Ag's Great Affluenza - 2

By Katie Micik
DTN Managing Editor

Editor's Note: "Ag's Great Affluenza" series analyzes how record U.S. incomes this past decade buoyed grain agriculture's long-term financial strength and global competitiveness. Subscribers can find other parts of this series in Recent Features.

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OMAHA (DTN) -- A new grain elevator is under construction in Julius Schaaf's hometown, and his eyes light up as he lists off the technology that will make it one of the most efficient in southwest Iowa.

Double pits will minimize truck lines during harvest, and it will have high-speed load-out capability for when it sends just-in-time corn shipments to the local ethanol plant.

It will be the closest delivery point to his farm, and those efficiencies could help keep Schaaf's combines moving at harvest time. It's also one more buyer competing for his corn and soybean crops.

Countless farmers share Schaaf's excitement of having a new buyer in the neighborhood. More than 500 high-speed shuttle elevators capable of loading 110-car trains now dot the countryside. Older elevators added storage and upgraded aging technology to stay competitive. A new export terminal opened in the Pacific Northwest, and all its competitors updated and expanded, resulting in a 30% increase in the PNW's export capacity. A frigid winter and North Dakota's oil shipments are testing rail's reliability now, but few discount the significance of recent upgrades.

After 25 years of struggling with having more capacity than grain, companies looked at the source of future demand -- growing populations and the growing middle class in developing nations -- and put their money on infrastructure necessary to get crops there. Billions of dollars' of boom-time profits were channeled into vital upgrades to grain origination, storage and port facilities.

Schaaf thinks exports will drive farmer profits in the future, even though much of his crop goes to ethanol and local feeders. As chairman of the U.S. Grains Council, he's spread the news about U.S. infrastructure upgrades to customers overseas, touting the quality of U.S. crops and the efficiencies of the supply chain.

"We've had a good run in corn with ethanol and in soy with biodiesel. They've been the drivers of demand domestically, but it looks like the ethanol market has reached its peak in the U.S," Schaaf said. "Yields are still expanding, and as we continue to raise more grain, grain exports and exports of value-added products are going to be critical to the profitability of farming going forward."

ETHANOL STALLS, GLOBAL POPULATIONS SET TO SURGE

USDA expects corn use for ethanol to hover around 5 billion bushels with growth limited by the 10% ethanol blend wall and lower gasoline consumption. Increases in corn use for ethanol will be much smaller than from 2000 to 2010 and will be reliant on expanded exports and infrastructure for E-15 and E-85 blends.

The global demand picture holds more promise for growth.

The United Nations expects the global population to reach 9 billion people by 2050. More than 1 billion people are expected to join the middle class -- with some of the largest gains in Middle East, Africa, China and Southeast Asia -- a trend that correlates with higher meat consumption. Grain production would need to double to meet the world's need.

Global coarse grain trade, primarily corn, is expected to increase 25% over the next decade as livestock production expands in feed-deficit countries. At the same time, demand for vegetable oils and biodiesel will drive a 36% increase in global soybean trade. USDA expects wheat, rice and barley trade to expand as well.

Jay O'Neil, an agriculture economist at Kansas State University's International Grains Program, said the UN's 2050 report was a wake-up call to grain industry.

"The grain industry said, 'Hey, wait a minute.' If we're going to have to double our crops, how are we going to handle that large increase in production? Do we have the storage, handing, transportation, export capacity?"

The industry's response: No, we don't, he said.

SHUTTLE ELEVATORS REVITALIZING GRAIN ECONOMY

Expanded corn and soybean production -- a result of the 1996 Farm Bill and biotechnology advancements -- created surpluses in areas with slack local demand, attracting the interest of exporters.

The railroads' pursuit of efficiency following their deregulation in the 1980s led them to the unit train, which could carry more grain in less time, said Ken Eriksen, Sr. vice president of transportation at Informa Economics.

The railroads and the grain industry worked together to create incentives for moving grain to the export market, he said. If an elevator could load a full train within a set period of time, usually about 12 hours, the railroad would knock a set amount off the rate. If an elevator took too much time, it'd be penalized.

"So we saw upwards of a dime a bushel of efficiency payment that you could see in the system," Eriksen said. The efficiency payments helped shuttle elevators expand their draw areas -- sometimes up to 50 miles -- and pay farmers prices that could compete with local feeding operations or ethanol plants.

The railroads extended the incentives to exporters who could unload trains quickly, allowing the railroads to maximize the number of trips a train could take each month.

The economic advantages of sending grain to the PNW export market spurred a building boom of 1-million-to-2 million-bushel grain elevators capable of loading 110-car trains. On BNSF Railway's tracks alone, the number of shuttle elevators nearly tripled between 2000 and 2013 as grain companies expanded their network from 77 originating elevators to more than 210.

Thirty one of those locations can both load and unload shuttle trains compared to none in 2000, the railway said.

"Not only can they load trains quickly, but they'll probably have two truck pits, and farmers will be able to dump a lot of corn very fast," Eriksen said. "They're not there for storage. They're there for put-through."

Farmers don't just benefit from time efficiency, he said. The lack of storage at the elevator means farmers need to keep more on-farm, where they can capture the carry in the market. On top of that, the shuttle elevator will often pay a premium for just-in-time delivery.

While some rail deliveries came to a standstill this winter as a brutal winter and increased oil shipments from North Dakota clogged the rails, spring shipping season has been a sloppy attempt at playing catch-up. Only time will tell if this year was an aberration or a new norm for winter rail traffic.

However, concerns about upgrading the U.S.'s other major export system -- the Mississippi River -- have kept major grain companies from investing in their facilities north of St. Louis, O'Neil said.

"What if there's a failure along the lock-and-dam system that could close it?" he asked. "Too many people are fearful it's not a what-if scenario -- it's a matter of when. As much as we all love to bash the railroads, there's a lot more confidence in the railroads' ability to carry on."

AN EXPANSION UNLIKE ANY OTHER

The grain industry has been burdened with surplus origination capacity for much of O'Neil's career. "It's been a financial thorn in the side for more than 30 years," he said.

In the 1970s, it appeared that Russia's appetite for grain would fuel exponential increases in grain exports.

"After the business came to light, the industry jumped to the conclusion that Russian business and exports would go up at a 45-degree angle every year, and they realized we didn't have the capacity to meet that kind of demand," O'Neil said. Back then, the industry embarked on a massive building effort that included new and updated export facilities, country elevators, rail cars, barges and more.

"And son-of-a-gun, we met the need, only to find that business did not go up at a 45-degree angle," he said. Grain companies lost money throughout the 1980s and 1990s, which O'Neil said is largely attributable to excess capacity. "We had too much of everything for a 20-year period."

This expansion is different, O'Neil said. There are still areas of surplus to locate new facilities, and the available information about demand is much better than it was in the 70s.

"We are still somewhat behind on having enough capacity to meet the growing demand of larger crops and of growing exports," O'Neil said. "So I think it's safe to say we're not in danger, at the moment, of exceeding capacity. We expect -- and these could be my famous last words, because you never really know for sure -- we expect to continue to grow."

Long-range outlooks call for larger crops due to a return to normal weather patterns and trendline yields. It also calls for growing demand as the world recovers from recessions and the economies in Asia continue to grow at a positive pace.

"If you put that all together, we still have room and need to grow capacity from a storage point of view and a transportation point of view," he said. "There's a bit of caution out there. No one's expanding with reckless abandon; trying not to repeat errors of 1980s, but we do have a more optimistic outlook."

Katie Micik can be reached at katie.micik@dtn.com

You can follow her on Twitter @KatieMDTN

(MZT/ES/SK)

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