Brazilian Rail Scores Huge Profits With Grain

April 8, 2018 06:00 AM
 
The only railroad operator along large swaths of Brazil’s main-growing regions reaps big profits due, in part, to a "Take or Pay" policy on grain shipments.

(Bloomberg) -- In Brazil’s agricultural heartland, executives are hunkering down for a fight.

On one side are heavyweight commodity traders like Bunge Ltd. and Louis Dreyfus Co., which buy grains from rural farmers and ship them to ports 1,200 miles away. On the other, Rumo Logistica SA, the only railroad operator along large swaths of Brazil’s main-growing regions.

Rumo’s multiyear transport contracts are due to expire later this year. A typical contract runs several pages long, but buried in it are three little words that form the crux of the conflict between traders and the railroad: Take or Pay.

The clause, sort of an anti-force majeure, requires trading companies to pay for shipping costs even when they don’t have the cargo to move. Two harvests ago, when a drought set in and crops withered, traders were forced to pay Rumo 283 million reais ($85 million) under the rule. During parts of last year, as margins grew too tight to make any real profits, traders bought soybeans and corn anyway just to fill up empty train cars.

“We just don’t want to lock ourselves into a situation where we will be forced to originate at negative margins, as was the case for most of the industry last year,” Bunge Chief Executive Officer Soren Schroder told investors in February. “There’s no reason for that.”

Rumo’s reason for wanting to keep the contract terms in place is clear. Take-or-play clauses have helped stabilize the railroad operator’s profit margins even when demand fell, adding to the good news for the company as its stock, as of Tuesday’s close, had rallied more than 750 percent since late January 2016.

"Take-or-pay is super fair for both sides and must continue," said Ricardo Lewin, Rumo’s chief financial officer. The rule ensures Rumo a minimum return after investing about 7 billion reais to expand capacity in recent years, while granting traders access to efficient and cheap transport in a nation notorious for bad infrastructure, he said. Otherwise, traders would be forced to rely on truck networks and be exposed to share price swings in the freight spot market, he added.

The company’s stock fell as much as 4.4 percent in Sao Paulo trading Wednesday.

Bunge declined to comment, and Louis Dreyfus didn’t respond to requests for comment on the progress of talks. Lewin said the negotiations will likely only intensify in the second half of 2018.

While the contract clause, from year to year, can cause losses for traders, they’ll benefit in the long run as capacity on railways is forecast to shrink, said Andre Pessoa, the head of crop-consulting firm Agroconsult.

"The contracts may not be favorable at this moment, but you may have to pay much more in the future without guaranteed access to the railway," Pessoa said on the sidelines of an event in Sao Paulo.

Exporters in Brazil, Latin America’s biggest economy and the world’s largest soybean exporter, spend an average of $2.31 per bushel to haul the commodity out of Mato Grosso state, more than twice the cost of moving soybeans a similar distance in the U.S., according Abiove, an industry group that counts Bunge and Cargill Inc. as members. Costs in Brazil have improved in recent years, after massive investments in new terminals and barge fleets opened up a shipping alternative along an Amazon route.

"Flexibility has a cost -- everybody wants flexibility, but you need to calculate that cost,” Rumo CEO Julio Fontana Neto said last month. “Trading companies became too neurotic because of the corn losses in 2016.”

He said the alternative is going back to the spot market. If that’s what traders want, “that’s fine,” he said, “but that will push up freight costs even higher.”

 

Copyright 2018, Bloomberg

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