In honor of Halloween, I think it is only fitting to write about scary things today. I realize that doing so does not fit with my eternally rosy and optimistic outlook on the world (sarcasm), but there are some things we need to keep in mind regarding markets as we move forward.
In no particular order, here are a few items that scare me about hog production profit prospects in the coming 12 to 18 months:
• A trade disruption that would leave any significant portion of the 22% or so of U.S. production that will be exported this year. Slippage of a few percentage points would not be a disaster, but anything over 4% would, in my estimation, cause a lot of difficulties, depending on the length of the disruption. The good news is that the probability of a larger disruption is pretty low, but after travelling to Wales last week to visit my son I am keenly aware of the volume of international travel and the risk that it entails for the U.S. livestock sector. We must be very vigilant – perhaps to excess in some cases – to protect our domestic livestock sectors. While the probability may be low, the impact would be huge!
• Something that negatively impacts U.S. consumer-level pork demand. There are several candidates for this one – a food safety issue, another bout of H1N1 or a mutated influenza virus, or a new furor over health concerns of a widely used process. None of them would be good and domestic demand, though slowing a bit lately, has been a big driver of 2011 success. Plus, I believe domestic pork demand is about to get a shot in the arm from higher beef and chicken prices. Anything that negatively impacts consumer preferences for pork would wash that positive impact away quickly. Outside of H1N1, we have been pretty fortunate – relative to beef (0157 E. coli), chicken and turkey (salmonella, bird flu). I hope it stays that way.
• A 2012 corn crop below 12 billion bushels. For that matter, another crop under 13 billion bushels would be no cakewalk. This year’s 12.433 billion bushels will result in a 262 million-bushel (23%) reduction in carryout stocks from this year’s level if current expectations are met. The Renewable Fuel Standard requires 600 million more gallons of starch-based ethanol in 2012. That will require 214 million more bushels of corn. We could get some respite from the use of RINs (Renewable Identification Numbers which are credits earned for blending more ethanol than was required in 2011) and feed use for chicken and cattle will almost certainly be lower. But USDA’s October forecast of 12.71 billion bushels of corn usage includes lower feed, lower exports, lower ethanol usage and slightly higher non-ethanol industrial use due to higher sugar prices (Figure 1). Should the crop be anything below that 12.71 billion bushels, 2013 year-end stocks will be even lower than the 866 million bushels projected for 2012. And we are entering the winter with a growing area of dry conditions in the western Corn Belt (Figure 2). I was quite surprised to see areas categorized as “severe drought” in Iowa and Minnesota in last week’s Drought Monitor map.
• Output growth of 4% or more – and maybe even less depending on the 2012 corn crop. Canada’s breeding herd was 1.2% smaller than one year ago in July, but appears to be steadying. The U.S. breeding herd is growing again. The rate is slow, but it is growing none the less. Cargill’s repopulation of the Texas locations purchased from Smithfield Foods has yet to show up much in the data and will not come as a rapid surge, according to my sources. It will still provide for 1% more sows over the next couple of years. All others will add to that number and every one of those sows will be more productive than the average sow today. The current 2% annual growth rate for litter size will very likely continue to give the incentives present to sell older sows and replace them with new, better gilts. It will not take much to get to 3-4% more hogs. And, continued gains in feed efficiency may still allow weights to increase.
• Insufficient slaughter capacity in the fourth quarter of 2012. Insufficient slaughter capacity is a phrase that makes the blood of any producers who were around in 1998 run cold. I do not think this situation would be as bad as that one for a number of reasons, but we need to realize just how tight things were last fall and will be this fall in order to see that next fall could be very tight, indeed, if output increases. Figure 3 shows that we are very close to the current “comfortable” weekly capacity of 2.355 million head. Any increases next fall will put us over this level. Could capacity increase by then? Yes, but not by a lot. Packers are nearly always trying to find cost-effective ways of increasing throughput and margins have been good enough to encourage them to continue pushing volume. But any increases will be of the tweaking variety, since there are no plants that are likely to expand dramatically in one year’s time and there are no sidelined plants to reopen. Does this suggest $8 hogs next fall? Not at all, but it could burden the system enough to push prices well below costs.
Note that I have not included the U.S. economy in this list. That might be short-sighted, but the truth is that pork usually doesn’t get hurt too badly by recessions. A soft U.S. economy will likely mean the U.S. dollar will remain weak, helping our exports and their values. We still don’t get harmed badly by a downturn in restaurant sales and people are still going to buy reasonably priced protein. That’s a role that pork, even with retail prices at record highs, will still be able to fill.
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Steve R. Meyer, Ph.D.
Paragon Economics, Inc.