Change On the Rural Horizon: Managing the Expansion of Grain Storage in the Corn Belt

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1 June 212 Change On the Rural Horizon: Managing the Expansion of Grain Storage in the Corn Belt by Dan Kowalski Lead Analyst, Knowledge Exchange Division Inside this Issue Introduction... 1 Background... 2 How Did We Get Here?... 3 The Way Forward... 6 Conclusion... 9 Key Points: Roughly 8 percent of U.S. grain storage capacity is located within the 12-state Corn Belt region, and this region accounts for 9 percent of new capacity added since 25. During this period, Corn Belt capacity increased by 17 percent, or 2.7 billion bushels. Off-farm storage now accounts for 42 percent of Corn Belt capacity, but its share grew nearly twice as fast as on-farm storage since 25 (24% growth vs. 13%). This trend suggests that most producers are opting to take on less risk and less leverage by utilizing elevator storage, whereas larger operations are storing more grain onsite. Since 25, operational risks for the grain handling industry have increased dramatically. Wider trading ranges for commodities, shifting transportation patterns, and competitive threats are among the most significant challenges facing the industry. Meeting the evolving needs of producers will be critical to the future survival and success of grain handling firms. Success factors will include the ability to offer sufficient storage capacity in optimal locations, faster/newer technology, and competitive rates. Based on grain supply forecasts for the 12 Corn Belt States, it is estimated that this region will need about 2.3 billion bushels of additional capacity by 22, of which 1.3 billion bushels is projected to be built off-farm. Yields for corn and soybeans will have the greatest impact on these estimates. If actual yields across the region trend five percent above or below our assumed rates, our estimates of additional storage needs would then range from 1.5 to 3.2 billion bushels. In turn, construction costs would range from $2.5 $5.1 billion. Introduction The landscape of the countryside is changing. Record grain production in recent years has necessitated massive investments in new storage bins across the heartland. And while the building craze began several years ago, it is likely to be years before new construction subsides. Not only has the demand for storage space increased, but the grain handling industry is operating in a new-normal 1

2 business environment. Extreme price volatility, an evolving transportation sector, and industry consolidation have raised the bar for managers as they navigate the industry s path for the future. U.S. grain production is expected to set a new record in 212, based on large increases in acreage and/or yield for corn, wheat, and soybeans. But what comes after the 212/13 crop year is of most critical concern for long term planning. Most analysts expect a lull in crop production over the next couple of years, as corn acreage will fall from a 75-year high after 212. Stocks are expected to rise from historically low levels and lower prices are likely to reduce incentives for crop production on marginal land. However, as corn and soybean yields resume their long-term upward trend, the U.S. crop supply will grow larger in the latter half of the decade. Given this continual growth in grain supply, we estimate that the 12-state Corn Belt region will build an additional 2.3 billion bushels of storage by 22, of which 1.3 billion bushels will be built off-farm. However, if corn and soybean yield growth rates deviate by five percent above or below our assumed rates, the impact to the projection would be significant. Accounting for this potential variation, total storage capacity across the region is expected to grow by a range billion bushels, with an associated cost range of $2.5 $5.1 billion. Background For nearly two decades prior to 25, grain storage capacity across the Midwest saw no growth, and in many states capacity declined. Overbuilding in the 197s and 8s left the industry with a record glut of underutilized storage space. In the latter half of the 199s, soybean acres increased significantly with the advent of biotech seeds, and both corn and soybean productivity accelerated. More bushels per acre enabled the industry to utilize silo and elevator space that had been dormant, and by the turn of the century grain supply in the Corn Belt had finally caught up with the volume of available storage capacity. Over the next five years availability of storage capacity edged up slightly. However, despite The challenge for the industry is how to prepare now for a supply picture that will continue to be a moving target. increasing production, storage utilization remained flat as strong demand dwindled leftover grain stocks. Then the Energy Act of 25 was passed, and the grain industry was suddenly poised for momentous change. The Energy Act included a Renewable Fuel Standard (RFS), mandating the inclusion of biofuels in the country s motor fuel. The RFS was then expanded in 27, doubling the amount of corn-derived fuel that would be produced, from 7.5 billion gallons in 212 to 15 billion gallons by 215. The guaranteed demand for copious amounts of ethanol resulted in a scramble from 25 through 28 to build out the ethanol production infrastructure. Since 24, the number of ethanol plants in the U.S. has tripled, the production capacity has quadrupled, and we are now consuming a third of the corn crop for biofuel use each year. Grain producers across the Midwest responded to the swiftly rising demand for corn-based ethanol and the continually increasing need for animal feed abroad. The grain supply originated from the 12 Corn Belt states (CB-12) jumped to a new level beginning in 25, and remained on average 15 percent higher over the ensuing five years than it had been in the previous five years. New storage capacity across the region increased by 17 percent over the same period, effectively maintaining full capacity utilization. While the expansion in storage was rapid, producers, cooperatives, and private grain elevators did not build beyond what was needed. Despite near record plantings of corn and soybeans, weather issues limited grain supply gains in 21 and 211. The grain supply (defined as carryover stocks + production for corn, wheat, soybeans, sorghum, and oats) was severely impacted from a two year La Niña event as production was insufficient to meet demand, 2

3 Figure 1: Cornbelt Grain Supply and Corn Used for Ethanol Production Grain Supply (Bil Bu) Avg 14.4 B bu Sources: PRX, USDA, CoBank * indicates forecast Avg 16.6 B bu Avg 17.1 B bu * Grain Supply which caused a drawdown of inventory stocks. Should we see a return to more favorable weather patterns, record plantings, along with a return to trend yields, would drive the industry back to surplus conditions. Soybean stocks relative to use are expected to fall in 212/13. But if normal growing conditions return and stay, stocks for corn, wheat, and soybeans should return to healthy levels by 213 or 214. Thereafter, growth in yields is expected to push grain supplies in the Corn Belt and the U.S. to new highs (see Figure 1). In anticipation of even greater grain supplies, one of the greatest challenges is sizing and locating the need for additional storage. Before the grain can be transported for feed, industrial, or export use, it will have to be stored. The challenge for the industry is how to prepare now for a supply picture that will continue to be a moving target. How Did We Get Here? Corn for Ethanol More Bushels, Fewer Facilities, and Higher Income Avg 18.7 B bu * To address the questions of how much additional storage will be needed in the coming years, and where it should be located, it is important to understand how the grain storage industry is changing in response to shifts in production and transportation patterns. 6 Storage capacity across the country continues to rise even as the number of 5 storage facilities continues to decline (See Figure 2). The loss of off-farm storage 4 facilities is due largely to the retirement of old, inefficient, and/or poorly located grain 3 elevators. In many cases this has meant 2 the closing of small wheat elevators and the expansion of existing, or construction 1 of new larger elevators for handling corn and soybeans. The average elevator size grew by 3 percent between 25 and 211, from 1 million to 1.3 million bushels of capacity. Much of this increase is a direct response to the increase we have seen in grain production. Bins had to become larger to handle the added supply, and permanent storage capacity was built to replace temporary storage. However, other factors are also in play. Corn Used for Ethanol (Bil Bu) Higher commodity prices have led to higher income on the farm, as well as increased revenues along the rest of the agribusiness supply chain. Net farm income set a new record in 211, while the farm debt-to-equity ratio also fell to the lowest level on record (See Figure 3). The same demand for grain that drove prices and production higher also generated the income necessary to pay for the extra storage. Producers are paying down debt and using cash rather than credit for new business investments to an extent never previously possible. Cooperatives, which maintain much of the Midwest off-farm storage, have also benefited from the rise in grain handling and crop values. According to the USDA, cooperative patronage dividend payouts increased by 7 percent from 22 to 27. Payouts have climbed even higher since then, even as co-ops have built a large portion of the $3.6 billion of new off-farm storage capacity from 25 through 211. Rail Access Matters Site selection for new storage facilities is determined by several key factors. In many cases, especially in the western Corn Belt, few are as critical as railroad access. With U.S. corn-based ethanol production reaching a 3

4 Figure 2: U.S. Grain Storage Capacity 15, 1, 5, shuttle loading facilities. By doing so, railroads can more efficiently move unit trains with cars directly from supplier to end user. As shuttle trains became the standard method for shipping grain to animal feeding operations in the Southwest, and to export terminals on the West Coast, the grain handling industry responded by doubling Midwest shuttle loading capacity since the early 2 s. With this rapid increase in shuttle loader construction, shuttle facilities now account for nearly 25 percent of all off-farm capacity in the Corn Belt, and 5 percent in the Southwest. On- Farm (Mil Bu) Off- Farm (Mil Bu) Off- Farm Facili6es Sources: USDA, CoBank plateau, most of the future increase in grain production is likely to be transported longer distances for feed or export. This will increase the importance of rail access as more grain is shipped domestically to animal feeding operations, and larger volumes of grain and meat products are exported to growth markets in Asia. Rail access is certainly not a new determining factor when it comes to locating grain storage facilities. Elevator proximity to rail lines has been important for decades. However, a shift toward shuttle loading, larger rail cars, and fewer main line track miles have all had a significant impact on grain storage facility operators, especially since the 199s. After the railroads were deregulated more than 3 years ago, the industry battled to remain solvent as it came to grips with reduced freight rates and vast inefficiencies. To regain financial footing, many of the railroads merged to minimize competition, and also abandoned unprofitable stretches of track. Since deregulation in 198, 3 percent of U.S. railroad track has been abandoned. The Midwest was hit most severely by rail abandonment as South Dakota and Iowa lost roughly 5 percent of their rail miles, and four other Farm Belt states lost approximately 4 percent of their rail routes. Railroads then pursued further efficiencies by building larger capacity cars and incentivizing grain shipments from The result of these changes has been distinctly negative for country elevators that are far removed from main line rail access, and markedly so if they have not invested in other competitive advantages (increased speed and space). Short line railroads that still provide service to many country elevators cannot use the larger rail cars or move as many cars, or at comparable speeds, between facilities. Therefore, short lines are far less profitable to operate, and thus charge significantly higher rates per mile. The attractiveness of the shuttle facility freight rates has caused many producers to reassess how they move their grain. This is especially true as producers are growing larger crops on more acres, and many have invested in large capacity trucks in which to haul their grain. For some of these producers, it has begun to make financial sense to bypass the local elevator and truck grain directly to a shuttle facility. This practice has contributed to the closure of many country elevators across the heartland, and this trend is expected to continue over the next several years. Speed is King Also contributing to the retirement of older facilities and the expansion of newer facilities is the ever-increasing demand for speed. Producers are harvesting more grain than ever, which has necessitated investments in more field equipment and labor. With production costs at record levels, idle equipment and workers pose a significant direct cost to the producer. Windows of favorable weather are oftentimes short at harvest as well, providing additional incentive for producers to 4

5 Figure 3: U.S. Net Farm Income and Debt/Equity Ratio Net Farm Income ($ Bil) $12 $1 $8 $6 $4 $2 $ Source: USDA * indicates forecast Net Farm Income Debt/Equity Ra=o move quickly. As a result, unloading time has become a key decision factor for producers that have options for delivery points. Facilities built in the 196s and 7s were designed to handle roughly 1, bushels per hour. Technology at the newest facilities has increased unloading speeds by two and in some cases three times versus older elevators. By adding pits (dumping areas for trucks) and legs (grain conveyors) at the elevator, operators can obtain a significant speed advantage over their competition. Many of the larger producers are willing to incur slightly higher transportation costs in exchange for less time spent waiting in lines. This advantage has proven to enhance elevator margins, as quicker turnaround often attracts new customers and therefore more bushels. Elevators operate in a high volume, thin incremental margin business, so maximizing capacity utilization is a critical factor in improving profitability. With more facilities investing in new, faster equipment, other operators will either choose to upgrade their facilities, or eventually become uncompetitive. Operators that fall behind, in what is already an extremely competitive industry, risk eventually facing acquisition or closure. In the end, this competitive environment benefits Debt/Equity Ra.o local producers by raising the level of service offered by all elevators. Intense competition also fosters consolidation, however, which can reduce the number of operators in a local area, and negatively impact prices offered to producers. Greater Gain with Greater Risk As grain supply and storage capacity have grown, so has the level of risk undertaken by grain elevators. While the grain supply increased by roughly 35 percent from 199 to 211, the value of the grain has more than tripled. Without question, higher prices in recent years have made successful risk management increasingly important. However, it is the unprecedented volatility that has made risk management and financial management much more challenging. Since 26, the average annual variation in price (range from high to low) for corn, wheat, and soybeans has more than doubled from the prior 15 year period (See Figure 4). Basis volatility across the Corn Belt has also risen significantly, further increasing price risk for elevator operators. The compound effect of higher and more volatile prices has dramatically increased the need for working capital financing at elevators. Lines of credit in excess of $5 million and daily margin calls of $1 million or more have become much more common even for some relatively modest sized country elevators. These levels of capital needs would have seemed improbable only a few years ago. Co-ops and elevators have also sought more capital to expand the size of their operations and their geographical reach. To keep up with national and global competition, many industry players have shifted from a small, local business model to serving producers across states or regions. Much of this growth has come through mergers or acquisitions. Thus, the number of grain storage operators has been falling along with the number of facilities, as both bins and operations grow larger. 5

6 $/Bushel $/Bushel $/Bushel $8 $7 $6 $5 $4 $3 $2 $1 $ $14 $12 $1 $8 $6 $4 $2 $ $2 $15 $1 $5 $ Figure 4: Annual Grain Futures Price Volatility Corn Avg Annual Price Range: $.93 Wheat Avg Annual Price Range: $1.4 Soybeans Avg Annual Price Range: $ Avg Range: $ Avg Range: $ Avg Range: $4.76 In an age of rapid growth, one thing is clear; elevated risk is unavoidable, and must be properly managed. Substantial risk is being absorbed by firms that are ever expanding into new ventures. However, firms that continue to operate as they always have, are incurring equally significant, albeit different risk. The Way Forward Rising Grain Supply and Storage Demand Surging demand for feed and industrial uses of grains has pushed U.S. crop production higher. And barring a major shift in biofuel policy, larger production volumes will likely be the new normal for years to come. Roughly 8 percent of U.S. grain storage capacity is located in the Corn Belt, and the region accounts for 9 percent of new capacity since 25. During this period, Corn Belt capacity increased by 17 percent, or 2.7 billion bushels. As we anticipate potentially the largest corn/soybean crop on record in 212/13, questions arise regarding the sufficiency of current storage capacity and future growth. Based on storage capacities reported by the USDA for December 211, and 212/13 projections from ProExporter (PRX), the supply of grain in five of the 12 Corn Belt states this year will exceed the capacity available to store that grain (See Figure 5). This is not a new problem, and was actually much worse in 29/1 when nine of the 12 Corn Belt states lacked sufficient storage capacity. To alleviate the pressure on limited space, temporary storage is typically erected for harvest season, when storage demand is at its peak. Most long-term forecasts currently project 212/13 to be the high water mark for U.S. and Corn Belt grain acreage for the remainder of the decade. Despite this, all forecasts also project considerable growth in grain supplies over that same period. Production of wheat, sorghum, and oats is generally expected to be flat or down slightly, so supply gains are likely to come mostly from advancements in corn and soybean yields. PRX projections indicate that corn and soybean supplies will increase by an average of 1.8 percent annually in the CB-12 region between 212/13 and the 219/2 marketing year. These gains will not be uniform across the region, as trend yields vary significantly across states. Nebraska, Iowa, and Illinois are not expected to 6

7 Figure 5: Projected 212/13 Grain Supply and Storage Capacity Corn Belt-12 States Grain Supply (M Bu) Storage Capacity (M Bu) Capacity Utilization ND 833 1,173 71% SD 1, % NE 2,153 1,97 19% KS 1,261 1,32 96% MN 1,922 2,11 91% IA 3,278 3,43 96% MO % WI % IL 2,794 2,911 96% IN 1,326 1,264 15% OH % MI % Total CB-12 17,45 17,972 97% Sources: PRX, USDA, CoBank ProExporter is one of the few grain advisory firms that projects state-level corn and soybean yields, so a comparison across different forecasts is difficult. On a national level, PRX yield projections outpace USDA and FAPRI (Food and Agricultural Policy Research Institute), for both corn and soybeans (See Figure 6). History, however, has taught that actual yields can differ from even broadly accepted forecasts by wider margins than these. If actual corn and soybean trend yields for the projection period (after 212) are five percent above or below the PRX baseline, the grain supply, and thus the need for storage, will shift by more than 3 percent. A five percent reduction in yields would result in additional grain storage needs of approximately 1.5 billion bushels across the Corn Belt. Likewise, yields five percent above the baseline would result in additional storage needs of nearly 3.2 billion bushels by 219 (See Figure 7). have the largest yield increases, but high baseline yields are likely to push production levels highest for these three states. Across the region, the grain supply could grow by 2.5 billion bushels between 212/13 and 219/2. Adjusting for the utilization of current capacity (excess in some states, lack in others), the CB-12 region will have to build an estimated 2.3 billion bushels of additional grain storage capacity by the end of the decade. A critical variable in this projection is the uncertainty of trend yields. In 211/12 the industry experienced the first occurrence of back-to-back years of below trend corn yields since Yield forecasts are largely derived from historical data, so as a result of yield slumps in the past two years, the industry is exceptionally divided on selecting an appropriate trajectory for future corn yields. Similarly, the range of industry yield projections for soybeans is also significant. Wide ranging yield expectations present a considerable challenge when forecasting grain storage needs. Relatively minor shifts in yield gains have a dramatic impact on overall grain supply, which can skew storage projections. On-Farm vs. Off-Farm Storage From 25 to 211, off-farm storage grew nearly twice as fast as on-farm storage in the Corn Belt region (24% growth vs. 13%). As farming operations continue to increase in size, more producers have the financial wherewithal to build storage bins on the farm and manage their own inventory. However, most producers, especially those on small-to-medium sized operations, still choose to store their grain in elevators. By using elevators, producers absorb less capital expenditure risk, eliminate the risk of grain quality deterioration Figure 6: U.S. Annual Yield Growth Projections 213/14-19/2 PRX USDA FAPRI Corn 1.5% 1.2% 1.3% Soybeans 2.7% 1.1% 1.1% Note: Years before 213 were excluded to reflect only the longer term trend 7

8 Million Bushels Figure 7: Additional Grain Storage Needs from 212/13-219/2 Based on Potential Annual Yield Growth Rates State/ CB-12 Yield Growth Rate Sources: CoBank, PRX Notes: BASE - 5 % YIELD Corn: 2.3 % Soybean: 3.% BASELINE Corn: 2.8 % Soybean: 3.6 % BASE + 5 % YIELD Corn: 3.4 % Soybean: 4.2 % (Mil Bu) (Mil Bu) (Mil Bu) ND SD NE KS MN IA MO WI IL IN OH MI CB-12 1,519 2,347 3,185 ND SD NE KS MN IA MO WI IL IN OH MI 1) State-level grain supply forecasts do not follow a straight trend line. As a result, projected storage capacity increases reflect gains in supply between 212 and the peak supply year before or in ) The column tiers in this chart are additive. Therefore, Base includes the green and yellow areas, and High includes all 3 colors. throughout the year, and may minimize total transportation costs. These economic benefits offered by elevator storage have helped the grain handling industry to grow at an even faster rate than grain production. We expect that off-farm storage will remain the preferred storage method for most producers over the next several years, and growth in off-farm storage will continue to outpace on-farm construction. To estimate the share of new storage capacity that will be built off-farm, we assume that the ratio of on/off-farm construction will follow the trend from According to the USDA, that trend varied dramatically across the Corn Belt states, with off-farm share of new construction ranging from a low of 31 percent in Missouri, to a high of 1 percent in Kansas. On average, just over half of Corn Belt storage was built off-farm from (See Figure 8). Applying these ratios to the baseline projection yields an increase of 1.3 billion bushels of off-farm capacity (equivalent to 1, average size facilities) in the CB-12 region by 219/2 (See Figure 9). This is only slightly less than the 1.5 billion bushels of off-farm capacity that was added during the period. Applying the same corn and soybean yield growth rate alternatives (+/- 5%) produces a potential range of 851 1,764 million bushels of additional offfarm storage needed across the Corn Belt by 22. 8

9 Figure 8: Off-Farm Share of CB-12 Storage Capacity Growth, Off-Farm IL IN IA KS MI MN MO NE ND OH SD WI Share 61% 47% 52% 1% 41% 42% 31% 62% 49% 42% 48% 94% Sources: USDA, CoBank Million Bushels Figure 9. Additional Corn Belt Off-Farm Storage 212/13-19/ ND SD NE KS MN IA MO WI IL IN OH MI income levels, and made necessary by demands for speed and volume, the grain storage industry has kept pace with the rapidly evolving needs of producers, processors, and transporters. While expanding, co-ops and elevator operators have adapted to a changing business environment. Rife with challenges, the industry continues to grapple with increasing competitive pressures, higher financial management costs, and a rapidly changing transportation sector. Sources: USDA, CoBank Note: The column tiers in this chart are additive. Therefore, Base includes the green and yellow areas, and High includes all 3 colors. At an assumed cost of $2.75 per bushel, cooperatives and elevator operators would need to spend $3.6 billion for new bin construction and/or expansion. Additionally, we estimate that maintaining and/or replacing existing storage will cost an additional five percent, or approximately $18 million in the baseline scenario. This raises the total baseline projected cost of off-farm grain storage capital expenditures in the Corn Belt to $3.8 billion, with a potential range of $2.5 - $5.1 billion. Conclusion The grain industry has undergone substantial change in recent years. Since 25, grain storage and handling businesses across the Corn Belt have collectively invested in one of the quickest and most expansive storage building efforts in history. Made possible by record farm All signs point to more evolution for the grain storage industry in the future. The industry will be defined by larger storage bins, but fewer total facilities, and fewer grain handling firms. Shuttle loading capabilities will grow increasingly important in the western Corn Belt states. These strategically located facilities will thrive, while small country elevators will struggle to keep pace, perpetuating industry consolidation and the closure of older facilities. To maintain competitiveness, all storage operators, small and large, will find that regular facility upgrades are critical. Yield gains in corn and soybeans will drive investments in new storage across the Corn Belt, with much of the expansion becoming necessary in the latter half of the decade. Nebraska, Illinois, and Iowa are expected to see the greatest gains in bin construction, as grain supply accelerates the most in these key production states. The grain handling firms that benefit from this next phase of industry expansion will be characterized by strong financial and strategic leadership, as they manage to grow in an increasingly competitive and volatile marketplace. 9

10 CoBank s Knowledge Exchange Division welcomes readers comments and suggestions. Please send them to KEDRESEARCH@cobank.com. Disclaimer: The information contained in this report has been compiled from what CoBank regards as reliable sources but is provided for general informational purposes only and is not advice. CoBank does not make any representation or warranty regarding the content, and disclaims any responsibility for the information, materials, third-party opinions, and data included in this report. In no event will CoBank be liable for any decision made or actions taken by the user while relying on information contained in this report. 1