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Know Your Competition

Know Your Competition

With weekly slaughter numbers running routinely above year-ago levels, feed costs running at exorbitantly high levels and U.S. consumers counting every penny, it may be difficult for pork producers to look beyond their current financial stresses. Still, with a growing reliance on export markets, it is imperative that U.S. pork producers consider their longer-term competitiveness in the international

With weekly slaughter numbers running routinely above year-ago levels, feed costs running at exorbitantly high levels and U.S. consumers counting every penny, it may be difficult for pork producers to look beyond their current financial stresses.

Still, with a growing reliance on export markets, it is imperative that U.S. pork producers consider their longer-term competitiveness in the international marketplace.

In an effort to gain perspective of the global pork market, let's take a closer look at the leading pork producing and consuming nations and consider where U.S. pork fits.

The China Effect

The explosion of meat prices in China, which began in 2007, has attracted widespread media and political attention. “Official” hog and pork prices, one of the major contributors to overall inflation, have skyrocketed since May 2006 (Figure 1).

In February 2008, China's overall consumer price index (CPI) rose to 8.7%, a record high in the last decade, while food prices rose by a staggering 23% year-on-year.

The price sensitivity of Chinese consumers has been well documented. This sensitivity, and their preference for fresh vs. frozen pork, has largely limited export opportunities for U.S. pork to China.

Domestic pork has historically been one of China's most affordable protein sources, but the recent price spike has forced Chinese consumers to look for substitute, low-cost animal proteins. Some cuts of imported pork and, particularly, U.S. poultry leg quarters, have become more attractive animal protein alternatives. The fact that imported U.S. pork is cheaper than domestic pork in the Chinese market may surprise many industry participants (Figure 2).

From a supply perspective, no one really knows how much the Chinese swine herd has contracted. Some sources indicate one million sows have been removed from the nation's breeding herd. Other reports note the total number of pigs (all sizes), estimated at 495 million in 2006, has been trimmed by 20%.

While the debate over the degree to which these declines have been caused by disease, higher feed prices, the cyclicality of hog production and other structural changes (i.e. consolidation as backyard farmers exit the industry), it is generally agreed that all four factors have played a part. More recently, severe winter weather also impacted supplies. At best, it will take a number of breeding cycles for domestic production to show signs of recovery, especially given high feed costs and ongoing disease constraints.

Make no mistake, the Chinese government has made a significant investment in the domestic pork sector, and it will continue its efforts to revitalize the industry. From a political and social perspective, it cannot afford to displace the rural population at a faster rate than is already occurring.

Specific government programs have included direct subsidies for sows, insurance for sows and hogs, free vaccines, the development of a pork futures market, restrictions on corn usage, transport assistance and stricter controls on packers. In addition, food security remains a key government initiative.

Regardless of what has caused this situation, it is clear that China needs more meat. Put simply, China remains too close to the edge in terms of juggling inventory/reserves and growing demand. The question that remains is how they will meet their protein needs. They have two alternatives and, to date, both have been pursued:

  1. Encourage domestic pork production; also support poultry, and to a lesser extent, beef. Significant amounts of corn and soybeans will be imported.

  2. Mexico's Domestic Production Contracts

  3. China will be forced to import meat, even though it is not their preferred solution. They will continue to restrict market access based on food safety concerns, which is viewed by many as thinly veiled protectionism. Competition among potential meat exporters to China is already intense. Anticipated trade agreements between China and countries such as Brazil and Argentina will only serve to heighten this competition.

Regardless of where China actually purchases pork, the pull on global supplies is likely to create opportunities for pork exporters in 2008 and beyond.

The Mexican market has traditionally been very important to the United States. In particular, it has been a key buyer of U.S. hams.

Unfortunately, 2007 proved to be a slow year for U.S. exports to Mexico. A “normal” year could have cut significantly into overall U.S. export volumes.

The easiest explanation of what happened in the Mexican market in 2007 is that domestic production was up. The high price of feed encouraged Mexican producers to rush hogs to market and even to sell off breeding stock (Figure 3). Consequently, there was more domestic pork on the market.

Russian Production on An Upswing

Assuming that the number of Mexican hog producers has now fallen, it would be reasonable to assume that there will be a reduction in the number of Mexican hogs marketed in 2008, and the slack in supply will be filled by an increase in imported pork.

In the past, the number of pork producers would have fluctuated according to market conditions. However, as the Mexican pork industry matures, it is increasingly less likely that producers will come back into the market as prices pick up. Rather, between imports and larger producers expanding production, there will be no room for old players. The industry will become more concentrated, which will push existing players to adapt their business models.

Russia is one of the world's largest importers of meat, and has been for some time. In 2006, Russia imported 3.18 million tons of beef, pork and poultry.

But anyone who has spent more than a few years in the meat industry will understand the split personality often ascribed to Russia as a major meat importer. It is known to be a particularly fickle market. What might be less well known is that Russia is also one of the world's largest producers of meat, and that it has established aggressive, industry-wide targets to increase domestic production and reduce dependence on imports.

While Russia has historically been a country of meat eaters, consumption of meat has declined dramatically in the post-Soviet years, dropping from 172 lb. per capita in 1988, to around 130 lb. today. The downturn in consumption, attributed to price rises following the collapse of the outdated Russian agricultural sector, led to a massive decline in so-called backyard livestock. This caused rapid price inflation for meat, which became unaffordable to the impoverished nation.

More recently, solid economic growth has begun to spur meat consumption and, when combined with meat price increases, has made Russia a very attractive market for pork exporters, especially for lower-value trimmings and offal.

Prices in this market are highly dependent on access, and the Russian government has been known to ban imports from certain countries when the price of some popular cuts gets to levels they believe are too high. However, there are signs that the government may be a little less inclined to use this “trick.” In the current tight protein market, competition with China for U.S. poultry leg quarters in 2007 serves as a very good example.

Russia does not have a pleasant history with being import-dependent for food. The Russian industry is looking to almost double its domestic pork production between now and 2012 (Figure 4). Energy, oil and gas conglomerates have been “encouraged” to diversify into agricultural production. Investment in agriculture is viewed as a sign of patriotism.

Proximity to feed

Remember the first law of international economics — as a net exporter of grain, the United States remains at a competitive advantage to net importing countries. This is in spite of the U.S. biofuel mandate, which effectively acts as a regressive tax on livestock production.

  • Capital availability

    This may seem like a reckless comment to make in light of the current economic conditions. While the cost and availability of financial capital is undoubtedly more constrained than it was just 12 months ago, U.S. agriculture remains well placed to access capital over the long term.

  • Packer efficiency

    U.S. pork packers are at the forefront of technology adoption and product development. They also benefit greatly from economies of scale.

  • Relatively open access to domestic and export demand

    U.S. pork is currently exported to more than 100 countries.

  • An integrated (and consolidated) value chain

    The timely and frictionless matching of supply and demand is the sign of a well-functioning market. A high level of industry integration ensures flexibility, speed and coordination.

  • But the 64-million-dollar question remains: If not in North America, where would you invest in the hog industry?