Tuesday, October 25, 2011

The $500 million question

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 2006 Analysis

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. 


Cost benefit?


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:

Single desk

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.


Impact on non-CWB crops

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.


Other issues

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”.

CWB “Benefits” Analysis (2006)

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.

Saturday, October 22, 2011

Facts, Lies and the House Debate

The debate over the removal of the single desk has gone to the House of Commons.  And unfortunately, the lack of clear information remains as opposition parties appear to be dealing with less than a full understanding of the single desk.  There’s far too much material from the last couple of days of debate to catalogue everything, so here are just a few examples.

On government authority and responsibility

Nycole Turmel, Leader of the Opposition (NDP):
Mr. Speaker, here is what the law says:  "The Minister shall not cause to be introduced in parliament a bill that will exclude any kind, type, class or grade of wheat or barley unless the Minister has consulted with the board, and the producers of the grain have voted in favour of the exclusion or extension."  That is the law of the land.  Why won't the Prime Minister respect the law, respect the producers, and keep the Canadian Wheat Board in place?

Ms. Turmel is paraphrasing Section 47.1 of the CWB Act.  It appears she’s saying that the Minister can’t change the Act because a plebiscite was held and farmers seem to want to keep the single desk.

Prime Minister Harper’s answer was bang on, saying, in part: “Mr. Speaker, the law of our system, our constitutional system, is extremely clear. A previous government cannot bind a future government to its policy.”  He said this because Section 47.1 only applies to adding or removing commodities from the provisions of the single desk.  It does not apply to repealing the Act. 

But Ms. Turmel wouldn’t let it go:
Mr. Speaker, it seems the Prime Minister forget about the law of our government.  I just read the law to the Prime Minister; it says: "that the Minister shall not cause to be introduced in Parliament a bill impacting the wheat board's mandate, unless the producers have voted in favour of these changes."

The second time she read the “law”, she changed it. Now she says it refers to “a bill impacting the wheat board’s mandate”, not just excluding a commodity.  Really?  Can you do that?  When your argument is so weak, can you really make it up as you go along, even when it’s wrong?

And then Nicki Ashton (Churchill, NDP) had a go at it:
Section 47.1 guarantees farmers the right to vote on changes to the Canadian Wheat Board's marketing structure. The government not only ignored that plebiscite but is also ignoring section 47.1 of the Canadian Wheat Board Act, which states that farmers must have a say in any proposed plans to alter the operation of the Wheat Board.

Now, apparently, Section 47.1 refers to “any proposed plan to alter” the CWB.  I guess if that’s what you need to say to make your argument, then that’s what you say, whether it’s true or not.

Hon. Ralph Goodale (Wascana, Lib.):
Section 47.1 of the existing act does not prohibit changes to the single desk. It does not prohibit even the elimination of the single desk. However, it makes it clear that the decision is one for farmers to take. It is not for politicians or bureaucrats, but for farmers themselves. Section 47.1 embeds in the law the principle that there ought to be a plebiscite, a vote, held among prairie farmers to determine whether or not the nature of the single desk ought to be changed.

I am utterly amazed that Mr. Goodale, the author and architect of the current CWB Act, would actually take the position that an Act that he wrote was meant to bind future governments to this policy, which would mean they can’t repeal the Act.  Are we really supposed to believe that was his intent?

Astonishingly, in a moment of lucidity (outside of the House), Pat Martin set the record straight, contradicted Mr. Goodale, Ms. Ashton and his own party leader, Ms. Turmel.

Pat Martin (Winnipeg North; NDP):
I don’t actually buy the argument that section 47 precludes the current government from amending the Act. I think the Prime Minister is right. You would have a constitutional crisis ...  It’s – it’s an impossible scenario. The Prime Minister is right. ... They have the right to amend legislation. That’s the nature of our whole legislative parliamentary democracy.

And that is why the government can repeal the Act, even without a plebiscite. And that is why all the opposition members who spoke on this are wrong; I can’t believe I’m saying this but Pat Martin has it right.

On the economics of the CWB

Over and over, we have heard opposition members criticizing the government for not doing a cost benefit analysis or providing any analysis on the impact of the removal of the single desk.  Yet, this doesn’t stop them from taking their own firm stands on this issue without the benefit of any analysis.  Many spoke of the economic calamity that will befall the prairies with the loss of the single desk (with no analysis to back it up), but I’ll pick on only one.

Mr. Peter Julian (Burnaby—New Westminster, NDP):
1.       The Conservatives have no interest in disclosing whether they have done any studies, because they know full well that the end of the Canadian Wheat Board will lead to lower household incomes for farmers. It is not just farm families who will suffer from the economic impact, but also the entire community. The government has provided no figures.
2.       Wheat producers in the United States have been at a serious disadvantage because there is nothing like the Canadian Wheat Board in place there.

I wonder if Mr. Julian would make these arguments if he knew that, in the last ten years (maybe longer) the US spring wheat farmer could sell his whole crop at the lowest price of each crop year and he would still get a better price than the Western Canadian farmer received through the CWB.  The government may not have commissioned this analysis, but they are real numbers.  Mr. Julian should try a different argument.

Others spoke of the premium prices the CWB supposedly gets.
Mr. Alex Atamanenko (British Columbia Southern Interior, NDP):
The fact is the Canadian Wheat Board currently seeks high-end markets for high-quality milling wheat and durum in over 70 countries, and does not have to pursue markets by reducing its prices. I might add that this obviously gives a premium to Canadian farmers.

Spoken with such certainty, such confidence, yet this is not obvious to Western Canadian farmers who consistently see higher prices just across the border in the US, even though the US sells into the same offshore markets.  US farmers get premiums over what Canadian farmers get; why is that not obvious to Mr. Atamanenko?

Hon. Ralph Goodale (Wascana, Lib.):
1.       There will be an imposition of new costs on farmers...

New costs?  The CWB reports to the federally appointed Grain Monitor that its marketing costs on spring wheat are over $10.00 per tonne and over $30.00 per tonne on durum.  Also, it is well documented that grain handling costs on CWB grains are substantially higher than on non-CWB crops like canola.  Remove the single desk, and you remove all these costs.  In fact, it has been argued that, with the removal of the single desk, total marketing costs will go down substantially. 

The CWB and its allies never talk about the cost of the CWB system.  Since the opposition parties in Ottawa don’t either, perhaps they get their information from the CWB.  But they should look at the costs; it’s all there in black and white; you just have to read it.

2.       The elimination of the Canadian Wheat Board has been the Americans' number one trade objective in North America for the past 20 to 25 years. Courtesy of the Conservative government, the U.S. is about to receive its fondest wish and Canada will get absolutely nothing in return.

I don’t get it.  The CWB says that by holding back sales, even US farmgate prices are higher than they would be without the single desk.  Remove the single desk, the CWB argues, and prices in the US go down.  Why would Mr. Goodale argue that the US is about to receive its fondest wish? Does it wish to have lower prices?  Or is the CWB wrong about raising the prices?  Or is someone just really not well informed?

The Job of the Opposition

The Opposition is meant to oppose the government, which includes criticizing government legislation and actions, often providing alternative policies.  Most of the time this is little more than criticism and attempts to publicly embarrass the government.  But when they take aim at the government with no understanding of what they are really arguing and no facts to support, and worse yet, make it up as they go, they really do no more than embarrass themselves.

Monday, October 10, 2011

Wishful thinking

When I heard the news of the Alliance Grain Traders proposed $50 million durum and pulse processing facility, my first thought was “This is such positive news - what could CWB supporters possibly find as downside?"  Well, they think they found it and it didn't take long before they were out in public spinning their version of the truth.

·         Bill Gehl, Canadian Wheat Board Alliance chairman said:  "If this company has a viable business plan, the single desk should not be an impediment to their project."

·         Stewart Wells, CWB director said: "There's no reason why anyone with a good business plan wouldn't be able to build their operation and still have a strong Wheat Board that's getting a fair price to farmers for their grain."

·         Terry Boehm, NFU president said: "It's perfectly possible to have a pasta plant whether the CWB is there or not.  Unless, of course, you're building a plant with the assumption that when the CWB is gone that you'll be able to access durum cheaper than you could have through the Canadian Wheat Board, which means less money for farmers."

·         Allen Oberg, CWB chairman said:  "Distance from domestic and export markets – not the single desk – is the biggest impediment to value-added processing plants in Western Canada."

Although none have ever had anything to do with an agricultural processing enterprise, these “spokesmen” somehow feel equipped to explain why they think the single desk is not an issue and why locating on the prairies doesn't work.  (And in the process, they insult Alliance Grain Traders CEO Murad Al-Katib by implying he doesn’t know what he’s doing.)

Gehl goes so far as to say transportation costs limit canola processing on the prairies: “Whether it is wheat flour, pasta, oil sands bitumen or canola, transportation costs have always limited what can be done with value adding on the prairies."  Perhaps he’s had his head elsewhere for so long that he hasn't noticed that there are now ten canola crushing plants on the prairies, processing close to half the crop - and many are expanding as we speak.  Domestic crush is clearly a dominant canola market influence.  I would love to be a fly on the wall listening to Gehl explain to Cargill, Bunge, Viterra, Richardson and Louis Dreyfus that they’ve got it all wrong and shouldn’t have built their crush plants on the prairies.

I’d also like to hear any one of them explain why oat processing is so successful on the prairies and why durum is being processed in North Dakota – both in the heart of production regions, miles away from the major consumptive areas.  (And both without the CWB single desk in their way.)

Boeme suggested that the only reason a processor would locate in the prairies is to get cheap grain for his plant.  Perhaps he should get together with Oberg and Gehl and decide which is the best argument for them - either it's good to locate in the prairies to get cheap grain or it's bad because of the distance to markets.  If Oberg is right, Boeme is wrong.  If Boeme is right, Oberg is wrong.  Ironically, they’re both wrong.  Check out the price of canola around Yorkton where the two new crushing plants have certainly supported prices.

Actually, there are many factors that go into the decision of where to locate; reliable supply of feedstocks, greater control of quality and logistics are among the most important.  Locating near a consumptive market means that you are out of position for other possible markets; locating near the supply of raw materials (like in the prairies) provides ready access to the materials you need while allowing you to serve more and varied markets.

More processing on the prairies is an effective counter to concerns over grain handling issues like terminal access, car allocations, and primary elevator congestion.  Since the CWB and its allies have always seen these as big issues with an open market, you’d think they would recognize that a new processor on the prairies actually helps alleviate these potential problems.

And yes, the single desk is a deterrent to new investment.  As any processor will tell you, they are running a factory, producing a product someone else is relying on.  One of the most important factors in establishing a processing business is to be a reliable supplier; and what that means is control.  One misstep and you could lose a major customer.  An environment where your single supplier is also a regulator is not attractive to prospective investments.  Open markets facilitate business by allowing you to respond the way you see fit; regulated markets frustrate business by being unresponsive or by changing the playing field without warning.

Western Canada lost three potential malt business investments due to the single desk.  Under the circumstances, they all did the right thing.  Because they were uncomfortable with the prospect of dealing with only one supplier (the CWB) they built in Montana and Idaho where they could access both local barley as well as imported barley from the CWB.  The Canadian malting industry has even told both the CWB that as long as the single desk is in effect, they will not invest in any expansions in Canada.

The CWB and its allies wish the single desk was not a deterrent to new value-added enterprise in Canada, but it is.  Their arguments lack substance or factual support and even go against conventional wisdom.

Through its actions, the processing industry has demonstrated the realities of dealing with both the single desk and the open market for years, showing its preference for the open market. Now, as we are beginning to see the response to an open market in wheat and barley, the CWB and its allies still fail to respect reality.

Actions speak louder than words.  Saying something over and over hoping it to be true is just wishful thinking.  And gentlemen, you don't build a prosperous industry on wishful thinking.