Alberta Hog Market Commentary and Outlook - Summer 2007

by 5m Editor
12 October 2007, at 12:00am

By Kevin Grier, Senior Market Analyst, George Morris Centre, in Guelph and Calgary. Published by Alberta Pork. This is the latest Alberta Hog Market Commentary and Outlook which looks at the performance of the U.S. hog market.

Kevin Grier, Senior Market Analyst

Price Outlook

The U.S. hog market started the year much stronger than 2006 but by summer, both 2006 and 2007 looked almost indistinguishable with regard to pattern and overall price level. For the first eight months of 2007, U.S. carcass prices have averaged about US$68/cwt compared to about $64/cwt in the first eight months of 2006. Figure 1 shows national average U.S. hog pricing on a carcass basis for 2001-2005, 2006 and the first eight months of 2007.

The August 15 Iowa Farm Outlook Newsletter reports that for the past 25 years extension agricultural economists have been surveyed in mid-July regarding their forecast of production and prices for selected commodities. Ron Plain, University of Missouri and David Miller, Iowa Farm Bureau have conducted the survey in recent years and reported the results of this year’s forecast at the American Agricultural Economics Association meeting in Portland, Oregon in late July. On average, meat, milk and egg production is expected to increase in 2007 and 2008. Beef is the only commodity expected to show a year-over-year decline. Note that this production increase is expected in spite of the higher corn prices. Has ethanol caused higher food prices due to forcing farmers out of business? While expansion may be less than previously expected, it doesn’t look like higher feed prices have triggered liquidation in animal agriculture yet.

US Hog Pricing

Figure 1 - Source: USDA

Overall the economists expect to see 2007 pork production increase by about 2 percent while 2008 production should increase by 1 percent. Fourth quarter 2007 production is forecast to increase by 2.5-3 percent. With regard to pricing, the U.S. ag economists expect that live prices should average around $49/cwt in both 2007 and 2008 ($66 carcass basis). Fourth Quarter 2007 prices are forecast to average $46/cwt on a live basis or about $61 on a carcass basis.

Meanwhile the U.S. hog production profit machine continued rolling through July. According to Iowa State’s John Lawrence, U.S. farrow-to-finish operations made nearly US$15 per head during July. That compares to over $20 per head in June and July. In 2007 so far, U.S. producers lost a little money in January and March but were solidly profitable in the other five months of the year. In fact, before this year, the last month that Iowa State calculates a loss was January of 2004. That is, while 2007 has been very good down south, prior to 2007 there were 35 months of uninterrupted profits.

With regard to forecasted hog pricing, the place to start is on the supply side. Since my last quarterly report to Alberta producers, the USDA released its March Quarterly Hogs and Pigs Report. The report provided a picture that was very similar to previous reports over recent years. That is, U.S. producers are planning a steady, cautious increase in sow numbers and farrowings over the next year. In fact, if the numbers are to be believed, U.S. producers do not intend to increase farrowings at all during the spring and summer quarters of this year. Overall, based on the March Hogs and Pigs report, I can see that U.S. hog slaughter will continue its steady, gradual upward trend. Figure 2 shows the trend in U.S. hog slaughter on a quarterly basis from 1999 through the first quarter of 2007 as well as my forecasted slaughter through the second quarter of 2008.

With regard to my own price forecasts, the starting point going forward is the June Hogs and Pigs report. That latest USDA report showed that, despite the ongoing U.S. profitability, U.S. producers continue to be on a slow and cautious path. The U.S. breeding herd only increased by 1 percent as of June and farrowing intentions are modest. Based on the Hogs and Pigs Report estimates of the pig crop in the spring as well as producer intentions regarding farrowings, it is possible to estimate slaughter in the coming quarters. Figure 2 shows actual quarterly slaughter as well as projected slaughter from the third quarter of 2007 through the second quarter of 2008.

US Quarterly Slaughter

Figure 2 - Source: USDA

There are two points to note from the graph. The first relates to the gradual upward trend. As noted earlier, the U.S. hog producer has been slowly and gradually increasing the breeding herd size. Not surprisingly, this translates into a gradual increase in U.S. slaughter numbers. The second point to note from the graph is that while the slaughter increase is gradual, it does translate into some very big numbers. That is especially the case when Canadian live shipments are factored into the tally. Most significantly, the Fourth Quarter 2007 kill is going to be record large. The Fourth Quarter 2007 kill should be at least 2.5 percent more than last year. In fact, some market bears are forecasting a 3 percent increase or more.

As of the end of August, very few are predicting big challenges this fall/winter. For example, as of the end of August, the October and December futures were holding together very well. In fact, from my perspective they were holding together remarkably well. Nevertheless, given the likely slaughter of the fourth quarter, pricing has got some material downside risk that producers need to be aware of and plan for.

One of the factors that will determine just how well the fourth quarter holds up is exports and in that regard, once again there is increased risk. The USDA’s Economic Research Service unit says U.S. exporters shipped 218 million pounds of U.S. pork products to foreign markets in June, more than 8 percent less than a year ago.

For the first half of 2007 total U.S. pork exports were 1.477 billion pounds, 4 percent less than the same period in 2006. Lower year-over-year exports are largely attributable to lower shipments to Mexico (-31 percent) and Russia (-21 percent). U.S. pork exports to South Korea, although about even with a year ago, are lower than expected so far in 2007. Lower Mexican demand is likely due to macroeconomic weaknesses related to manufacturing and repatriated wages from workers in the U.S. In Russia, Brazilian competition appears to be slowing demand for U.S. pork products. In South Korea, expanded beef imports through June could have been a contributing factor to lower than anticipated Korean demand for U.S. pork. For the year, U.S. exports are expected to be almost 3 billion pounds, almost 3 percent below 2006. In 2008, plentiful U.S. pork supplies and a lowvalued currency are expected to push exports to almost 3.1 billion pounds.

The net result of the supply and export demand situation is that pricing is expected to be generally stronger in the next four quarters than in the previous year. The following table shows forecasted pricing in the U.S. on a carcass basis for the remaining quarter of 2007 and the first two quarters of 2008 in comparison to the corresponding quarters in the previous year.

2007/08 2006/07 2005/06
Fourth Quarter '07 62 62 0%
First Quarter '08 64 62 2%
Second Quarter '08 69 71 -3%

Alberta Hog Markets

Prior to July, this year was already shaping up to be a fairly poor year for Alberta hog producers. As of July, however, a poor year became a dismal year as the ramifications of Olymel’s price reduction decision began to take hold. As is well known now, Olymel has informed producers, largely through the Western Hog Exchange (WHE), that they are going to exercise the review clause in the contract. That means that each WHE-Olymel contract will probably be changed at the review date with a reduction of 12 cents per kilogram. When contracts are up for renewal, producers can accept the 12 cent reduction in price or terminate the contract.

Olymel says that the reduction is necessary due to the “pressures that the packing sector has been under over the last number of years.” Most people in the industry understand that the packing sector has been under a great deal of financial stress. Of course most of that stress is due to strategic decisions and the ability to hide behind a weak dollar. With that said, however, most everyone agrees that Olymel has been very good for the Alberta industry and has been working hard to grow its business and the industry.

Nevertheless, a 12 cent reduction in price is a huge blow to the Alberta industry. Last year in Alberta, the average Index 100 price was about $125/ckg. That very low price would be pulled down to about $113/ckg on an Index 100 basis. Average producers lost money last year under the current contract terms. Even the top producers would have lost money last year at a hog price of 12 cents less. This year, under current contract terms, top producers are just breaking even. A 12 cent reduction would push top producers deeper into the red this year. Alberta producers cannot afford the reduction.

According to my calculations, last year packers probably lost about $3-$6 per head on kill and cut operations. This year they have lost an average of about $5 or more per head. If those calculations are reasonably accurate, it suggests that a 12 cent reduction in the price is more than necessary to break even. In other words, the price reduction appears very aggressive.

Alberta already leads the country in the dubious distinction of having the highest producer attrition rate since 2002 at 30 percent (StatsCan). In fact, no other province comes close. This reduction is going to mean that no producer can make money.

The company might be able to run a double shift in early 2008, as was the intent, but now I question whether there will be enough market hogs beyond next year. In addition to the negative impact on prairie pricing and the ramifications it has for the future, it is also going to send more hogs south. More producers will work towards supplying weaners and feeders to the south. That will be especially the case as the local finishing markets dry up.

A major move like this leads me to speculate on a number of things. The first thing that comes to mind is that Olymel’s Coop Federee owners in Montreal have thrown in the towel on Alberta. The investment was not performing and they have decided to get what they can from operations for the short term and then get out. Then again if they were going to try to sell it, the plant would have been worth more with a functioning second shift. As noted above, that appears to be a dubious proposition.

Another question has to be whether Olymel is trying to send a message to the Alberta government. Over the past year the WHE and Olymel tried to create some form of joint venture to partner in the Red Deer plant. Perhaps not surprisingly, they wanted Alberta government help. The Government of Alberta declined.

Perhaps Olymel is trying to send a message to Quebec hog producers? I think Olymel needs a price reduction on the hogs it buys in Quebec. Now it can point to Alberta as a competitive benchmark. It also shows the Fédération des producteurs de porcs du Québec (FPPQ) that it knows how to play hardball.

Perhaps almost as interesting as the price reduction is the fact that Maple Leaf is not going to match it. Signature 3 contracts out of Saskatchewan are going to just take a reduction of 1 cent compared to the original offers in April. Saskatchewan producers are giving that one the thumbs up, especially given what Maple Leaf could have offered. Maple Leaf says that the closure of its Winnipeg kill will coincide with the beginning of its second shift in Brandon this fall.

Hog Inventories

Statistics Canada recently released its July inventory report. That report showed that Alberta sow numbers declined by about 2 percent on a year-over-year basis as of July 2007. Overall the entire Canadian herd declined by 1 percent. In contrast, however, the Saskatchewan and Manitoba herds increased by about 1 percent. Figure 3 shows the trend in western sow numbers from 1997 through April of this year.

Western Sow Herd

Figure 3

Alberta Price Forecasts

In addition to the U.S. hog price, any Canadian hog price forecast also implicitly involves a Canadian dollar forecast. For my purposes, I have never really found any source that is particularly reliable as an indicator of the overall direction of the Canadian dollar. As such, I tend to use the Canadian dollar futures markets at the Chicago Mercantile exchange. With that noted, the Canadian dollar futures were hovering around US$0.94/C$ for the fourth quarter and between 0.94-0.95 for 2008. For its part, the Bank of Montreal says that “the lack of Bank of Canada tightening and a weaker starting point should take away the Canadian dollar’s shot at parity” (BMO Capital Markets Forecast Update, August 21, 2007). It is looking for exchange rates around 0.93-0.95 for the first half of 2008.

Fourth Quarter '07 115-120
First Quarter '08 120-125
Second Quarter '08 130-135

In addition to the U.S. market and the Canadian dollar, the Canadian hog market is also dependent on local supply and demand conditions. That is the spread or basis is dependent also on local conditions in addition to the transportation factors of moving hogs off the prairies. As such, the Olymel decision to lower prices at Red Deer will negatively impact overall pricing in Alberta, if not Saskatchewan as well. For the purposes of my forecasts below, I am basing them on the pricing levels prior to the 12 cent reduction. With those caveats noted, the following are my Alberta forecasts for the fourth quarter and the first two quarters of 2008 on an Index 100 basis.

Summer 2007