow us to say that the CWB does not add benefit; we can only say that the results of theses analyses are flawed in favour of the CWB and should not be relied upon to demonstrate value with the single desk.
Value of CWB single desk marketing approach for barley: $59 million
This is based on the 2005 study by Andrew Schmitz, Troy Schmitz and Richard Gray (SSG), commissioned by the CWB. It said that the CWB earned premiums on malt barley averaging $59 million annually (and nothing on feed barley). On a typical two million tonne malt program, this means about $30 per tonne of the malt premium (over feed) is allegedly due to the CWB. But the typical malt premium over the domestic feed barley price tends to be less than $30; this means that SSG is saying that without the CWB, the malt price would be below the feed price, something that happens nowhere else in the world.
This study also says that the CWB captures these premiums through “price discrimination”. The authors took CWB sales contracts and categorized them by destination: Canadian domestic, US, Japan and the rest of the world. Comparing prices by destination, the study found that Japan paid, on average, more than other destinations. They postulated that this must be due to price discrimination. However, the same approach used on canola – a non-CWB crop – would show the same results.
For example, Mexico and China are price sensitive buyers and tend to buy at harvest time when prices are lowest. Japan, on the other hand, is less price sensitive and buys canola consistently through the crop year, even when the price is seasonally high. Comparing these destinations as SSG did on their barley study would also show that Japan’s average price of canola is higher than other destinations. SSG’s results on barley do not prove price discrimination by the CWB single desk.
The methodology used by SSG is clearly flawed and cannot be used to demonstrate premiums captured by the single desk.
Value of CWB single desk marketing approach for durum: $92 – 103 million
The approaches used in the studies used on wheat and barley were employed by the CWB to estimate the value on durum. For the same reasons as above, the results are suspect.
Tendering and railway and terminal handling agreements: $38.1 million
This is a simple calculation by the CWB including railcar tenders and volume agreements. It shows that the grain trade will negotiate away some margins for volumes. In reality, this is not a benefit of the single desk; it shows only a portion of the benefit of an open market where companies would compete. Data shows that the margins on canola (where there is strong competition) are much smaller than on CWB wheat. It is estimated that total CWB handling costs on wheat and durum are about $8/tonne higher than on canola; on 20 million tonnes that works out to $160 million.
In an open market, grain companies would compete on all the wheat, not just the amount that the CWB decides to tender. In an open market, the “benefit” would be far greater.
Net interest earnings: $66.2 million
The current net interest earning (2009-10) is $9.6 million. It has gotten smaller due to much of the receivables on credit sales being paid or written off.
Approach to managing delivery system access: $115 million
Using posted Canadian Grain Commission (CGC) handling and cleaning tariffs on canola and “CWB observed” canola basis levels, the CWB estimated that “grain handling companies have charged almost 40% more in basis than their actual handling costs”. The CWB assumed that the CGC tariffs are the elevator’s “costs” and the basis is the amount they are charging for handling.
For example, if the canola basis was $40 under and the CGC tariffs totalled $25, the CWB postulated that the grain companies were charging $40 when their “costs” are only $25 – overcharging by $15. The CWB suggested that if allowed, grain companies would “over charge” the same way on wheat. The CWB then argues that the single desk ensures that grain companies don’t overcharge.
The problem with this approach is two-fold. First, the basis is not the amount being charged by grain companies to handle canola; it is a reflection of the current spot market and also reflects a west coast selling basis, which could be $25 under, leading to a calculated gross margin of $15, which would cover handling, cleaning as well as storage and interest. (This study was done in 1996; current basis levels indicate a much lower gross margin on canola.)
Second, the CGC tariffs are not the “cost” to clean and handle. Grain handling is a high fixed cost business and the cost to handle the next tonne of grain – the marginal cost – is effectively zero. This explains why at times grain companies get very aggressive in their pricing to draw grain into the elevator.
Further, the tariffs are not used by canola handlers to determine what they charge farmers. They are published because the Canadian Grain Commission stipulates that grain companies submit them for publication.
The CWB argues that if grain companies were given the same opportunity to overcharge on wheat, it would cost about $115 million. However, data shows that grain companies actually charge less to handle canola than wheat; removing the single desk will decrease wheat costs, not increase them.
Terminal blending: $7 - $10 million
The CWB states “A portion of this is the benefit that accrues to farmers as a result of the terminals blending different downgrading factors ... to increase the proportion of higher quality milling wheat.” This calculation does not however, include an assessment of the cost of shipping high quality grain on sale of a lower quality – shipping #1 CWRS on a sale of #3 CWRS, for example. Nor does it factor in the added cost of terminal storage due to having the wrong grade in position and being stored for lengthy periods of time. Another factor that should be considered is terminal inefficiencies such as loading at multiple terminals and demurrage.
Farmer access to producer cars: $6 million
Producer car shippers determine that producers loading their own cars save as much as $1,500 per car. This is because they are avoiding the elevation and cleaning charges for CWB grain going through an elevator. What it doesn’t factor is that in a competitive market, elevator charges for wheat will come under pressure, similar to canola. If wheat charges at the elevator were the same as canola, the value of loading producer cars would drop to an estimated $500 per car. In addition, shipping in producer loaded cars increases the potential for mis-grades at the port (grades that may not be needed at the port) which reduces port efficiency.
Posted by John De Pape at 6:34 PM