Remember what a mess we had in the grain market back in the winter of 2013-14, when rail congestion was so bad that ethanol plants across the Midwest were waiting days to receive train service, and secondary freight prices got so desperately high that they added an extra $1.50 per bushel to the cost of shipping grain from anywhere in the United States? Most eastern North Dakota origins were bidding $1.20 under the futures price (or worse) for corn that they couldn't even get rail service to ship out. What ever happened to fix that? More importantly, what could grain owners be doing today to protect themselves from a similarly cheap basis environment if that same scenario would arise again this fall?
Several things helped to ease the 2014 congestion: the relatively large volume of harvested grain eventually worked its way to its destinations, and over the years, the railroads themselves have added more rolling stock and more track capacity to meet demand. But the most significant relief for rail congestion in the northern Corn Belt in the past several years has been the rerouting of North Dakota's Bakken oil off the railroads and into pipelines -- notably, the Dakota Access pipeline (DAPL). Since June 2017, DAPL has carried anywhere from 520,000 barrels per day (bpd) to 600,000 bpd of oil from North Dakota's Bakken region through South Dakota, Iowa and Illinois to refineries there. That's more than half of North Dakota's crude oil output (900,000 bpd in May 2020 during the COVID-19 lockdown recession or 1.2 million bpd at its pre-COVID-19 height) that has been kept off the rails lately.
Now, a federal judge from the U.S. District Court for the District of Columbia has ordered the DAPL must be shut down until a full Environmental Impact Statement can be prepared by the U.S. Army Corps of Engineers -- a process that will take at least 13 months -- instead of the simpler Environmental Assessment that the Corps conducted before granting an easement for the pipeline to cross under Lake Oahe (the Missouri River). Shutting down DAPL will likely displace 208.1 million barrels of crude oil over the course of a year, and assuming that a large portion of that displaced crude oil will instead be transported by rail, we will likely see crude-by-rail volumes approaching the maximum volumes noted in the bad old days of 2014.
That decision came July 6, ordering the pipeline to be emptied by Aug. 5, which DAPL's operators claim is physically impossible given the long process required to shut down a pipeline safely and keep its surfaces from oxidizing so that it can be useable again once the Environmental Impact Statement is done. For this reason, and because of the serious disruptive consequences (including to grain markets) of shutting down the pipeline, its operators have filed an emergency motion in federal appeals court for a "stay pending appeal," to be decided by July 20. If the judge's order isn't stayed, the appeal would have to go to the Supreme Court, which could be a very long process. The question of whether that oil will continue flowing in a pipeline and continue to not clog the same railroads used by grain shippers -- that's still very much up in the air.
If DAPL doesn't shut down, the Standing Rock Sioux Tribe and Cheyenne River Sioux Tribe plaintiffs are worried that their water supply, which is drawn downstream from DAPL's Missouri River crossing point, could be polluted in the event of a pipeline leak. As it happens, the rural water system that provides the water I drink here in South Dakota, also draws from the Missouri River about 50 miles downstream from the DAPL crossing. The pipeline itself is operating peacefully and invisibly, underground, about five miles east of my farm. Personally, I worry less about any quickly sensored pipeline leak than I worry about the potential derailment of the extra oil trains that would come rumbling through my hometown or the danger when those congested trains park on a siding and block my access to emergency services.
If DAPL does shut down, there will be economic consequences for North Dakota oil producers who may have to shut down some currently profitable oil wells because there simply will not be enough capacity to move all the oil on rail and other pipelines. Analysis from Rystad Energy consultants, even taking into consideration recent idled production and spare capacity on other, westbound pipelines, suggests, "If DAPL is actually emptied, a massive ramp up of rail exports will be required in the second half of 2020 to absorb more than 600,000 bpd of Bakken production -- twice as much as what was exported [by rail] in the first half of 2020." There will also be consequences to the tax revenue of the state of North Dakota. There are also greater safety hazards to the public as more oil gets shipped by rail. But most alarming for farmers, and for anyone who needs to buy food over the next 13 months, there will likely be a major disruption to the nation's food supply chain.
In an amicus brief filed by 18 states (Indiana, Montana, Alabama, Arkansas, Iowa, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Nebraska, Ohio, South Carolina, South Dakota, Texas, Utah, West Virginia and Wyoming) in the D.C. appeals court Tuesday, July 14, 2020, the authors point out that "all Amici States, even those that the pipeline does not pass through, stand to suffer disastrous consequences ... [because] many Amici States produce large amounts of grain currently shipped by rail -- grain that will suffer displacement, owing to competition with higher-revenue oil for access to rail transport, if the Dakota Access Pipeline is shut down. Such competition is likely to revisit the market conditions that obtained before the pipeline became operational in 2017, namely intractable railroad congestion, rotting grain, higher food prices and, ultimately, a potential for food shortages."
By comparing the local basis market conditions during the rail congestion of 2014 to "normal" basis market conditions in 2010 or 2018 (when U.S. corn supply and demand conditions were abundant and had no remarkable disruptions), then applying those "worst case" effects to expected 2020 grain-by-rail shipping volumes, I calculated if rail congestion of that severity were to affect the grain markets over an entire marketing year, the revenue losses to America's farmers could range from $526 million to $1.3 billion. Bear in mind that's a conservative estimate that included only 12 states' grain volumes, and it doesn't even begin to account for the disruption and freight cost effects on ethanol plants, soybean processors, fertilizer shippers, export facilities and all the other segments of the agriculture industry that depend on efficient rail service.
There is a chance now for grain producers and grain shippers to prevent themselves from taking part in those losses -- if they lock in new-crop basis values now or, for shippers, if they lock in freight prices now. It won't guarantee that, in a potentially congested environment, the trains will arrive on time, but it could result in a nice gain if reselling those shuttles on the secondary rail market, which you may recall skyrocketed as high as $5,875 per car for BNSF shuttle service in March and October of 2014. Read " Rail Service Challenges in the Upper Midwest: Implications for Agricultural Sectors -- Preliminary Analysis of the 2013-2014 Situation" here: https://www.usda.gov/…
This is not to suggest that new-crop basis values are remarkably attractive selling opportunities right now (-25 the December futures contract at a major corn processor in Cedar Rapids, Iowa, or anywhere from -50 to -80 the December at elevators in the eastern Dakotas). Furthermore, we don't know for sure that these values will weaken in the coming months or that freight prices will rise, or that the pipeline will lose its court appeal and have to shut down at all. Nevertheless, this is a textbook opportunity for risk management. There is a known risk, and there is a way you can remove that risk simply by making a contract to lock in a price.
I'll close with a final quote from the amicus brief: "DAPL, which opened in 2017, alleviated otherwise intractable logistical problems that arose for the nation's farmers and food supply when Bakken oil displaced grain commodities on critical railway corridors. In 2014, the volume of crude oil shipped by rail hit a peak of 31.8 million barrels per month. In 2017, the volume of crude shipped by rail declined to a low of less than 10 million barrels per month and by 2019 remained at a mere 70% of the volume shipped by rail in 2014. That relief benefited grain farmers and shippers as well, for transporting crude oil by pipeline frees up rail capacity for agricultural products, plain and simple."
Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at email@example.com or on Twitter @elainekub
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