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BACKGROUND – OPERATING ENVIRONMENT

The grain business is capital intensive and inherently risky in terms of supply, commodity prices, currency exchange rates, Canadian government regulation of the industry, and, from time to time, the current political climate existing with key customers. Weather is obviously a major risk, and it determines local and overall supply. Grain production in the Canadian prairies covers tens of thousands of square miles of Manitoba, Saskatchewan, and Alberta, and stretches into the Peace River district of British Columbia. The success or failure for the entire crop year, for the farmer-growers, grain handlers like UGG, and road and rail transporters, is determined by the amount of rainfall in April and May. Not enough rain in those key months translates into a drought-reduced harvest. Added complexity was demonstrated by an analysis of a century of rainfall data that revealed that weather events thought to occur every 100 years actually occur every nine to 11 years. However, UGG was a grain handler, not a crop grower. The threat to UGG was related to the volume of grain that it would process, much of it at a fixed price established by the Canadian Wheat Board (CWB).[1] UGG had an established average market share of 15 percent. UGG (and its competitors) would be allocated rail cars by the Canadian Wheat Board that were almost entirely determined by its market share in the preceding year, no matter how large or small the crop. There was, therefore, little opportunity to gain (or lose) grain handling market share. Consequently, it was overall grain production volume risk that drove revenues and profits.[2]

Grain is a commodity traded on global exchanges. The price of grain, such as wheat, like any other commodity, is driven by supply and demand. While local weather conditions impact Canada's grain-producing provinces, supply and demand are also impacted by global[3] weather conditions. Political risk is another factor in the supply-and-demand chain, as Canada is a major grain exporter. A grain embargo placed on a major customer nation is a critical threat. It has been said that wheat is 15 percent protein and 85 percent politics.

Canadian grain (wheat, barley, oilseeds, and pulse crops)[4] is harvested in the fall. The average Canadian harvest is over 60 million tons. The farmers harvest the grain and then transport it to the storage elevators operated by UGG and its competitors. The primary grain elevators are located on railroad sidings in farming communities that enable the railroad to collect the grain in special hopper cars and transport it to the two main grain terminal ports at Thunder Bay on Lake Superior for shipments going east, and Vancouver for shipments going west. As a result of almost 100 years of railroad regulation and transportation subsidies,

Western Canada was dotted with smaller wooden grain elevators, most of which could accommodate only short trains. The business was inefficient. By the 1990s the grain business was in transition. Deregulation of the railroads and the removal of transportation subsidies provided the railroad companies with the incentive to eliminate uneconomic branch lines. This, in turn, required that the smaller wooden elevators that dotted Western Canada would have to be replaced by giant modern elevators able to accommodate 100 or more grain railcars. The railroads were driving cost inefficiencies out of the system. This imposed a massive increase in capital requirements on UGG (and its competitors) as it embarked on an infrastructure rebuilding program – replacing its multitude of old wooden elevators with large, high-throughput, concrete ones capable of loading the multiple carloads demanded by railroad rationalization – reducing grain handling costs per metric ton, but adding new fixed costs.

Adding to the financial pressure of investing in grain handling infrastructure replacement, working capital requirements were also increasing rapidly. During the 1990s, the western Canadian grain handling companies responded to the increasing demand for crop inputs (seed, fertilizer, herbicides, and pesticides) by aggressively investing in the farm retail business. Farm retail sales showed dramatic growth as biotechnology delivered new products and genetics that promised to increase and protect crop yields. This substantially increased the amount of retail credit extended to farm customers.

  • [1] The CWB was created in 1935 – with antecedents going back to before World War I – as a mandatory producer marketing system for wheat and barley grown in Western Canada. It was illegal for farmers under CWB jurisdiction (anywhere in Western Canada) to sell their wheat and barley through any channel other than the CWB. The CWB became a voluntary marketing organization only in 2012.
  • [2] Interview with Peter Cox.
  • [3] Agricultural Futures Markets.
  • [4] Pulse crops are peas, beans, and lentils.
 
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