New Profit Streak Set

Year's end is always a good time to review the key happenings of the past and contemplate important things for the future. Two words come to mind when I do that regarding the U.S. pork industry - profits and costs

Year's end is always a good time to review the key happenings of the past and contemplate important things for the future. Two words come to mind when I do that regarding the U.S. pork industry - profits and costs.

This past year has been a pleasant surprise from the profitability standpoint. It is not often that the pork industry can string together three profitable years. In fact, it has not happened since the 1970s, when pig production was still adjusting to the new grain price paradigm ushered in by sales of grain to Russia. The record for consecutive profitable months on the Iowa State University (ISU) Estimated Costs and Returns series was set in 1976 through 1979 at 33.

That record has now officially fallen (see Figure 1). November's estimated profit of $8.19/head made 34 straight profitable months. The closest that the estimate came to zero during that run was last January when it fell to just $2.11. The largest monthly profit during the string was $44.84/head in November of 2004. It is almost inconceivable that the highest profit month could be in November, but that is exactly how it happened when meat and pork demand were so hot.

Can the streak continue? The answer, in my best economist's judgment, is a resounding "maybe!" The ISU series uses a weighted average of monthly feed costs for each month's sales. As we move forward, the feed costs for each month will include more and more high-dollar corn. It appears that December may remain profitable, but without a good price rally in January and February, one or both of those months could go into the red.

I think higher corn and soybean meal prices will drive average breakeven costs into the $62-$64/cwt. carcass range in 2007. Today's Chicago Mercantile Exchange (CME) Lean Hogs futures prices tell us there is a chance that hog prices from April through year-end could stay above that level, but it is going to be very, very close. Should any problems develop with the 2007 corn crop, the possibility of prices staying higher than production costs will be practically zero.

Which brings us to word number two -- "costs."

There is no doubt that costs will be higher in the future and that they will stay higher indefinitely, in my opinion. Figure 2 shows my feed cost index. The important feature to note is that past feed cost increases were short-lived. We have always been one corn crop away from ample corn supplies and lower prices.

Such is not the case this time. This is not a supply-driven increase in prices. The fact that this rally is being driven by higher demand for corn and that the demand will get stronger yet means that this shift will be permanent as long as oil prices stay high (say $50/barrel or higher) and the federal ethanol subsidy stays in place.

I only wish I had realized how sensitive corn prices would be to the wheat situation this past fall. A normal seasonal pattern would have meant that many feedmill bins would have been full of relatively low-priced corn. The counter-seasonal rally means that, unfortunately, many of you did not get that corn bought, and that actual hog production costs will increase more rapidly than normal.

Smart Buying
What can you do? Smart buying will still pay dividends. You may not ever get a chance to buy $2.00 or $2.25/bu. corn, but you will have chances to buy it in the bottom part of its new range. The same will hold true for soybean meal. Both could still provide you a competitive advantage.

In addition, higher feed costs will make feed efficiency and tight management even more critical to success. I know that you didn't get to where you are by being sloppy but let's face it, good times almost always cause us to get a little lax about the things that are a real pain to do.

Corn at $3.50 and higher will compensate you for your renewed efforts. Refocusing your attention on diet formulations, feed systems, feeder adjustments, ventilation, etc. could be the difference between profits and losses in 2007.

In Gratitude
Thanks again for your attention to these ramblings each week. It is such an honor to have you devote a few of your precious minutes to reading this column and contemplating a few of my ideas. I don't take that lightly, since my moments are precious as well.

And, of course, this is a season of precious minutes. Ones spent with family and friends and ones spent contemplating and celebrating the coming of the Savior of the world. Make all of them count this year and please accept the Meyer family's wishes for a Merry and Blessed Christmas and a great 2007.

Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.