Do we need to hold our breath?

barn being constructed
While producer profits are attractive, no recipe for expansion right now, as corroborated by the recent USDA Hogs and Pigs report.

2021 will go into the books as a "good" year for pork producers and that may be an understatement — the profits on a per/head basis were second only to that of 2014. Looking ahead to 2022, our forward curve is still very respectable and is forecast to continue the string of profits, albeit at a slightly discounted level. Profitability chart attached. It is natural for our industry to hold its collective breath and wonder whether or not this could be true. I think the good news for the production community is that it is ok to exhale and enjoy the environment. The promises of profits this year are not just speculation, you can do something about them if you choose in the form of futures/options/insurance  — and that is good news to start the new year.  

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This environment is characterized by what I have termed to be a "profitable stall." While producer profits are attractive, we do not seem to have the recipe for expansion right now and that is corroborated by the recent Hogs and Pigs report that does not indicate widespread expansion. Let's unbundle the why behind the what.

  • Prop 12: Dr. Steve Meyer did a good job in this space last week of articulating the complexities of this California provision and what it means to our industry. The biggest conclusion is that there is a lot of confusion. This has a two-pronged consideration for pork producers. First, we are still uncertain how everything is going to play out and, therefore, find it difficult to make a decision to expand with confidence. Second, if we do participate in Prop 12 compliant production without an expansion of our physical footprint, the added space requirements decrease throughput by about 10%. Neither of these is conducive to increased production.
  • Inflation, construction cost, labor: Call it what you want — the price of steel, supply chain constraints, a tight labor market and a backlog of projects. No matter how you slice it, the cost of construction has moved markedly higher, perhaps as much as 25% in some instances. This price jump is enough to cause hesitation in and of itself, combine construction availability into the mix and the opportunity to expand is constrained – even if you wanted to do so.
  • Input prices: It is more than just the price of corn and soybean meal, we have seen an increase in the cost of production in nearly every realm. From lysine to interest rates, the cost to produce a pound of pork has moved sharply higher in the last year or so. Attached is the cost of production calculation from Dr. Lee Schulz at Iowa State. Note that we rocked along for the past several years with production costs in the low 60s when things were relatively stable and the price of corn didn't make it out of the shadow of $3.60. Things have changed with the cost of production calculation now in the low 80s and no immediate return to the previous levels expected anytime soon. In fact, my best guess is that we see the cost of production go even higher in subsequent years as we sort through the myriad of disruptions caused by the global COVID situation and the introduction of renewable diesel anticipated to cause an acreage battle in the next few years. We are going to need the higher revenue prices to offset our higher production costs.

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  • ASF, packer contracts, barn rent: The fear of the devil at the doorstep that could unravel all of our export markets is, appropriately, a consideration prior to expansion. This same sentiment is being considered by our packing community and we have not witnessed too many packer agreements being offered that fall in the category of "good" for the producer. Additionally, contract finishing rates have not moved higher to offset the increased construction costs or interest rate increases. And who can blame them? If a contracting firm wants to add 10% to its finishing space footprint, it is tough to reflect an agreement that is enticing to the potential barn owner without raising the compensation rates on the other 90% of your contract production. We are stuck right now and it is a good thing for pork producers. 

Is there hope for something better than just treading water? I think so. Maintaining biosecurity is the table stake for success, a border closing incident does nobody any good up and down the pork supply chain. Domestic demand (as measured by an economist) is softening a bit but is still at higher levels than previous years. The decrease of production in Europe makes the United States more viable in a world market, any sign that the COVID cloud is lifting should be beneficial for all of us. In short, the livestock insurance program can keep the devil out of the house and provide an opportunity for additional profits while the forward curve on the CME allows a producer to lock in good money in 2022. These levels of profits could be enhanced if we get a couple of cards to fall our way. Exhale and enjoy the fresh air.  

Comments in this article are market commentary and are not to be construed as market advice. Trading is risky and not suitable for all individuals. Click here to contact the author. 

Source: Joseph Kerns, 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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