A Continental Barley Market: Where Are the Gains?

A Continental Barley Market: Where Are the Gains?

Richard Gray, Alvin Ulrich' and Andrew Schmitz2

'University of Saskatchewan, Saskatoon, Saskatchewan. 2University of California at Berkeley, California.

Received 15 September 1993, accepted 12 October 1993

Under a continental barley marketing system, the Canadian Wheat Board would no longer be the only exporter of barley to the United States. Even though the volume of malting barley exports to the United States would increase, the historic price premium in both Canada and the United States would drop suficiently to lower total revenue to malting barley producers. The United States' Export Enhancement Program allows the Canadian Wheat Board to sell feed barley at premium prices in some markets, including the United States. Under some conditions the continental barley market would adversely affect optimal trade flows and reduce revenue j ) r feed barley producers. The potential to offset these losses in revenue by reducing grain-handling charges or by growing higher-yielding feed varieties appears to be very limited.

Dans un systtme de marche' continental de lbrge, la Commission canadienne du blP ne serait plus le seul exportateur d'orge vers les Etats-Unis. M6me si Ie volume des exportations d'orge de malterie augmentait, la prime dont a longtemps be'ne'jcie' cette cate'gorie d 'orge, tant au Canada qu 'aux Etats- Unis, tomberait sufisamment pour abaisser leu recettes totales des producteurs. Par ailleurs, le Programme amiricain de stimulation des exportations (EEP) autorise actuellement la CCB a vendre son orge fourragPre a prime sur certains marchis, dont les Etats-his. Dans certaines circonstances, le marche' continental de I 'orge aurait un effet nigatifsur les courants d'e'change et re'duirait les recettes des producteurs de ce type d'orge. Les possibilite's de compenser ces pertes de revenu par une compres- sion des ffais de manutention et de stockage ou par la mise en service de varie'tis fourragPres a rende- ment plus e'leve' paraissent trPs restreintes.

INTRODUCTION For several decades, the Canadian Wheat Board (CWB) has had the legislative mandate to be the sole exporter of barley produced within the designated CWB area. However, in November 1992, the Canadian government announced the possibility of legislative changes that would allow firms and individuals, other than the CWB, to export barley to the United States. This possibility has been referred to as a move to a continental barley market (CBM) since it would imply that after such a change in legislation, Cana- dian farmers would face barley market forces that would be truly "continental" in nature

rather than being partially hidden or distorted by the marketing structures and goals of the CWB. This paper attempts to estimate the effects such a move to a CBM will likely have on the gross revenue of barley roducers within the CWB designated area. P

CANADIAN SUPPLY AND DEMAND

Supply In terms of area seeded, barley is the second- most widely grown crop in western Canada; in terms of value, it is exceeded only by wheat and rapeseed. In the past five years, Cana- dian production of barley has varied between

Canadian Journal of Agriculfural Economics 41 (1993) 2.57-2 70 257

258 CANADIAN JOURNAL OF AGRICULTURAL ECONOMICS

10.2 million and 13.9 million tonnes (Mt), with the majority of this volume produced in western Canada on an area varying from 3.6 million to 4.4 million hectares (Mha) annually. Approximately 30% of this production is exported as feed barley and a further 6-8 % is exported as malting barley or malt. Domestic malt consumption consumes another 2-3% and the remainder (i.e., approximately 60%) is used domestically for feed. Of course, these percentages vary somewhat from year to year, depending on the size of the crop and international market conditions. In recent years, the percentage of the crop that has been utilized for malting purposes has gone up because of increased purchases of malting barley by the United States and China. This has been largely due to contract production of white aleurone six-row barley by Anheuser-Busch, the largest U.S. brewer, and to the development of a world- class two-row malting barley from Canada called Harrington.

In the last decade, between 70% and 75% of all barley area was seeded to malting barley varieties; however, only 12-23% of production from malting varieties was actually purchased for malting purposes. Some people have said that because of the relatively low chance of having production from malting varieties actually sold for malting, many farmers are irrational to plant malting varieties. However, with the exception of a few new semi-dwarf feed varieties (e.g., Duke, Winchester, Samson) suitable for central Alberta and several small areas in Manitoba, there are no feed varieties that yield more than 10% higher than malting varieties (Manitoba Agriculture 1993; Saskatchewan Agriculture 1993; Alberta Agriculture 1993). In the past 10 years, malting price premiums in Canada have averaged about 58% over feed prices. Given even a one-in-five chance of having barley from a malting variety actually selected by a maltster, there is a small gain to be expected, on average, by trying for the malting premium. In western Saskatchewan, where the odds of being selected for malting are probably one in two or one in three, it is somewhat surprising that anyone grows a feed

variety. In central Alberta, where new semi- dwarf feed varieties can yield 50% more than the highest-yielding malting varieties, it is not surprising to find that the percentage of barley planted to malting varieties is lower than in other parts of the prairies.

Types and Uses of Malting Barley Commercial barley varieties have two types of heads (those with two rows of kernels and those with six rows of kernels) and two different colors of kernel skin or aleurone (blue and white). Each of these types has somewhat different processing attributes, and the malting industry considers these differences significant enough that there is generally little substitution between types.’ Brewers in North and Central America use mostly six-row barley, with Canadians using mostly blue types and Americans using mostly, but not exclusively, white types; most of the world outside North and Central America use two-row barley for malting.

Traditionally the Canadian prairies produced mostly six-row barley varieties. However, since the early 1970s, with the introduction of the two-row varieties, Klages and Harrington, the production of two-row barley has rapidly replaced production of six- row barley. Present malting and brewing tech- nology dictates that malting barley can be used for feed, but feed barley cannot be used for malting. Any barley used for malting purposes, even if identical in variety and quality, will sell at a premium over the same barley used for livestock feed.

Although malt is the major solid ingre- dient used in brewing, beer is basically water mixed with a little alcohol and flavoring. On average, between 13,500 and 18.000 bottles (i.e., 341 mL size) of beer can be brewed from one tonne of malting barley. A tonne of malting barley is usually priced between $90 and $230. Hence a single bottle of beer con- tains from 0.6 to 1.7 cents worth of barley, depending on the price of the barley and the recipe that is used. Given a brewer’s wholesale price in the range of 40 to 50 cents a bottle and a retail price ranging from $1 to $3 a bottle, it is easy to see that even a doubling

A CONTINENTAL BARLEY MARKET 259

of the price of malting barley will have almost no appreciable impact on the wholesale or retail price of beer. This is an important con- cept to keep in mind when discussing the premiums that are paid for malting barley in Canada and the U.S.

Demand for Canadian Malting Barley

Roughly 350,000 t of barley are used by Canadian breweries, and between 200,000 and 300,000 t of barley equivalent are generally exported as malt. Malt exports have increased from 177,000 t in 1984-85 to 339,000 t in 1991-92. In terms of importers of Canadian malt, by far the largest is Japan, followed by the United States and the Dominican Republic. In recent years, these three countries imported over 90% of Cana- dian malt exports. The largest importers of malting barley are China and the U.S., and they account for most of Canada's exports. Since 1986-87, sales to China have increased from roughly 190,000 to 500,000 t , and sales to the U.S. have increased from roughly 50,000 to 300,000 t.

Demand for Canadian Feed Barley In western Canada, barley is the major feed grain and much of it is fed on the farm on which it was grown. Over the past five years, domestic feed consumption has been quite stable at between 7.2 Mt and 7.9 Mt annually. Exports of Canadian feed barley are much more variable and have ranged from 2.3 Mt to 4.0 Mt. In the past five years, roughly 75 % of Canadian feed barley exports have gone to Saudi Arabia, the USSR and Japan. Exports to the U.S. have risen from about 50,000 to 200,000 t and now represent about 5% of total exports.

UNITED STATES SUPPLY AND DEMAND

Supply The peak years for U.S. barley production were from 1984-85 to 1986-87, averaging roughly 13 Mt. Since then, the average has

been in the neighborhood of 9 Mt. Not sur- prisingly, the peak in domestic feed use cor- responded to the peak in production. U.S. imports of barley were stable from 1976-77 through 1988-89 at roughly 220,000 t . Between 1988-89 and 1990-91, imports of malting and feed barley increased significantly, roughly doubling in the course of four years. These imports were largely from Canada. U.S. barley exports rose significantly after 1985-86 to 2-3 Mt per year. This was, in large part, due to the U.S. Export Enhance- ment Program (EEP).

American Demand for Malting Barley

The majority of U.S. malting plant capacity can be found in Wisconsin, Minnesota, North Dakota, Colorado and Idaho. This is not unex- pected, since the majority of malting barley is produced in Minnesota, North Dakota, South Dakota, Montana and Idaho and since Wisconsin is situated between the major malting barley production area and the major breweries of the eastern U.S. In the past five years, annual U.S. production of barley malt has been roughly 3.3 Mt, domestic malt use has been about 3.2 Mt, exports of malt have been about 0.1 Mt and exports of malting barley between 0.1 Mt and 0.2 Mt.

Over the decades, Minneapolis has evolved into the most important trading center for malting barley. Although the majority of malting barley purchased in the U.S. (i.e., up to 90%) does not pass through the Min- neapolis cash market (i.e., much of it is contracted between farmers, grain companies and maltsters), the Minneapolis market price for malting barley has become the basis for almost all the cash trade in malting barley. In this regard, the prices received in the Min- neapolis market are usually, but not always, the highest prices that users are willing to pay, since many of them are buying only the relatively small quantities they need in addition to the quantities they have already contracted for. In general, U.S. sellers of malting barley receive a price for their malting barley which is, at most, equal to the Minneapolis cash price minus freight and handling.


Malting Barley Price and Premium Comparisons

With the move to a CBM, there will no longer be a single seller of Canadian malting barley to Canadian and American users. Theory tells us that a monopolist has the potential to extract higher than normal returns from the marketplace. In the past, the CWB was a monopolist selling Canadian malting barley. Was it able to extract higher than normal returns from the Canadian and U.S. markets for malting barley? This question can be answered by looking at a comparison of returns received by Canadian and U.S. producers of malting barley.

The first type of comparison to use is historic Minneapolis prices for malting barley relative to prices paid by the CWB to fanners.

Most U.S. malting barley production and consumption consists of six-row varieties, thus comparisons involving prices for six-row malting varieties are more valid than those involving two-row varieties. Table 1 shows that the 10-year average price for six-row malting barley in Canada was about $175/t. while the average price received for the best- quality six-row malting barley in the Min- neapolis cash market was about $ 1 5 7 1 ~ This would imply that the CWB was able to obtain an average of $18/t premium over a roughly equivalent U.S. product.

A second way of comparing annual differences is to use weighted average prices for malting and feed barley received by U . S . farmers. Such a price series should include prices farmers received for contracted barley and prices received in the cash market,

~

Table 1. Malting barley price premium comparisons

Minneapolis cash Canadian Wheat Board NASS Feedd Maltingb Feeda Maltingb Feed' Malting'

1981-82 123 171 131 187 1 I9 129 1982-83 98 142 110 164 139 140 1983-84 143 164 138 169 132 142 1984-85 129 157 131 190 1 I9 133 1985-86 97 142 110 184 97 1 I4 1986-87 90 1 I8 80 155 100 I22 1987-88 105 120 74 146 129 183 1988-89 128 227 124 214 112 153 1989-90 119 173 124 20 1 78 126 1990-91 1 40 158 90 143 100 132 10-year average 117 157 1 1 1 175 1 I3 137

10-year malting premium average Premium ($it) $40/t Premium (%I 34

$64/t 58

$24/t 21

'Minneapolis prices are simple average annual prices converted to Canadian dollars at the Bank of Canada average noon spot rate from 1 June to 1 June; prices are for #2 or Better Feed and for #3 or Better Malting. 'These are final realized pool prices, basis Thunder Bay, for #ICW Feed Barley and for Special Select Six-Row Malting Barley. 'These are average prices for all classes of feed and malting barley throughout the U.S. and are given on a calender-year basis rather than a crop-year basis. Sources: 'USDA, Feed Situation and Outlook Repon, various years.

'CWB, Annual Report, various years. 'USDA, NASS, Agricultural Prices Annual Summaries, various years.

A CONTINENTAL BARLEY MARKET 26 1

weighted by the volumes sold under each marketing method. Such a weighting of prices would be much more compatible with CWB data and would also give a truer picture of the average incentive that exists to grow malting barley in the U.S. Fortunately such a price series for both malting and feed barley has been generated by the U.S. National Agricul- tural Statistics Service (NASS). This annual price series (see Table 1) has been calculated by using average monthly prices received by farmers weighted by average monthly marketings. Although such a weighting is still not directly comparable with CWB pool prices, it should be more representative of average U.S. malting premiums than the use of Min- neapolis cash prices. The 10-year average malting barley premium using NASS data is almost $20/t less than that implied when using the Minneapolis cash price data. In percentage terms, the NASS data imply a 10-year average price premium of about 21 % above feed prices, whereas Minneapolis cash data imply a 10-year average price premium of about 34%. This should be compared with the average 5 8 % price premium obtained by producers selling to the CWB during the same 10-year period.

Based on these two types of price comparisons, it is obvious that the CWB was able to obtain substantial price premiums from malting barley sales. There are several reasons why this was possible. First of all, “selection rates” for malting barley in Canada are considerably lower than in the U . S . ; this means that, in general, the average quality of the malting barley offered for sale by the CWB will be somewhat higher than the average quality of the U . S . product. Second, as a single seller, the CWB is able to offer large quantities of barley with a guaranteed quality throughout the year. Malting houses are willing to pay a premium for such a service over and above what they would be willing to pay if they had to deal with several sellers who could not consistently offer such large volumes of barley with guaranteed quality. Third, the negotiating power of the CWB was no doubt strengthened in the U.S. market by Canadian legislation that made it

the only possible supplier of Canadian malting barley in the U.S. market.

THE EFFECTS OF A CBM ON THE MALTING BARLEY MARKET

A move to a CBM could dramatically effect the size of malting barley premiums that the CWB and others can obtain. However, even if such a move does not happen, it is very unlikely the CWB would be able to obtain the same level of premiums that it enjoyed over the past 10 years. One of the main reasons for this has been a concern that the brewing industry in Canada may be less able to compete if Canadian maltsters are charged a higher premium than U.S. maltsters who purchase Canadian malting barley. Based on this concern, the CWB has started to price malting barley for domestic consumption based on the “top of the range” six-row malting barley price in Minneapolis plus 10%. On average, the use of such a formula will generate a domestic malting barley premium significantly less than that historically paid by Cana- dian maltsters.

Now consider what is likely to happen under the proposed CBM. Individual producers would compete for access to the domestic malt market rather than selling through a “single desk” (i.e., the CWB). This would have the effect of driving malting barley premiums down. In addition, the increased supply of malting barley accessible to U.S. maltsters from many Canadian producers would most likely reduce U.S. malting barley premiums. The net result would be lower malting barley premiums for both Canadian and U.S. farmers without a significant increase in total malting barley consumed in North America.

How much lower could Canadian premiums drop if there were no longer a “single desk” selling agency? Under the CWB’s new pricing mechanism used in 1992-93, domestic maltsters paid an extra 10% above the top Minneapolis price for six- row barley. Under a CBM, this would be gone. In addition, there would be no mechanism to force Canadian malting barley


prices to be based on the high-priced Minneapolis cash market, since grain corn- panies could contract directly with Canadian farmers (much as they do now with American farmers) at a price just sufficient to induce farmers to grow and market malting barley rather than feed barley. Most likely, the net result would be a move to premium levels indicated by NASS data rather than to premiums indicated by historical Minneapolis cash data. In other words, even in the best- case scenario, under a CBM, Canadian farmers could expect to receive no more than the Minneapolis cash price less freight and transport.

Since a larger pool of farmerkontractors would be available to American maltsters under a CBM, it is expected that maltsters could offer an even lower average premium than they do now and still secure almost all their needs. It is difficult to quantify how much lower the premium would be, but a $2/t (i.e., roughly 10%) reduction in the average NASS malting barley price premium over the NASS feed barley price (see Table 1) appears reasonable.

Under a CBM, increased U.S. purchases of Canadian malting barley would be expected. The selection rate for malting barley as a percentage of production from malting barley varieties in Canada is currently much lower than in the U.S. This suggests that there are Canadian stocks of reasonably high-quality malting barley that are not sold into the U.S. market currently. Under a CBM these stocks would likely displace some American malting barley of lesser quality.

The exact amount of an increase in Cana- dian malting barley marketings into the U.S. is hard to quantify. However, it is known that Anheuser-Busch has about a 45% market share of the beer market in the U.S. This corn- pany has already contracted for white six-row aleurone barley in Canada for several years, and this has led to increased exports to the U.S . of 150,000 to 200,000 t annually. It is doubtful that this company will contract much more, since its contracted area has remained relatively stable for the past few

years. Coors, another major brewer, contracts with farmers in Montana and Idaho to grow only one specific two-row variety, often under irrigation. It is very unlikely that Coors will offer contracts to Canadian farmers or that Canadian farmers would be interested in trying to grow a variety agronomically unsuited to most of the prairies. This leaves roughly 40% of the U.S. malting barley market open to additional sales from Canada. This is slightly less than the market share held by Anheuser-Busch. Since Anheuser-Busch has had no real restriction in contracting production of malting barley in Canada in the past few years and since the volume of its purchases from such contracts has averaged somewhere around 175,000 t annually, one would expect that other smaller U.S. maltsters and brewers would not purchase more than this amount, even if a move to a CBM makes such contracting easier for these smaller companies. This would represent an additional 150,000-175,000 t in sales and would be roughly a 50% increase in exports of Cana- dian malting barley to the U.S. Hence, under a CBM, Canadian malting barley exports to the U.S. would be an estimated 500,000 t (with the most optimistic scenario suggesting a ceiling of 600,000 t at a somewhat lower premium). This is in keeping with the fact that the U.S. has been almost self-sufficient in malting barley, even at the relatively low average premiums implied by the NASS data, and with the fact that U.S. production of malting barley has increased, even though the premiums were lower than in Canada.3

The losses in premiums and gains in export volumes that would likely occur under a CBM, with no single-desk selling agency, are summarized in Table 2 . In any given year, volumes and premiums could vary substan- tially from those presented in the table; however, one would expect them to average out near these levels in the longer term. As Table 2 shows, these losses could conserva- tively reach $12 million to $13 million annually. However, losses could certainly be higher if the increased exports of malting barley to the U.S. discussed earlier did not materialize, if historic NASS premium fell by


Table 2 . Impacts on malting barley revenue under a CBM

Producer revenue

-$9.9 mil. -$6.3 mil.

GAIN from higher exports to U.S. $3.3 mil.

NET RESULT -$12.3 mil.

Assumptions used in above estimate: Canadian domestic disappearance 450,000 t Existing exports to U.S. 350,000 t Expected new export volume to U.S. 150,000 t Total expected exports to U.S. 500,000 t

Domestic premium expected if no CBM $44/t

Domestic premium expected under CBM $22lt

Price premium expected for exports to the U.S. if no CBM $40/t

Price premium expected for exports to the U.S. under CBM $22/t

LOSS of premiums: on domestic market use on existing exports to U.S.

( i .e . , top Minneapolis six-row price + 10%)

(i .e. , historic NASS premium - $ 2 )

( i .e . , top Minneapolis six-row price)

(Le., historic NASS premium -$2)

more than $2/t or if the U.S. government responded to increased imports with trade restrictions.

THE EFFECT OF THE CBM ON THE FEED BARLEY MARKET

About 90% of the barley produced in Canada is used as livestock feed. Two-thirds of this barley is fed domestically, with the remainder being sold through the CWB to export destinations. In recent years, a small but growing proportion of exports has been to U.S. destinations. Under the CBM, producers and private companies will have the right to export barley directly to U.S. destinations. This change in marketing structure has the potential to change the flow of barley and the pricing structure in the North American feed barley market. In this section, we attempt to estimate the effect of this policy change on the revenue received by feed barley producers in western Canada. A CBM could result in a revenue increase for Canadian feed barley producers if either the gross revenue from

sales increases or marketing costs decrease. The potential market for Canadian feed barley is primarily limited to the states of Montana, Idaho, Washington, Oregon and California. A great deal of the debate regarding the impact of a CBM centers around the size of the U.S. market available to absorb potential Canadian feed barley exports. The U.S. is a large aggregate exporter of feed grains (domi- nated by corn); however, some states are in deficit and others have supplies available for export both to other regions within the U.S. and to export markets. Prices in the western U.S. reflect the greater of either the Nebraska corn competitive price plus transport or port price minus transportation costs. The above- mentioned states make up the natural markets for feed barley from western Canada because of their distance from corn-producing states and their proximity to Canada and the ocean. Other western states such as Colorado have lower feed grain prices, thus making them less attractive to Canadian sellers. This pricing pattern has been reflected in CWB export pat- terns, which have been primarily into Idaho


and Washington, with occasional shipments to other neighboring states.

Export Revenues from Canadian Feed Barley with the CBM

There are various key conceptual issues that have to be considered when modeling the effects of the CBM. The first major point is that the EEP creates opportunities for Cana- dian barley to be shipped to the U.S. Con- sider in Figure 1 the impact of the EEP (the model is based on that developed by Carter and Schmitz 1992 for durum wheat). At the free-trade price, Pus, the U.S. exports Q to the rest of the world (ROW). EDRW and ESus represent excess demand and supply schedules for the U.S. from the ROW. In this model, Sus and Dus are the U.S. domestic supply and demand schedules, respectively.

Suppose the U . S. introduces an EEP of T per unit exported. The export subsidy increases U.S. exports but it also drives up the domestic price from PUS to Plus . The export subsidy program thus drives a wedge of T between U.S. and world prices. The CWB has a strong incentive to arbitrage this price wedge by reducing sales to third markets

and increasing sales to the U.S. The reduction of third-market sales shifts the import demand facing the U.S. rightward from EDRW to ED'RW. At the same time, domestic U.S. demand for U.S. grown barley shifts leftward from Dus to D f u s . The U.S. excess supply curve (ESus) shifts right to ES'us. U.S. exports increase to Q'. In the equilibrium, the U.S. domestic price is Plus and the world price is PRW.

From this model, it is clear that the EEP has a distinct impact on the market; Canada now exports to the U.S. Canadian exports to the ROW fall while U.S. exports to the ROW rise. In addition, in order for the CWB to maximize returns from barley sales in the presence of the EEP, it has to charge different prices in different markets. The CWB does not need market power to do so. The U.S. price and the price in non-subsidized markets such as the Japanese Market, are above the subsidized ROW prices. In the above model, competition is assumed and the EEP is the reason why price differences will be observed among markets. It is the EEP that introduces the market distortion; market power (as used in conventional economic theory) is not needed nor is it assumed.

1

PAS

PUS

ph

US Domestic Quantities US Export Quantities

Figure 1. The effect of the EEP on U.S. trade flows


In order to model the EEP empirically with reference to Figure 1, it is first of all important that the United States be allowed to both export and import. Standard spatial price equilibrium models are not capable of allowing for both exports and imports; this is a limitation of the Haley et a1 (1992) study. Second, in response to the EEP, it is clear that the CWB, in order to maximize returns, has to consider all of the markets at the same time when pricing and exporting. Prices will differ among markets because the EEP has created an imperfectly competitive marketing situation for the CWB.

The framework used is a world trade model. For illustrative purposes, the model uses estimates of supply and demand curves for feed barley in four distinct markets: the U.S. domestic market, the Canadian domestic market, the Japanese import demand and the residual import demand from the ROW. Esti- mates of supply and demand curves are derived from elasticity estimates and the approximate prices and quantities in each of these markets. These estimates are shown in Table 3. A set of linear supply and demand curves that are consistent with these elasticities, prices and quantities are calculated and are shown in the same table. All prices are FOB farm gate, expressed in Canadian dollars.

Trade takes place between these markets to establish an equilibrium selling price in each market. For the U.S., which has acom- petitive market structure, “market arbitrage” will determine the trade flows. The domestic barley price has to be just equal to the ROW price plus the EEP subsidy. This is accom- plished in the model with the use of a formula, based on the demand curves, that allocates sales to the domestic market and the ROW in such a way as to maintain this EEP price gap.

The CWB has a stated objective of marketing grain in such a way as to maximize the return to grain producers. Given this objective, the CWB would ideally ship grain to the U.S., Japan and the ROW in such a way as to maximize revenue. It must do so within the confines of the marketplace. In general, if the CWB charges the ROW more than the U.S. domestic price minus the EEP, then the CWB will not make the sale. Similarly, the CWB can charge the Japanese a higher price for barley but this price cannot exceed the U.S. domestic price or the U.S. will make the sale. In recent years, virtually all of the feed barley imports from North America into Japan origi- nated from Canada. Given this history, it can be assumed that all of the Japanese import demand for feed barley is satisfied from Cana- dian exports at a price just competitive with

Table 3. Basic feed barley market parameters

Elasticity Pricea Quantity (%AQ/%AP) ($It) (Mt) Intercept Slope

Canadian markets: Domestic demand -0.70 100 7.00 11.9 -0.049 Domestic supply 0.00 100 11.00 11.0 0

U.S. markets: Domestic demand - 1.30 100 4.00 9.2 -0.052 Domestic supply 0.00 100 6.00 6.0 0

Other markets: Japanese imports from

ROW net import North America -0.20 100 0.90 1.08 -0.0018

demand - 1.20 80 4.50 9.9 - 0.0675

aAll prices are FOB farm gate in Canadian dollars. Source: Authors’ estimates.


the U.S. domestic price. In both the Japanese and the ROW markets, the Canadian farm gate price is increased by $20/t, which is the freight subsidy in the Western Grain Trans- portation Act (WGTA).

The CWB can also make sales into the U.S. domestic market either directly or through export agents. These sales increase the supply of barley in the U.S. and increase U.S. domestic use and U.S. exports. A second effect on sales into the U.S. is the “Canada-U.S.” basis effect. Small quantities can be shipped into markets in the Pacific Northwest region to meet local demand. This would include small domestic users just across the border and areas such as Idaho and the Yakima Valley in Washington. As Canadian shipments increase beyond these local requirements they cannot be reexported out of the U.S. so they must go to domestic users that are farther from the Canadian border. If more than 500,000 t were shipped, these sales would have to go to the Central Valley in California. These shipments, without back- haul, tend to return $8/t lower when backed off to southern Alberta than sales to the Yakima. Based on this relationship, the model assumes that the Canada-U.S. basis increases by $16/t for every 1 Mt shipped.

In the base run, it is assumed that the $10/t lower U.S. terminal charges would be reflected in prices such that Shelby, Montana, would be at a $10/t premium (i.e., a negative basis) to Milk River, Alberta, just across the border. This means that if both the EEP and the WGTA were removed, then the farm price in Shelby, Montana, would be just $10/t higher than the Canadian farm price just north of the border. In an alternative model, it is assumed that there is a zero basis for the first tonne shipped. In both of these scenarios, it is again assumed that the Canada-U.S. basis increases by $16/t for every 1 Mt shipped. This basis is incorporated in the Canada-U.S. trade flow and will be a factor in determining “revenue maximizing” quantities to be shipped into the U.S.

The base run simulates existing market conditions using the market supply and demand curves as described in Table 3, and

the basis as described above. Market-clearing conditions are introduced in the U.S. market, which establishes the differences in price levels between the markets through the “no arbitrage” conditions. The CWB, recognizing each of these market linkages, then allocates the available supply to each of the respective markets in such a way as to maximize producer revenue. As shown in the left-hand side of Table 4, the model indicates that, with a premium, CWB sales to the U.S. market would be 620,000 t, almost double current levels. With no Montana premium, the model showed that exports to the U.S. would be half that level, or 310,000 t, which is close to the current level of exports.

It is useful to consider the situation with no EEP in place. The removal of $30/t EEP results in a decrease in U.S. price from $101/t to $83/t, a drop of $l8/t. Removal of the EEP program would result in an increase in the Canadian price by $4/t, from $99/t to $103/t. These price movements are in line with the estimates of Haley et al’s study and the observed effect on relative prices since the EEP was introduced. Note that in this situation no feed barley would flow to the U.S. , because the average price in Canada would be well above the U.S. price. This, of course, is the effect of the WGTA subsidy, which artificially increases the farm prices in Canada.

To illustrate how a policy change in Canada would affect CWB pricing and, hence, producer returns, the market conditions for the CBM are shown in the right-hand side of Table 4. In this situation, it is assumed that if prices in Canada are lower than U.S. feed prices, then barley will flow from Canada to the U.S. until the domestic prices (including basis) are equal. In the $10/t Mon- tana premium situation, the CBM would result in a slightly greater product flow into the U.S. from 0.62 Mt to 0.74 Mt. This increase in volume depresses U.S. prices slightly, increases domestic use and exports to the ROW slightly, and increases the requirement for the export subsidy. Note, however, the total revenue to Canadian producers falls from $1087.96 million to $1087.53 million, leaving


Table 4. Market conditions (continental market, $lO/t premium)

Base Continental market Quantity Price Revenue Quantity Price Revenue

(Mt) ($It) ($ mil.) (Mt) ($/t) ($ mil.) Canadian supply and demand:' Exports to U.S.b 0.62 101 Domestic sales 7.05 99 Exports to Japan' 0.86 121 Exports to ROWd 2.46 91 Domestic supply 11.00 Average pool price 99 Total revenue U.S. supply and demand: Domestic usee 3.96 101

Exports to ROW 2.66 71 Domestic supply 6.00 Imports from Canada 0.62

Other markets: Japanese imports' 0.86 121 ROW imports total' 5.12 71

Exports to Japan 0.00

62.98 697.64 104.17 223.16

1087.96

399.05

188.57

104.17 362.55

0.74 99 7.06 99 0.86 121 2.34 91

99 11.00

3.96 101 0.00 2.79 71 6.00 0.74

0.86 121 5.12 71

73.61 697.56 104.18 212.18

1087.53

399.03

197.13

104.18 362.56

Market arbitrage conditions: aCWB maximizes total revenue. $101t Shelby, Montana, basis premium; U.S.-Canada basis = $16/t exported (e.g., 0.5Mt x $16/Mt = $811 basis). 'Japanese imports from North America = Canadian exports; and Canadian farm price for Japanese exports = U.S. farm price plus the WGTA subsidy of $20/t. dCanadian farm price for ROW exports = U.S. farm price minus EEP plus the WGTA subsidy of $20/t. eU.S. market clearing: U.S. price = Japanese price = price ROW + EEP bonus: EEP bonus level $30/t. 'ROW imports = Canadian + U.S. exports.

b

feed barley producers slightly worse off on average. In the situation with no Montana basis premium:

the CWB sells barley to the point where the U.S. price, minus basis, is less than the Canadian price, and no additional barley will flow across the border if a CBM were established because it would not be profitable for private traders.

The results presented above are based on many assumptions. In particular, the basis premium in Montana and the elasticities used in the model are a subject of debate. To

address this issue, we repeated the modeling of the CBM using widely different sets of elasticities and a lower Montana basis. The results did not change a great deal from those presented earlier. Perhaps what is most striking about these results is the similarity in the total revenue under all scenarios to the producers in western Canada. Allowing an open border will not dramatically affect the feed market. In many situations, the CBM will not result in any increased exports to the U.S. In other situations, the CBM will result in a small increase in exports to the U.S. with small negative effect on feed barley prices.


OTHER POTENTIAL GAINS FROM A CBM

Reduced Marketing Costs with the CBM The CWB uses the commercial grain handling system (i.e., elevators and railways) to procure supplies for export into the U.S. and other markets. Within western Canada, much of the barley that is sold outside the commercial system moves directly from barley producer to feed user, resulting in a saving of elevation and handling costs of at least $10/t. A move to a CBM will mean barley producers and the private grain trade will have direct access to U.S. markets for barley. Some proponents of change suggest that the CBM will result in large volumes of barley being directly shipped from Canadian farmers to U.S. maltsters and feed grain users, thus saving elevation and handling charges on these shipments, relative to the freight and handling charges that the CWB has been incurring when selling into the U.S. market.

The potential for direct shipments from Canadian farmer to U.S . user is difficult to estimate. However, conversations with major feed grain users in Idaho and Washington who have bought barley from the CWB indicate that they require a continuous supply of a large volume of barley priced competitively with corn to make it profitable to include barley in their operations. For example, when J . R. Simplot fed mostly barley in its Idaho operations, it received roughly 25 to 30 truck- loads of barley per day. It found this arrangement to be very difficult to deal with, arguing that the major problem was accessing and col- lecting large volumes of barley on a daily basis, citing the greater convenience of negotiating unit trainloads of corn. In addition, it indicated that switching between grains occurs only if a ration can be sustained for a period of several months (i.e,, they do not switch rations on a weekly basis).

A similar situation appears to be the case with malting barley. Prairie Malt in Biggar, Saskatchewan, is surrounded by farmers who grow malting barley, yet it prefers to obtain most of its malting barley needs through

commercial channels. Similarly, almost all of the U.S. malting barley, with the exception of that used by Coors, is contracted between maltsters and grain companies. The grain companies, in turn, make contracts with farmers. From the maltsters’ point of view, such an arrangement costs them slightly more but passes on the problems of procurement and quality guarantees to the grain companies.

This would strongly suggest that the U.S. malting and feed barley users in the potential Canadian barley market area will have to generally deal with commercial dealers who are able to procure supplies and provide a steady supply to these end users. It is conceiv- able that smaller feed grain users may be willing to purchase barley in truckload quantities. However, locating these feed users will be very difficult for most Canadian producers. Insuring payments and resolving quality dis- putes (especially in the case of malting barley) could also be very difficult. Thus, commercial dealers in all likelihood will have to incur handling and elevation costs to provide this service to most U.S. buyers. Hence, there appears to be a very limited potential to significantly reduce handling and elevation costs on the majority of both malting and feed barley that could potentially move to the U.S.

Increased Area of Higher-Yielding Feed Varieties Some proponents of a CBM have argued that the move to a CBM would encourage many more farmers to switch to growing higher- yielding feed barley varieties instead of malting barley varieties because of the drop in malting premiums. I t is then assumed that these feed varieties, because of their higher yields, in the long run will generate revenue in excess of that previously obtained from sporadically selling barley for malting. From this, it is assumed that total revenue from growing barley will be much higher with a move to a CBM. However, such an effect will be largely mitigated because, first of all, under a CBM, selection rates will increase; hence, more farmers will receive a malting premium, although this premium will be


considerably less than before a CBM. This will encourage farmers to plant an increased percentage to malting varieties. Second, with the exception of central Alberta and several small areas in Manitoba, there are no areas in the prairies that can enjoy more than a 10% increase in yields by switching to feed varieties. Such a small yield increase will not be sufficient to induce a significant shift to feed varieties, especially in light of our first point.

CONCLUSION

This study examines the implications of introducing a CBM for western Canadian barley. Such a move would reduce market revenue flowing to barley producers within the CWB-designated area. The greatest loss would occur in the malting barley market. Even though malting barley exports to the U.S. would likely increase, the premiums paid by the Canadian malting industry and others would be greatly reduced.

The only feasible market for Canadian feed barley in the U.S. lies in the Pacific Northwest, but even this market would be profitable only when the EEP is in place. To significantly expand sales in this market, Canadian barley must be shipped at additional freight cost to displace barley in more distant markets like California or it must displace lower-priced, less-subsidized corn in nearby markets. Expanded sales into this feed market would reduce average prices received in western Canada for exports to the U.S. Since the potential for increased feed barley shipments into the U.S. is limited, a CBM could easily result in reduced revenue from feed barley sales, but the impact would be less than in the case of malting barley.

There appears to be limited potential to significantly reduce freight and handling charges under a CBM because most of the large potential U . S . buyers of Canadian malting and feed barley require large volumes of consistently available product of depend- able quality before they will make a shift to Canadian supplies. Such requirements generally necessitate the use of grain elevators and railways. There also appears to be limited

potential, given the present barley varieties available in western Canada, for farmers to increase barley revenue by growing higher- yielding feed varieties in place of malting varieties.

The reduction in the prices received for malting and feed barley will result in reduced barley area and reduced revenues from barley produced in western Canada. The proposed CBM could easily result in a loss of at least $12 million for the combined malting and feed barley markets.

NOTES 'It does not deal with estimating changes that may occur to consumer welfare. *Thus Anheuser-Busch will not use Canadian- grown blue aleurone six-row barley in place of U.S.-grown white aleurone six-row barley (in Canada, the white aleurone has been used to visually distinguish licensed six-row feed barley varieties from six-row malting varieties). However, in recent years, Anheuser-Busch has been able to contract with Canadian farmers to grow unlicensed white aleurone barley for potential export to the U.S. Coors, another American brewer, uses only barley from a variety developed several decades ago, even though it must pay a relatively higher

'In this analysis, there is an implicit assumption that the larger trade volumes will not bring about trade retaliation by the U.S. government. 4For a complete description of the sensitivity analysis, please refer to Schmitz, Gray and Ulrich (1993).

remium to induce farmers to grow it.

ACKNOWLEDGMENTS The authors would like to acknowledge Dan Schmeiser for his valuable assistance in writing the paper.

REFERENCES Alberta Agriculture. 1993. Varieties of cereal and oilseed cops for Alberta: 1993. Edmonton: Alberta Agriculture. Carter, C. A. 1993. An Economic Analysis of a Single North American Barley Market. Report sub- mitted to the Associate Deputy Minister. Grains and Oilseeds Branch. Ottawa: Agriculture Canada, March. Carter, C. A. and A. Schmitz. 1992. Effects of U.S. dururn wheat imports. Davis: University of California at Davis.


Haley, S. L., P. A. Riley, K. Z. Ackerman and M. E. Smith. 1992. Evaluating export subsidy pro- grams: The case of U.S. barley. Journal of Infer- national Foodand Agribusiness Marketing 4: 1-29. Manitoba Agriculture. 1993. 1993 field crop variety recommendations for Manitoba. Winnipeg: Manitoba Agriculture.

Saskatchewan Agriculture and Food. 1993. Varieties of grain crops for Saskatchewan 1993. Regina: Saskatchewan Agriculture and Food. Schmitz, A., R. Gray and A. Ulrich. 1993. A continental barley market: Where are the gains'? Saskatoon: University of Saskatchewan, Depart- ment of Agricultural Economics, April.

Documents

A Continental Barley Market: Where Are the Gains?