Is history repeating itself?

Part One of a Conversation with Howard Jay O’Neil

I spoke with Jay by phone from his home in Southern Oregon. He has recently taken semi-retirement from the faculty at Kansas State University, where he managed the commercial operations of the International Grains Program; he now operates his own private consulting business. When I spoke with him, Jay had recently returned from speaking at a buyers’ conference in Thailand organized by the USSEC, the US soybean export council. Prior to that he was doing similar workshops in Central America for the US Grains Council.

Jay told me that he started in the business in January 1973 straight out of college. “I joined Continental Grain in Orinda California,” he continued. “It was right at the beginning of what was later described as “The Great Russian Grain Robbery,” and I was right in the middle of it.

“I stayed with Conti until May 1977, when I was hired by Pillsbury to work as a grain merchandiser in the export grain organization they had at that time.

I worked in Omaha, Nebraska for one year, moved briefly to St Louis Missouri, their regional office for export trading, and then to their Minneapolis headquarters. I stayed with Pillsbury until 1984, when they sold their grain origination business to Cargill. Pillsbury had quite a sizeable operation at the time with over 90 domestic facilities.

“When the Soviets came in for grain in the 1970s, the US just didn’t have the transportation logistics to handle the volumes that they wanted to buy. The US agricultural industry was not ready or equipped for that much demand. There simply weren’t enough rail cars, barges, or export facility capacity to handle the volumes.

“By the early to mid-eighties the U.S. had built the export capacity needed to meet what we expected to be long-lasting Soviet grain demand. But then the Russian demand slowed down. They didn’t have enough money to continue buying the volumes that they had been buying.

“The industry found itself in a horrendous position with an over capacity of transport equipment and export capacity.  People were driving around the US looking for empty rail sidetracks where they could store their surplus railcars. We were using old military sites, unused industrial sites, anywhere we could find to store them.  We parked our empty railcars in the expectation that we would need them one day. But it would be many years, and hundreds of millions of dollars in industry losses, before the excess rail and barge capacity would diminish and balance out with cargo demand.

“I remember one particular meeting at Pillsbury in Minneapolis where the management group turned to the Vice President of our barge division, and told him to send out teams to look for trees along the Mississippi and its tributaries that were big enough to tie off barges to let them sit.

“Everyone was shouldering excess transportation assets, as well as export assets, and everyone was hemorrhaging red ink. In the mid-eighties the grain division in Pillsbury lost more than $200 million in a single year; that was a huge sum at the time. I imagine that many of our competitors were in the same position. We were only a medium sized grain company: the bigger companies must have lost even more. Every single company in the grain business at that time was losing money.

“The management group at Pillsbury did a study to answer the question, “When will the surplus railcars and barges rust away to the point where they go to scrap, or when will demand pick up enough to use those cars?” The answer the group came up with was sometime around 1999/2000! It was a surprisingly  good projection. The excess capacity situation continued through the 1990s as well, although of course to a lesser extent than in the 1980s. But boy, were the 1980s bad! We all suffered! We had all over-expanded!

“When Pillsbury sold their grain merchandising operations in 1984 I joined Ferruzzi down in New Orleans, managing their feed grain export business in Myrtle Grove Louisiana.

“We are all dependent on the market in this business. You can’t dictate what sort of profit margin you can obtain. You can only extract whatever profit margins the market will allow, and back then it wasn’t allowing any. During my time at Ferruzzi, many of the vessels we were loading had negative fobbing margins. The entire industry was in a down cycle and incurred negative profitability—negative fobbing margins. We were paying more for the barges and the railcars than we were getting back from many of the ships we were exporting.

“We closed our facility for two months in an attempt to stop the losses, but the fixed costs of maintaining the facility were higher than we expected. We found that it was better to continue throughput loading, and have at least some revenue coming through to cover some of our variable costs.

“That rule still applies today; it is better to keep facilities running, even at low throughput margins, than to close them. It is better to try to extract some revenue to, at least, cover something against variable expenses, than to have no revenue and still have to pay your full overhead costs. So we opened the elevator again, but things didn’t really get better.

I left Ferruzzi in 1986 and took  a job with Bartlett Grain Co in Kansas City Missouri, where I managed their cross-country grain trading group and export grain operations for 17 years.”

I asked Jay if the Carter grain embargo in January 1980 had made the situation worse.

“The US has had two grain embargoes,” he explained. “ One was under the Nixon administration, the other under Jimmy Carter. They were effectively soybean export embargoes. Both were very detrimental to the US grain industry. The Nixon and Carter embargoes motivated the Japanese to go to South America and invest capital in the development of the South American soybean industry.”

“Wouldn’t that have happened anyway?” I asked.

“It would have,” Jay replied, “but not as quickly, or on such scale. We created our own competition by imposing those two embargoes.

“Is history repeating itself now?” I asked.

“I have no doubts that history is repeating itself with the current trade war with China. We are once again helping to create our own competition. China has been put in a very difficult situation in terms of grain, both politically and economically. The Chinese are almost certainly saying to themselves that they can no longer depend on the US as a reliable supplier, and they will certainly try and diversify their buying options. China is already investing in South America, Sub-Saharan Africa, in Russia and the Black Sea looking to encourage soybean production outside of the US.

“We are once again creating our own competition and that won’t be reversible. We will see grain production increase around the world, and that will make it more difficult for US grain farmers for next ten or twenty years, and beyond.”

“But to what extent can China find alternative sources of supply of beans?” I asked. “I know that the Black Sea region, particularly Ukraine, has expanded corn production,” I continued, “but is corn a substitute for soy?”

“No they are not interchangeable. Animal feed has a percentage of starch, usually from corn, but you also need protein, and that comes from the soya meal.

“China has a substantial soybean crushing industry that has to be fed by imports. The country only produces 2-3 million tonnes of beans each year, pretty much all of which goes to direct human consumption. They must import the vast majority of their oil seed needs every year.

 “You can grow corn in a lot of places, but it is a  bit more difficult to grow soybeans. Then again, you have the seed technology companies that are coming up with better, shorter-season soybean varieties that can do well in colder climates such as Canada and Eastern Russia, areas that have previously not previously been able to grow soybeans.

“No one is predicting that these new areas will ever be major oilseed exporters. They will sell a few million tonnes here and there, but nowhere near the 85 plus million tonnes that China needs each year. China will have to depend on South America and the US, but with a growing percentage of that coming from South America.”

“After you left Ferruzzi they tried to squeeze the soybean futures market in Chicago. They failed, and the company went out of business. Is there is a danger that history repeats itself in that sense as well?”

“Unfortunately, squeezed margins may have prompted some trading companies to try and replace that lost income by taking bigger risks in the futures markets or on the flat price. This has rarely  worked.

“I have been in the business for 45 years and I have seen some great companies, Continental Grain, Cook Industries, and André either go bankrupt or exit the grain business. The ones that went out of business did so because someone speculated, took overly big risks, didn’t hedge. André got out of the business after big losses in their soybean department. Cook Industries went bankrupt because of bad positions on crush spreads in soybeans. Even Conti’s sale to Cargill followed losses in the Russian bond market.  It was always something foolish.”

© Commodity Conversations ®