Why are hog prices so strong if high costs are not the driver? Why are hog prices so strong if high costs are not the driver?
Strong consumer-level pork demand is a necessary condition for the strong wholesale and hog demands that have driven good hog prices the past two years.
July 11, 2022
I have heard statements to the effect of "these high costs have sure pushed meat prices/hog prices higher," or "these meat prices are certainly getting inflated" on several occasions in recent months. The sentiments are well placed but the statements reflect a general misunderstanding of inflation and factors that drive prices. Timing and length of time period are key to both issues. Let's consider the costs versus price issue this week.
Costs have risen is a well-documented fact. Higher soybean and corn prices, pushed primarily by energy policies that have driven the values of fats and oils upward, have taken costs to what may be record levels. Figure 1 shows my model based on Iowa State University's costs and returns series. Note that the 2022 and 2023 annual estimates have fallen in recent weeks as both corn and soybean meal prices have waned a bit; so much so that the 2022 actual figure may not quite reach the previous record of $89.51 set back in 2013. It will be close and rainfall in key growing areas over the next few weeks will likely be the determining factor.
Hog prices have risen at almost the precise time that costs have risen (see Figure 2), a fact that has led many to conclude that costs drove prices. That conclusion reflects one solid understanding of a key economic principal: In the long run, the price of a good must cover all of its cost of production and provide a "normal" rate of return on invested capital. If this axiom does not hold, no one would invest in the production of the good. But there are a couple of caveats and qualifiers that are important.
The "long run" is in fact a long period of time and we all know that, over shorter periods of time, prices may not provide a normal rate of return and may not even cover all costs. As long as they are high enough to cover variable costs, the firm will continue to produce because fixed costs must be paid even if production ceases. Further, producers in some industries such as ours, must make output decisions well in advance of the actual sales date and these time lags may leave us in protracted periods of loss. All of you have seen these in spades.
The mechanism to get from short run losses to long run total cost coverage is, in fact, the pain of short run losses. Costs rise causing losses. Some producers exit and some may reduce output pulling supplies downward and pushing prices higher. Higher prices alleviate the losses and bring the industry back to a period of covering total costs and earning normal rates of return. Returns may, over the short term after the adjustment, actually be higher than normal before new investment pushes them lower again.
But consider the timing of this scenario in the pork industry. From the commencement of economic losses, the decision to exit or reduce production will result in fewer hogs not less than 11 months down the road. Supply reductions will only become large enough to noticeably impact output 18 to 24 months into the future!
"Costs are driving today's higher hog prices" misses that entire adjustment process. Figure 2 demonstrates that the production sector hasn't seen losses since costs began to rise. In fact, that last period of sustained losses was in 2020 when costs were still low. Those losses, of course, were driven by the disruptions of the Covid-19 pandemic but it is clear that the high costs of 2021 and thus far in 2022 have not caused economic losses. Therefore, they cannot be the driver of the higher prices we have witnessed since 2020. And I would argue that, due to the absence of widespread losses, will not be a "driver" of higher prices in 2023 – or maybe even 2024.
To be accurate, U.S. pork production was 2.2% lower, year/year, in 2021 and will be down about 2%, yr/yr, in 2022. 2020 losses were a factor in the 2021 cutbacks but, again, those reductions were not cost driven. This year's reductions are being driven, in my opinion, primarily by lagging productivity. I can't look back at the last 18 months and find any economic losses, much less any significant losses due to high costs.
So why are prices so strong in the presence of high costs if high costs are not the driver? Well, sometimes it is better to be lucky than good and I think pork producers have benefited from a huge dose of serendipity. That's not to say it is underserved as I firmly believe in the adage that luck is "the moment where preparation meets opportunity." And I'm sure that the harder one works, the "luckier" one gets!
Demand has been the difference maker! Domestic consumer-level pork demand has been rising steadily since 2018 and has been on a tear in 2021 and 2022 (see Figure 3). Real per capita expenditures for pork, a measure of the condition of pork demand, grew by 12.3% from 2019 through 2021 and are up over 8% more so far this year. Though per capita availability/disappearance/consumption has been relatively flat over that period and U.S. consumers have paid higher and higher real (ie. inflation removed) prices over that time, demonstrating a strong willingness to pay for pork. That's strong demand! And strong consumer-level pork demand is a necessary condition for the strong wholesale and hog demands that have driven good hog prices the past two years.
Export demand also contributed to wholesale pork and hog demand from 2019 through the first half of 2021. That, of course, was primarily due to China's need for pork to backfill their African swine fever losses. Since July 2021, though, China has not been a major player in the U.S. market and its positive has lessened. But the price-quantity relationships we expect for this year for both the cutout value and hog prices are still better than those of 2021 – thanks to domestic demand! See Figures 4 and 5.
With all that said, today's high costs – and the high costs of buildings and equipment – will, in my opinion, have lasting positive impacts on hog and pork prices. Or at least these high costs will not allow hog prices to fall significantly. First, because prices indeed must cover total costs in the long run and, second, because high costs are key factors in slowing any expansion that may occur. Economic theory and practical history tell us that firms do not respond positively to high prices. They respond to profits and, while last year was good, this year still looks a bit marginal and next year is still, to a great extent, a roll of the dice.
Source: Steve Meyer, who is solely responsible for the information provided, and wholly owns the information. Informa Business Media and all its subsidiaries are not responsible for any of the content contained in this information asset. The opinions of this writer are not necessarily those of Farm Progress/Informa.
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