AgDM newsletter article, June 1997

Rail transportation changes & implications for elevators

By: C. Phillip Baumel, Charles F. Curtiss Distinguished Professor for Agriculture and Professor of Economics, 515-294-6263, pbaumel@iastate.edu

Rail car shortages have plagued the grain industry for over 100 years.  The most recent case was in late 1995 and early 1996.  U.S. farmers had just harvested a huge 10.1 billion bushel corn crop in the fall of 1994.  As a result, rail shipments to export ports went up 73 percent with barge shipments up 25 percent.  Despite these increases, grain shippers wanted to ship even larger quantities during the last half of 1995 and the first half of 1996.

The huge increase in grain transport demand resulted in a dramatic increase in barge rates.  For example, in the fall of 1995, barge rates from McGregor, Iowa increased almost 33 cents per bushel to a rate more than double the rates prior to the increase in exports.  Although rail rates also increased, the total cost of shipping by barge to New Orleans exceeded the cost of shipping by rail.  This huge increase in barge rates, as well as barge shortages, sent grain shippers rushing to the telephone to order rail cars.  Grain car shortages followed.

Increased efficiency

Railroad efforts to increase rail car efficiency have created changes in the manner in which railroads operate.  Railroads have initiated shuttle trains, car pools, reduced loading and unloading times and 100-car train rates.  Larger trains are sent to shippers who have made prior commitments for them, leaving fewer cars to be distributed to shippers who have not made prior commitments.

Larger cars

Almost all the new cars purchased since 1988 have been heavier and larger than the standard 263,000 pound gross weight cars.  Currently about 25% of the entire grain car fleet has 286,000 pound gross weight limits.  These heavier cars cannot be used on most branch lines unless the lines are upgraded or the cars are light-loaded to 263,000 pounds.  With the current emphasis on rail car efficiency, these cars are not likely to be light-loaded.  So, they are likely to be used only for mainline service.  Assuming all future orders are for heavy cars, the share of cars available to branch line elevators will continue to decline.

Market-based allocation

Grain car supply is also affected by the trend toward market based methods of allocating railroad cars and providing guaranteed car supplies to shippers.  This includes the BN, CP and the UP guaranteed car supply programs and other forms of guaranteed car supply.  These market-based methods of allocating car supplies require grain shippers to do advanced planning and to make advance commitments.

Implications for elevators

Elevators loose money if the amount of grain they sell exceeds the capacity of the grain transportation system to move it in the contract delivery period allowed.  Moreover, if the grain is stored outside, the elevator faces the risk that the grain will deteriorate as the late winter and spring temperatures rise.  This situation occurred in the winter of 1996.

Traditionally, elevators have hedged and sold grain when the “basis” narrows or improves. Since a hedge consists of taking opposite positions in the cash and futures markets, the elevator profits when the basis strengthens (cash price rises relative to futures price).  When the basis increases to the level that elevators believe is very strong, they sell large amounts of grain.   Increasingly, farmers are doing the same thing.

This tends to create increased demand for cars.  Grain car shortages are the result.  However, elevators that sell large amounts of grain in strong basis markets, without having a guaranteed supply of rail cars, face a huge risk of failing to obtain cars.  This may result in an inability to deliver the grain by the contractual delivery date which usually results in penalties for failure to fulfill the terms of the contract.

The inability of railroads to profitably supply cars to elevators during peak shipping periods increases the risk that elevators without a guaranteed car supply will be forced to default on sales contracts.  This suggests that grain elevators need to develop the ability to forecast peak shipping periods, obtain a guaranteed car supply for those peak periods, and consider grain sales strategies that do not rely exclusively on the “basis” to determine when to sell grain and order grain cars.

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