25-year-old formula dictates how grain moves across Western Canada, drawing criticism

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More than two decades ago, the Canadian Transportation Agency designed a formula that would regulate the movement of grain across Western Canada.

The formula was supposed to last five years. It still stands today, despite federal investigations calling for its elimination and criticism from practically every party involved in getting grain from the ground to market.

The policy, known as maximum revenue entitlement (MRE), enriches railroads and doesn’t pass efficiency gains to their customers, say some agricultural economists, shippers and farmers.

North America’s most expansive railroad − Canadian Pacific Kansas City Ltd. (CPKC) − also has issues with the MRE but for different reasons. The formula does not reinforce its market power, the railroad argues, and by capping profits, it discourages investment.

After decades of debate, the impetus for change might finally be here: The MRE is where two of Ottawa’s major promises to the country collide.

The first one came to the forefront last week as Prime Minister Mark Carney promised to redesign the flow of goods across Canada by flagging major investments in port infrastructure. The underutilized Port of Churchill is one such site up for consideration, and the MRE does not cover service to this arctic port.

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Ottawa has also promised to slash red tape and streamline regulatory processes in food production, in part to help Canada’s farmers contend with an increasingly hostile trading environment. China’s recent 75.8-per-cent duty on canola seed is emblematic of this struggle.

“If our regulations are putting us at an unfair advantage with our trading partners, we need to take a serious look at them,” said Heath MacDonald, Minister of Agriculture and Agri-Food, in a recent interview with The Globe and Mail.

The Maximum Revenue Entitlement came into force as a result of grain transportation failures.

The fundamental challenge was − and always has been − the market power of the railroads, said James Nolan, professor of agricultural and resource economics at the University of Saskatchewan.

Of the 370 primary grain elevators in the country, only four are serviced by both Canadian National Railway and CPKC (formally Canadian Pacific).

Across the past century, Ottawa has regulated this market power with a number of regulatory tools. By the 1990s, railroads were subject to fixed-rate tariffs, largely based on distance for moving grain.

But a straightforward tariff rate structure wasn’t working for farmers or the railroads, said Mark Hemmes, president of the Quorum Corporation, the government contracted third party that monitors and reports on the transportation of Western grain.

It dissuaded movement of grain and meant that the railroads didn’t invest in this part of the business.

At the turn of the millennium, after a federal review, Ottawa decided to try to encourage a more competitive grain transportation industry, said Prof. Nolan.

One such system (as suggested by the federal review) could have included the European open-access style. But in this case, rail tracks are typically publicly owned and the railroads compete for access to the tracks.

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But before pursuing radical options such as these, Ottawa − alongside the railroads − put forward a short-term solution: the maximum revenue entitlement.

In essence, CN and CP agreed to limit the total revenue they could receive for transporting Western grain.

At the foundation of this formula is the “base” − the estimate of the railways’ revenue per tonne of grain, calculated when the MRE began more than two decades ago.

The base would then be plugged into a formula that multiplies it by distance and tonnes moved. Each year, the cap increases to account for increased labour, fuel and material costs.

Should the railroad go over the cap, it has to pay a penalty that is given to the Western Grains Research Foundation, a breeding and field crop research centre.

In effect, the MRE was supposed to be a band aid until Canada could figure out a way to foster genuine competition within the railroad industry, and grain movement in particular, said Prof. Nolan.

But, despite a 2015 review of the Canadian Transportation Act that recommended its elimination within seven years, the regulatory policy is still in place today. And it still uses the same base cost.

Grain companies are broadly in favour, said Wade Sobkowich, executive director of the Western Grain Elevator Association.

Without a regulation such as the MRE, railroads would be free to charge whatever they wanted. And these transportation costs − paid by the elevators − would be passed down to farmers.

But it is a far cry from a competitive system, said Mr. Sobkowich.

“The devil is in the details with these things,” he said.

Under the MRE, railroads can deduct direct investment and certain operating costs related to grain infrastructure.

There have been a number of investments over the past twenty years. For example, the railroads have replaced smaller, older government-owned hopper cars with their own purchase of high-capacity hopper cars that can carry significantly more grain.

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Grain terminals are also fewer and larger. In 1999, there were more than 1,000 across the country, according to data provided to The Globe from the Quorum Corporation. Today, there are less than 400.

Many of these elevators use a loop track system where trains don’t need to stop (and incur the costs from starting up again). Now, more than 130 car trains can be loaded in hours instead of days. One decade ago, there was only one loop track elevator in the prairies. Now, there are 53.

This − among other efficiency gains − amounts to serious cost savings. The time it takes for cars to cycle from the country to port and back again (referred to as a car cycle) has decreased to 14.2 days at the end of this crop year from 23.1 days in 1999-2000.

Fuel efficiency of trains, or technology that cuts the labour costs of running a railroad, are other efficiency gains for railroads, said John Corey, president of the Freight Management Association of Canada.

But the gains are not passed down to farmers or grain companies, like they would be in a competitive system, he said.

Mr. Corey, and voices in the grain industry, are therefore calling on the Canadian Transportation Agency to re-examine the basis of the formula.

“Anything that was around 25 years ago and hasn’t changed, that’s a problem,” he said, adding “it is time for an adjustment or at least a review.”

CPKC doesn’t want an adjustment to the MRE. It wants the regulation eliminated.

In a statement sent to The Globe, the company argued that the MRE is an “antiquated and harmful regulatory intervention that should be removed.”

The argument is that the MRE is inherently uncompetitive. It means the railroad is less inclined to invest in grain infrastructure that would, in turn, benefit grain companies.

Grain movement should instead be governed by the laws of competition and market forces, said CPKC. Pricing would still be subject to existing regulations under the Canadian Transportation Act, like it is for other commodities.

CN did not respond to a request for comment.

In an interview earlier this month, Mr. MacDonald, the Agriculture Minister, did not address questions about the MRE, but did say that Ottawa is considering the Port of Churchill for investment.

Mr. MacDonald also said that increasing railroad competition is on the table, specifically mentioning interswitching.

This rail policy forces railroads to allow limited access to their tracks by competitors, for a price. It means many grain elevators could then be serviced by more than one railroad, and therefore have some space to negotiate their rail rates.

The Liberal government promised to extend the life of an interswitching pilot project during the election campaign.

This system is closer to a genuinely competitive model, said Prof. Nolan.

However, attempts to extend interswitching has always been met with fierce opposition from the railroads.

But Mr. Corey says that until Ottawa accepts that Canada has a rail duopoly and decides to enforce policies for dispute resolution and rail access, it will not have competitive supply chains and the railroads will continue to have market power.

“For them it is like shooting fish in a barrel every day,” he said. “They have the shippers [grain companies] at a disadvantage and they’ll use that to their advantage.”