Transformation of the Grains Industry in Western Canada   Murray Fulton     February 1997   Order Information

The recent offer by Alberta Wheat Pool (AWP) and Manitoba Pool Elevators (MPE) to purchase all the outstanding shares of United Grain Growers (UGG) highlights a number of trends in the grain handling industry and raises a number of interesting questions.

Although many people are raising their eyebrows about the prospect of co-ops buying a publicly-traded company, the pools' offer must be seen in the light of a major transformation of the grain handling industry that is anticipated in western Canada.

For over fifty years, the three largest elevator companies on the Prairies &endash; the three pools &endash; have confined their operations to specific geographical areas. Although a few of the elevator companies (UGG, Cargill, Pioneer) have operated in all three Prairie provinces, the markets have nevertheless been thought of as being separate. A successful bid by the two pools for UGG will signal the arrival of a single market in which all grain handling companies would compete. In particular, Saskatchewan Wheat Pool (SWP) can be expected to enter both the Alberta and Manitoba markets (they already hold about 5 percent of the Manitoba market through AgPro), while the remaining grain companies (plus other new companies) may use this as an opportunity to make further inroads in all three provinces.

This unification of the grain handling markets on the Prairies is a response to the perception that a number of fundamental changes are likely to occur in the near future. One of these changes is in the area of grain transportation. The removal of the WGTA has resulted in the replacement of a highly regulated system with what many anticipate will be a market-based system. The advantage in a market-based system will go to those grain companies which can source grain from a variety of points, can blend grain effectively, and can offer efficiencies in transportation logistics. In short, large systems contain substantial economies of scale.

A second anticipated change is in the area of grain marketing. Although the CWB still retains single-desk selling authority in wheat and barley for export (farmers will make a decision about barley by the end of February), prudent grain companies know they must take steps to position themselves for the possibility the CWB will lose this authority in the next 5-10 years. For instance, the recent announcements by ConAgra that it will build three terminals in Saskatchewan and a bio-fuels plant in Alberta must be seen as being part of this positioning. Grain companies also know they need larger organizations to access international markets for such non-board crops as canola, lentils and peas.

A third change is the growth of processing activities on the Prairies. Partly because of the elimination of the WGTA and partly because retail markets are demanding more processed products, grain companies are trying to establish a presence in processing. Examples include the SWP's diversification efforts and Cargill and Archer Daniel Midland's expansion in canola facilities. An important factor in operating processing facilities is the ability to source grain directly from farmers.

Finally, the Alberta and Manitoba pools have some highly specific reasons for considering an expansion of their operations at the current time. An important factor is the need to fully utilize West Coast terminal capacity (the decision by the SWP and Cargill to build a terminal at Robert's Bank will leave Alberta Pool with excess capacity at the West Coast). The pools also had to be concerned that if they did not launched a take-over bid for UGG, some other company would (and still may).

Thus, although ownership of the grain handling industry is already very concentrated, substantial pressure for further merger and consolidation still exists. Grain handling appears to be going the way of the milling and the malting industry in Canada, both of which have extremely high levels of concentration (Archer Daniels Midland dominates the milling industry, while ConAgra dominates malting).

The potential purchase of UGG by the two pools raises a number of questions. The first is whether effective competition would still exist in grain handling were the takeover to occur. At the current time, the top four companies (provincial wheat pool, Cargill, Pioneer, and UGG) operate 88 percent of the primary elevator storage capacity in Manitoba, 92 percent in Saskatchewan, and 94 percent in Alberta. These concentration ratios are high and would be of major concern were co-operatives not present in these markets. The presence of co-operatives reduces the concern about market concentration because co-ops traditionally behave differently than their for-profit counterparts. They either hold prices down or return the profits they earn to farmers in the form of patronage refunds. Indeed, co-operatives were seen by Nourse, a leading co-operative theorist in the US, as a way of providing a "competition yardstick."

The acquisition of UGG by the pools would raise the concentration ratio in both Alberta and Manitoba, although not to the degree indicated by adding current market shares (AWP and UGG currently have 76 percent of capacity in Alberta; MPE and UGG have 71 percent in Manitoba). In all three provinces, not all UGG customers would continue to do business with the new company. As well, efforts by the other grain companies would reduce the market share held by the two pools and an acquired UGG. The result is that in both Alberta and Manitoba, the market share of pools will not likely rise above 65 percent, a figure roughly comparable to the market share held by the SWP in Saskatchewan during the late 1970s and early 1980s. Although this figure is high, the fact that the Alberta and Manitoba pools are co-operatives reduces the concerns about lack of competition. In Saskatchewan, the take-over would not affect competition dramatically, since the UGG elevators would continue to be run independently.

Concentration in the grain handling business is a concern and must be carefully monitored. While the proposed acquisition of UGG is likely to result in levels of concentration that are still acceptable, the potential for abuses of market power exist, particularly if the Alberta and Manitoba pools were to convert from co-operatives to for-profit firms, or if future mergers and acquisitions were to occur.

A second question concerns how the two pools would operate UGG and whether the purchase of UGG will ultimately lead to a merger between the two pools. One possible scenario would have the pools merge their operations with UGG operations in their respective provinces, leaving the UGG operations in Saskatchewan to be handled separately. Another scenario would have the Manitoba and Alberta pools merge their operations to form a large cross-province co-operative. While such a co-op would benefit from economies of scale, there have been many failed merger discussions between the three Prairie pools over the last 50 years (the most recent occurred in the last decade). The formation of a cross-province co-operative would have significant ramifications for SWP.

A third question that arises is how the two pools would finance the purchase of UGG. Although this question is of particular importance to how successful the pools will be if their takeover bid goes ahead, it is also indicative of a more general problem. Co-operatives throughout the industrialized world currently find themselves short of equity as they attempt to expand their operations and to retain a foothold in a much more concentrated and industrialized agriculture. For example, both UGG and SWP changed their financial structure to have greater access to equity capital.

This equity shortage is the consequence of a co-op's unique financial structure. In traditional co-ops, members receive benefits based on their business with the co-op, not the amount of equity they have contributed, and member equity is not generally tradable. The result is that farmers' incentive to invest in their co-op is reduced. Nevertheless, this structure has been adopted to ensure co-ops operate in their members' interest. As UGG has discovered, going public to raise capital may make a company vulnerable to take-over bids.

Farmers need to realize their co-operatives are one of the few ways in which they can retain some control over the grain handling system and farmers must work hard to ensure their co-ops work in their interests. In the first 30 years of this century, farmers took an ownership in the grain industry and formed co-ops like UGG and the pools to provide competition and to gain countervailing power. The agricultural transformation now underway fundamentally threatens farmers' ownership and control of the grain handling industry. The response of AWP and MPE to these changes is only one visible sign of the impending transformation.