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The Cost of Doing Business – Export Versus Country Cash Prices

The Cost of Doing Business – Export Versus Country Cash Prices

CN’s David Przednowek Director of Marketing Grain on how the cost of rail freight fits into grain pricing.

If there is one thing that farmers understand inside out, it’s the cost of doing business. In western Canada, variable crop production costs like seed, fertilizer, and crop protection are sunk into the crop up front. Fixed costs like machinery costs, insurance, fuel, land rent, and a slew of other things also need to be considered. After the crop is in the ground, it’s mostly up to Mother Nature to deliver a crop that covers a farmer’s costs and delivers a profit.

Gross profit is determined by yield and the price the farmer receives for grain at the farmgate, whether that’s a price picked up in the yard, delivered to a country elevator, or delivered to a processing facility. The farmgate price is driven by local and international supply and demand factors, the cost of transportation and handling, and target profit margin for the grain company. And these components aren’t exactly itemized line by line on a farmer’s cash ticket. All of this complexity leads to a lot of questions. Farmers want to know what it costs to move grain through the supply chain in relation to what price they receive for their grain, as well as what the gap between country prices and export sales prices are.

Some of these are not easy questions to answer – there are a lot of moving parts to consider. The grain supply chain is complex. A lack of price transparency in terms of where the export market is trading makes it challenging to analyze. The reporting of grain sales and indicative export values, unlike in the United States, is not mandatory.

When you hear the word basis, it refers to the difference in price between two geographic points. Basis is not simply the cost of transportation from A to B. Take the west coast export market, for example. The price of grain free on board (FOB) a vessel alongside an export terminal in Vancouver or Prince Rupert reflects international supply and demand factors among other things, and the price varies with time. Most grain internationally is transacted in U.S. dollars and farmers in western Canada get paid in Canadian dollars, so exchange rate has a lot to say about the value of grain as well.

Besides supply and demand, the value of grain in the country in part takes into account the transportation and handling costs associated with getting that grain from the country elevator onto a vessel alongside a grain export terminal. Grain handling costs effectively start with the country elevator’s handling and elevation costs into a railcar, rail freight comes next, and ends with the cost of unloading the railcar at export terminal, moving it through the terminal, and loading it onto a vessel. And don’t forget the cost of moving grain by truck to the country elevator.

A grain company sets the price in the country based on where they can, need to, or want to buy grain. There are so many factors influencing these pricing decisions, including what competitors are offering and what end-users are willing to pay, but always with an eye to where the farmer is willing to sell as well as how much revenue can be extracted from the marketplace, especially at peak price periods. And then there is the risk premium associated with making a trade. For example, some grain sales call for very tight quality specifications versus others, bringing more risk into the equation. And the grain trade collectively making millions of tonnes of commitments in advance of harvesting a crop brings with it not just quality risk into the equation but general supply risk in the case of a drought.

Some commodity risks can be mitigated more readily than others. When it comes to commodities like canola, soybeans, and wheat, when a grain company sells or buys grain they can hedge part of their risk by taking an offsetting position by selling or buying futures contracts. The basis can’t be hedged as well, however, for a number of reasons. Trying to make sales back-to-back and not taking too long or too short a position are ways of mitigating risk and managing basis risk. For other commodities like durum wheat, peas, malt barley, and lentils, there is no futures market where some of the grain company’s commodity price risk can be effectively hedged. Grain is contracted, bought and sold on a flat price basis. Regardless of commodity, grain trading companies operate within a risk management structure for individual commodities and foreign exchange of long/short limits to manage their risk.

The difference between the price of grain in the country versus at export position varies over the course of the crop year and is influenced by a whole host of factors. The gap is usually widest at harvest time when the crop is coming off when supplies are greatest as is demand for delivery opportunity from farmers. The gap usually narrows later in the crop year when grain supplies in the country are lower and international competition is more intense - remember most of the rest of the world is harvesting when farmers in western Canada are putting the crop in.

And then there is the impact of supply chain costs on how big that gap can get. The gap at any point in time between export prices at the east coast and country prices is going to be wider than the gap between west coast export prices and country prices. To get grain from the middle of Saskatchewan and onto a vessel in Vancouver or Prince Rupert, you have the cost of rail freight and along with the costs of unloading the railcar, moving grain through an export terminal, and onto a vessel.

Things get more complicated moving east. Grain unloaded at a grain terminal in Thunder Bay may be loaded onto an ocean-going vessel or onto a laker, or grain may be moved directly by rail from western Canada to rail-unloading facilities in the St. Lawrence. Regardless, there are a whole lot of extra miles to cover moving east versus west, which means extra transportation and handling costs. There are tolls and charges associated with moving grain through the St. Lawrence Seaway. And if a laker is being used to move grain to the St. Lawrence, there is the extra double-handling cost associated with unloading the laker alongside a terminal and re-loading onto an ocean-going vessel. The extra cost associated with moving grain in a unit train from, say, Regina, to Thunder Bay and through the Seaway on a laker versus moving that same grain to Vancouver could be an extra 15 to 20 dollars per tonne.

There is no doubt that the emphasis on grain movement is into export markets for western Canadian grain, with the heaviest focus on movement through grain companies’ own export terminal assets at the west coast, Thunder Bay, and in the St. Lawrence. But to think of this market as an export only play isn’t right. The demand for some commodities in the domestic market is very strong, and that also has a role to play in determining the price a farmer sees. For example, there is 8 to 9 million tonnes of canola crushed in western Canada, and export markets have to compete with the domestic crush market for supplies of canola.

Grain is bought in advance of sales being made, and grain is sold to end-users well in advance of when it is shipped. On average the export market is trading two to three months forward (with a lot of exceptions) – one can compare this price of grain in the country for the next-to-nearby month as a benchmark.

It is not unusual to see the gap between west coast FOB export and mid-central SK country prices for mid-protein spring wheat in the 90 to 100 Canadian dollar per tonne range in the fall and winter in an average year. This year, the CN tariff rate for moving a unit train of wheat from the Saskatoon area to Vancouver has been around 40 dollars per tonne, and there is a bit of seasonality to the rates around that number. In this specific example, that leaves 50 to 60 dollars per tonne for the grain company involved in the transaction before their own costs are accounted for when it comes to fall-winter shipment.

This west coast example represents just one segment of a grain company’s overall book of business. Generally stronger profitability during peak demand gets rolled up with business later in the crop year that is typically leaner margin business due to tighter supply availability and stronger international competition for some commodities. And the profitability of west coast business is generally greater compared to shipments pointed east and south. The size of the grain shipment program over the course of the year is one more layer to consider, with a lower proportion of export shipments occurring in the spring and summer. Using publicly available information regarding rail freight rates, grain handling charges, and spot grain prices, University of Manitoba ag economist Derek Brewin found that the simple average wheat basis for the 2015-16 crop year was $81.53 per tonne, compared to the longer-term average of around $70 per tonne.

The bigger the rail the program the grain supply chain can deliver from fall into early spring, the greater the opportunity for grain companies to maximize their profitability when the gap between country and export prices is at its greatest. Average weekly bulk grain shipments on CN have increased in the October – December window from 3500 per week in 2009 to almost 5500 per week in 2016.

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About David:

David Przednowek is CN’s Director of Marketing. He is responsible for all marketing and pricing activities for carload movement of grain and processed grain products across the CN network. Prior to joining CN, David was with the Canadian Wheat Board in a variety of roles, including operation of the CWB’s voluntary grain pools, commodity trading, vessel chartering and marine logistics, and market analysis. His family farms in eastern Manitoba.