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More Volatility Ahead

Pork producers need to chart a course for survival, working closely with their lenders. Given all the issues, the embattled pork industry faces more volatility and financial risk than ever before, according to Kent Bang, a banking official with Bank of the West, Omaha, NE. With lenders asking for more information, Bang recommends that producers meet with their bankers at least twice a month and provide

Given all the issues, the embattled pork industry faces more volatility and financial risk than ever before, according to Kent Bang, a banking official with Bank of the West, Omaha, NE.

With lenders asking for more information, Bang recommends that producers meet with their bankers at least twice a month and provide them with the following information:

Risk Management Not Optional

  • Update your budget/projections continually. “I have customers who are not in the greatest shape financially, but they are staying afloat by doing a monthly, 12-month budget,” Bang explains. “I know that is a lot of work, but in order to keep everybody in our financial institution comfortable that we know where we are, this is required.”
  • Analyze equity and liquidity after projected losses.

  • Review loan covenants and communicate with your lender. Make sure you know what is in your loan document.

  • Take action early if you need to make changes in your business.

  • How We Got Here

  • Look constantly for profit opportunities or opportunities to minimize losses. Take into account your marketing situation, financial statement and emotional condition.
  • Finalize your debt structure and very closely analyze your liquidity. “Ask, how can I make my working capital get me through this?” Bang said in an address at Kansas State University's Swine Day in early November. Liquidity can be in the form of cash or available credit to support your current operating base.

Raising pork efficiently and at a low cost used to be the formula for success in the pork industry. Those factors are still important, but now producers need to have expertise at risk management — whether they educate themselves or hire consultants to manage that volatility.

“It takes people who understand hedging and options strategies and laying out a market risk management program,” Bang says. “And one of the most important things is having a margin mentality — not trying to pick the highest hog market or buy the lowest-priced corn, but looking at the margin every day, every week, and picking a margin that you are comfortable with going forward.”

Bang believes there are great opportunities for those who survive the current challenges. Exports appear to be on the rise again, and U.S. pork stands well suited to benefit due to its low-cost leader position and its excellence at slaughter, processing and delivery.

“I think exports are going to be the savior for us in the short term and help push us out of these doldrums and low prices,” Bang says.

The pork industry has been hammered by high production costs and a deepening recession that threatens to extend its profit drought to three years and counting, Bang explains.

Producers have been told repeatedly that they must reduce sow inventory and cut production flows. But Bang points out there are several reasons why that is so difficult to do, and the resulting production lag will be an “elongated hog cycle as compared to historical numbers.”

Many producers simply have higher investments in the hog business than they have ever had in terms of fixed assets, which are very difficult to pare back, he says.

Higher Cost of Production

A surge in specialized production, production and packer contracts has also made it harder to reduce the size and scale of hog operations.

In the last significant industry downturn in 1998-1999, most of the industry had a large land base to soften the blow of low hog prices and perhaps ease the transition out of hogs. “The model today is that much of this industry is very specialized from the standpoint that hogs are all producers do and have, so it is all or nothing,” he explains.

Bang points to the February 2004 to September 2007 period, when sow numbers only grew 3.97%, according to U.S. Department of Agriculture data. “The point is there was only 1.1% annual growth in the breeding herd during the most profitable period in the history of the industry,” he says.

Conversely, from October 2007 to October 2009, the most unprofitable period in U.S. pork industry history, sow numbers dropped by 5.38% (Figure 1). That compares to the previous major downturn (1998-2000), when the breeding herd was scaled back by 9.15% (629,000 sows), nearly twice the reduction in sows, reflective of a time when industry change was much easier, he says.

Paragon Economics President Steve Meyer has said the pork industry needs a 12% reduction in order to restore the pork industry to profitability — and Bang believes he's right.

Producers may find that cutting 5-10% of sows will provide more space in barns and may prove to be a better option than trying to close down a facility (see sidebar) or sell their hog operation at this point, he notes.

Next Page: Competing Meats Challenge

Higher Cost of Production

Bang says the blame for the current down cycle sits squarely on higher cost of production. Sure, the export market has declined from its highest point in 2008, the porcine circovirus vaccine worked better than expected and boosted production, and industry prices took a big hit when the novel H1N1 influenza virus struck on April 25, 2009. But the uptick in production costs has been driven by corn-based ethanol.

“We have a new user of corn who can afford to pay a lot of money for corn at times. We have a new demand for a product that we have always had, and a finite amount of our largest ingredient to grow pigs,” he explains.

Pork demand is also facing the challenge of the deepening U.S. recession, which may be a major factor going forward.

Last year's average cost of production was around 60¢/lb. on a live weight basis, and Bang expects those costs to continue near 50¢/lb. in the foreseeable future. “The typical cost of inputs has ranged around 40¢/lb. on a live weight basis over time. If the industry would have had those costs over the last two years, there would have only been a couple of months with losses,” he notes. “In my mind, the problem is clearly a cost issue. We are going to have to figure out a way to live with those kinds of costs.”

In September 2009, there were 186 ethanol plants operating with a production capacity of 13.06 billion gallons/year. Fifteen plants are expanding or are under construction, with annual production capacity of 1.5 billion gallons.

Ethanol plants are covering all of their variable costs, so producers can expect those plants to operate as long as crude oil values are relatively high. That means high ethanol prices and elevated value for corn, Bang says.

The federally mandated ethanol blend for fuel is at 10%. Because production exceeds demand at that level, ethanol producers have petitioned the Environmental Protection Agency (EPA) to increase the blend rate to 15%. Bang expects the EPA to increase the blend rate to 12-13%.

Competing Meats Challenge

In 2008, domestic meat consumption was 220 lb. per capita, down from the previous year; 2009 is projected to be another down year. With exports accounting for 20% of production, that leaves 80% of pork for domestic consumption.

That presents a disturbing trend line because all meat and poultry production is declining simultaneously, leaving them to compete during a recessionary period. Bang cited statistics presented at the American Banker's Association annual conference in early November, where one out of six families in the United States in 2009 had financial trouble putting food on the table. And, consumer debt is at record levels and rising, which means increasing domestic demand for pork and other meats will be that much more challenging.

Six Steps to Take When Closing Down a Hog Facility

Pork producers who want to shut down their hog barns for an extended period of time due to the current hog industry crisis, but anticipate returning them to production in the future, need to do more than just turn off the lights.

University of Minnesota Extension Specialist Mark Whitney outlines six steps that should be taken to ensure barn safety while empty and retain the ability to economically return barns to production someday:

  1. Thoroughly clean the facilities and equipment

    Remove all organic material from the barn, pens and equipment to minimize deterioration. Wash all surfaces thoroughly and allow to dry, removing as much moisture as possible. Manure, animal dander, feed dust and manure gases can all combine with moisture or condensation on cooler surfaces, accelerating degradation. Grease motors, drive chains and other moving metal parts to block moisture penetration.

  2. Empty feed lines, feeders and water lines

    Feed contains salts and other products that, when combined with moisture, can cause corrosion. Flush feed lines with whole grain, such as corn, to remove as much of the feed particles and salts as possible. Flush and drain water lines, then blow out lines with air if possible to remove all water. Shut off the main water line going into the barn and remove all water orifices, such as nipple waterer receptacles.

  3. Removal of manure from under empty barns is perhaps the most important step

    Gases such as methane, hydrogen sulfide, carbon dioxide and ammonia continue to occur as manure continues to decompose — even in cold weather. Buildup of methane also creates a risk for explosion. Other gases pose extreme health and safety hazards. Take all necessary precautions when pumping out manure pits, including ensuring adequate ventilation. Try to remove all accumulated solids. Some producers choose to fill pits up to one-third to one-half full with water after removing manure to relieve pressure and stress on pit walls. However, this can increase the level of condensation in the barn, he cautions.

  4. Use supplemental heat over winter

    In order to prevent flooring and foundation from freezing, deteriorating and potentially losing structural soundness, provide minimum heat over winter months. Frost can crack exterior walls, causing leaks in pits and potentially resulting in structural failure. To ensure proper operation and to minimize the cost of heating, have a qualified individual inspect and maintain the heating system.

  5. Minimum ventilation should be provided in empty barns

    This will ensure adequate removal of moisture and gases that may accumulate as manure decomposes and furnaces operate. Failure to provide adequate ventilation could result in increased equipment and facility corrosion or severe injury or death due to carbon monoxide poisoning or hydrogen sulfide asphyxiation. Keep the facility reasonably tight and room inlets operating properly to ensure fresh air is properly introduced and distributed in the barn. Close and seal sidewall curtains in curtain-sided barns. Close louvers of large summer operating fans in tunnel- or year-round mechanically ventilated barns to prevent back drafts and leakage of air using insulated panels or heavy plastic. Allow only one side of the barn to introduce fresh air during winter months (south side in barns running east-west) to prevent snow “blow through” in the building attic. Check the operation and cleanliness of all minimum ventilation fans. Dirty or rusted fan shutters can reduce airflow capacity of a direct drive fan by 40%.

  6. Routinely inspect empty facilities

    Check empty barns periodically, weekly during cold weather. Inspect heating and ventilation systems to ensure correct operation. Check for signs of water or mold damage, particularly in the attic. These signs may indicate roof damage or poor air distribution with inadequate ventilation. Actively bait and check rodent traps to ensure that infestation does not occur.

When considering bringing a facility back into production, have a qualified technician inspect all electrical and heating systems and thoroughly test all water and feed systems and other equipment and penning to ensure they are functioning properly.