The Railroads Can't Hack It

Written By Briton Ryle

Posted April 7, 2014

It’s hard enough for farmers to survive these days as they contend with unpredictable weather, pests, and wild market fluctuations that can make or break an entire harvest’s profitability.

But now South Dakota farmers have yet another obstacle to contend with: They can’t get their produce to market!

Is it the weather? Or some kind of crop contamination?

Actually, it’s something much more mundane than that… not enough railcars. Trains aren’t coming to pick up their crops for the lack of shipping capacity.

But some suspect there might be more to it than that. They wonder if certain commodity markets are being favored with priority rail service over others… especially to the north.

A Tale of Two Dakotas

South Dakota’s rail network is limited enough as it is, with just one main line across the north running from east to west and another main line in the east running from north to south; it kind of looks like the number “7.”

Jamming up that rail network is car after car of oil originating from North Dakota’s Bakken shale oil fields on their way to refineries down south. With the tight oil boom, there just aren’t enough railcars available for South Dakota’s corn, soybeans, and other crops destined for ethanol plants and food markets.

The dominant railroad companies in the area — Burlington Northern Santa Fe Railway, owned by Warren Buffett’s Berkshire Hathaway (NYSE: BRK.A), and Canadian Pacific Railway (NYSE: CP) — have said they’re doing their best.

Steven Forsberg of BNSF admits his railroad “has not met our customers’ expectations” but assures that it “remains committed to an aggressive plan to restore service to the levels customers need and had historically come to expect.”

Canadian Pacific spokesperson Ed Greenberg revealed his railroad has already spent approximately $5 billion on infrastructure improvements and capacity expansion over the past five years, with another $1.3 billion worth of projects planned for 2014.

It has been something of a perfect storm for the railroads, with several factors coming together to slow them down. 2013 saw not only bountiful harvests of corn, wheat, soybeans, and other crops, but also a continued increase in oil production from the shale fields.

Then came the coldest winter in a generation, hampering the railroads’ efficiency and creating severe backlogs of freight.

South Dakota Republican Senator John Thune is concerned with the economic effects the delays are having on agriculture — his state’s top industry. “We’ve got an awful lot of shippers that we’re hearing increasingly from that are very concerned about the backlog, the delays and the amount of time it is taking to get railroad cars… hindering their ability to run [their businesses] efficiently and profitably.”

Chris Fischbach, a farmer and director with the South Dakota Soybean Association, said some local grain elevators are waiting up to a month between trains, where normal wait times used to be just 10 days.

“I have every reason to believe the railroad will get through the majority of this backlog,” Fischbach said, remaining optimistic. “The more commodities and material they turn, the more money they make, too.”

But some are wondering if the money the railroads make might be influencing their servicing priorities.

Where the Money Is

The more complicated shipping requirements of oil and liquid natural gas fetch among the highest shipping rates of all commodities. While stopping short of openly accusing the railroads of prioritizing shipments on the basis of fees, South Dakota Democratic Senator Tim Johnson is ready to raise the issue at the April 10th hearing of the Surface Transportation Board.

“We need to take a hard look at whether there is undue preference being shown to particular shippers,” he demanded, noting the beehive of rail service activity buzzing in and out of North Dakota’s oil fields. “They should not be playing favorites. It’s important that the federal Surface Transportation Board monitor these issues.”

Yet conspiracists contend there might be more to it than that — possibly a concerted effort by industrialists to move commodity prices. How better to influence prices than to limit supply?

Note the recent price performance of the main commodities in question:

commodity prices 4-7Source: TradingCharts.com

While light, sweet crude oil is near the upper level of its medium-term trading range, agricultural commodities such as corn, wheat, and soybeans have all suffered a disastrous 2013 and have only slightly rebounded in the opening months of this year due to the severe, cold winter.

If someone wanted to influence a commodity price downward (such as oil, in order to lower the cost of manufacturing and industrial activity), they would ensure the market is well supplied. If they wanted to influence a commodity price upward (such as the beaten-down agriculturals), they would ensure the market is under-supplied.

Whether the conspiracists are right or whether it is simply a combination of the recent cold snap and overtaxed rail networks, agricultural prices are on the rise.

Until the railroads get more locomotives and railcars to farms in South Dakota and other breadbasket states, we can expect agricultural prices to continue rising.

Limited Time Offer

But that might not happen soon enough to save the crops waiting to be picked up.

Lisa Richardson, executive director with the South Dakota Corn Growers Association, warns, “Corn sitting on the ground near grain elevators might not be able to get to market because of the rail car shortage before conditions warm, causing the crops to rot.”

It’s not just a matter of getting old harvests out, but also of making room for new harvests coming in. “Some with corn and other agricultural commodities held in facilities on their farms are eager to empty out the storage bins so they have room ahead of upcoming harvests later this year… Farmers are more worried about this than how cold it is or how much rain they’re going to get. It’s a huge issue; huge issue,” Richardson stressed.

But BNSF Vice President for Agriculture John Miller does not offer much hope to farmers. “As we know, winter wheat harvest is fast approaching,” he alluded to the June harvests throughout Texas, Oklahoma, Kansas, and Nebraska.

“In past years when there was plenty of available freight, we have been able to strategically pre-position covered harvest to meet harvest demand. Due to the car order backlog we are currently experiencing, this year, we will have limited availability to pre-position cars.”

Once again, South Dakota farmers are being placed at the end of the line… not only behind oil shipments to their north, but also behind other grain harvests to their south.

But if the railroads think they can simply push South Dakota around, they have another thing coming to them — a staunch fight from the state’s top politicians.

“The weather this winter is not helping matters,” South Dakota Republican Representative Kristi Noem acknowledged. “But when the weather straightens out we need to get cars moving, get locomotives down here to move those cars,” she demanded.

“We’ve got to get it moved out before we hit another harvest season, and we need the space. This is key to our economy, being able to move our products. [The railroads] have a commitment to do so, and we’re going to make sure they do,” Noem made clear.

Investors See Opportunity

How the situation unfolds over the coming weeks will be critical not only to the region’s farmers but also to food prices in supermarkets across the nation. It all comes down to a very simple equation: low supply equals higher prices.

Given the recent tumble in agricultural commodities during 2013, conditions might be pointing to starkly higher prices in 2014 and may present opportunities for investors. While you might intuitively want to stay away from grain consumers — such as cereal companies like Post (NYSE: POST), which will be faced with higher production costs — you may want to make an exception to this rule in the case of Kellogg (NYSE: K).

Shares of Kellogg soared almost 6% late yesterday afternoon on rumors it is being eyed as a takeover target. At the same time, a block of 2,000 call options with a May $65 strike were bought late yesterday afternoon.

Christopher Rich, head options strategist at Jones Trading Institutional Services LLC in Chicago, noted, “This is absolutely the kind of options action that could signal takeover activity.”

Investors may also consider the actual commodities themselves. If you don’t like futures contracts, there are a number of agricultural ETFs to choose from, such as iPath DJ-UBS Grains ETN (NYSE: JJG) and Elements MLCXGrains Index (NYSE: GRU).

Of course, given the huge demand for rail transport, you might want to consider some rail companies, too. Warren Buffett did, buying BNSF in 2010 — quite a forward-looking deal in anticipation of the shale oil boom in North Dakota and the increased demand for rail service it would set off.

While we can’t buy the entire rail company like Buffett did, we could pick up some shares of BNSF’s owner Berkshire Hathaway (NYSE: BRK.B) for $124 a share. Just make sure you don’t type in BRK.A, as it costs over $186,000 a share.

Here are few other railroads if you want to focus on other regions…

CSX Corp (NYSE: CSX), Genesee & Wyoming Inc. (NYSE: GWR), Kansas City Southern (NYSE: KSU), Norfolk Southern (NYSE: NSC), and Union Pacific (NYSE: UNP).

railroad stocks 4-7Source: BigCharts.com

All of these have beaten the S&P 500 over the past five years since the financial crisis. After all, you can’t have an economic recovery without the railroads.

Until next time,

Joseph Cafariello for Wealth Daily

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