Executive Summary

The English pig industry is operating in an extremely difficult climate with high feed prices having a huge impact on cost of production.

This report examines the industry and its future from three different perspectives:

• what is likely to happen to cereal prices and the factors affecting those prices.
• the effects of cereal prices on pig production costs showing them at 148p in March 2008 and estimating them to reach 180p per kg by 2010.
• risk management and the steps producers can take to manage their feed costs.

Section 1
Commodity futures

There are a large number of factors that could influence world supply and demand in the feed sector over the next five years:

• Chinese meat consumption will continue to increase and China may become a net importer of maize.
• US bioethanol expansion may mean reduced maize exports.
• The US, which has been traditionally a big exporter of soya beans, will export a lower proportion of their crop to produce biodiesel. They may, however,maintain soya meal exports.
• Availability of oilseed meals such as soya meal and rapeseed meal will be good.
• Glycerol will be available in much bigger quantities as a by-product of biodiesel production and may have a role to play in the feeding of pigs.
• Demand for cereal grains looks set to be very strong, primarily due to additional requirements for bioethanol production.
• There will be good availability of distillers’ grains from bioethanol plants, which will have an increasing influence on pig nutrition as a partial substitute for soya meal.
• Volatility in pricing of agricultural commodities looks set to increase
• There will be increased trade (exports) of biofuels.
• The supply chain for a wide range of ingredients such as phosphates will be tighter as supply struggles to keep up with demand.

Some specific EU factors

• The EU requires member states to have a minimum proportion of biofuels and other renewable fuel on their markets. The targets were 2% of petrol and diesel by 31 December 2005 and 5.75% by 31 December 2010.
• The EU system for approving new genetically modified crops typically takes two to three times as long as it does in the US
• The zero tolerance policy regarding unapproved GM crops also makes it very difficult to ship from countries where these varieties may be grown.
• The biggest problem for the EU is looming in 2009 when the US intends to grow the next generation of GM soya varieties. The EU has no viable alternative to feeding soya to pigs and poultry. If the US varieties are not approved in time by the EU there is a danger that we will be held to ransom by South America.

Price forecasts

• There will be a strong and growing demand for food, feed and bioenergy over the next five years, with supply struggling to keep up. Prices for cereals and oilseeds therefore look set to move higher.
• The price of crude oil will have a big impact on agricultural commodity prices, as it will determine the economics of producing biofuels. Where biofuel usage is mandatory, food and feed prices will be forced to take the burden of any crop failures, so prices will perhaps continue to move higher than before.
• The availability of oilseed meals, distillers grains and glycerol for use in pig feeds looks set to improve.

Section 2
The outlook for feed and its impact on pig cost of production

This section compares forecast costs with the baseline year of 2006, when the cost of producing pig meat in Great Britain averaged 108.2p/kg dw.

• In 2008 as a whole, average purchased compound prices are expected to be just over 70 per cent higher than the 2006 level. However,much will depend on the weather conditions in the first half of 2008. Prices in the second half of 2008 will also be affected by developments in southern hemisphere harvests.
• Average compound feed price forecasts for 2010 range from £158 to £310
• Feed costs per kg of pig meat totalled approximately 50p per kg in 2006 but are now up to about 88p. As a result, feed’s share of total costs has increased from 46 per cent to 60 per cent.
• The cost of producing a kg of pig meat is forecast to rise from an average of 108.2p in 2006 to 148.1p in March 2008.
• Assuming an average producer price of 115p in 2008, this implies a loss of 30p/kg, which is equivalent to £22 on every pig produced. On an industry-wide basis this means an annual loss of £200 million.
• The forecast cost of production in 2010 ranges from 120.2p to 180.9p depending on the assumptions used. However, even at the low end of the range, production costs will be well above pre-2007 levels.

Section 3
Risk management for farmers and the pig industry

Interest rates

Most business activities generate some element of financial risk, but two of the most common for farmers are interest rates and foreign exchange. There is currently a great deal of uncertainty in the financial markets, which generates risk. The areas of financial risk for UK farmers include UK interest rates, the dollar exchange rate and the exchange rate with the Euro

• Barclays’ economics team is expecting three 0.25% rate cuts between early April and end of August 2008 to leave the base rate at 4.5%. This compares with other bank economic forecasts ranging from no cut at all to as many as six cuts over the next twelve months.
• A short-term view of interest rates is often not appropriate for pig producers as they tend to borrow for long periods, particularly for buildings and land. Over longer periods interest rates will tend to vary more widely, for example UK interest rates have fluctuated by nearly 2.5 percentage points in the last eight years alone.

Foreign exchange markets

• Foreign exchange markets have been volatile in recent months and in the short-term observers are concerned about a further slowing of the UK economy in response to a possible recession in the US, as well as a slow down in European growth.
• Since soya prices, for example, will be influenced by the sterling/dollar exchange rate, some may wish to take out a ‘translational’ hedge to lock in to a particular rate and cash it in at the time they pay for their feed.
• Barclays are forecasting GBP will weaken further against USD in the short term, forecasting a fall in GBP/USD to 1.93 over the next twelvemonths, while they predict a relatively stable GBP:EUR relationship at around 1.3 for the next twelvemonths.
• These are not particularly dramatic changes but, if they come to pass, they will not help reduce the already high cost of feed.

Managing risk in feed prices directly

Buying forward cover

• This is a common practice among intensive livestock farmers, although it is not without its risks. To buy forward at a time when the value of the finished product is static or rising may well make good sense since it locks a major element of total costs at a known level which will leave a profit or at least limit any short term losses.
• Equally, if a short term contract has been taken, when it comes up for renewal at a time when cereal and protein prices have been rising while output values have not improved, there could be a sudden jump in costs against static output values resulting once again in reduced profit or a shift to trading losses. It is this last combination of circumstances in which the industry now finds itself at the beginning of 2008.

Using forward grain markets and Options

• Buyers of feed can buy an Option to buy wheat at a given price. If the market goes up, they exercise the option to buy at the lower price, thus effectively locking in to a maximum feed price. Should the market fall, they ‘tear up’ their Option contract, write off the cost of it, and buy at the lower price in the market.
• In the case of livestock feed, the business which buys the Option to buy feed ingredients could be either the pig farmer or his feed compounder. In the latter case the feed manufacturer will pass on the costs of the arrangement, no doubt including administration, to their customer, but at least both parties know that they can trade with each other for the duration of the arrangement without worrying about what the grain market is doing.

Managing risk through collaboration in the supply chain

• Fixed price contracts. These involve negotiating a price based on known feed costs and other costs in the chain which leave a modest margin for efficient operators and offer the opportunity for the more efficient to prosper further.
• Sale contracts linked to commodity prices. To reduce the risk of either or both parties to a fixed price contract being locked in to an unfavourable arrangement for any length of time, they may wish to consider a contractual arrangement with flexibility built in. An example of this would be linking finished pigs to wheat prices, for example the HGCA spot price on a given day, or the London International Financial Futures Exchange (Liffe) futures price for wheat.

Further Reading

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You can view the full report by clicking here.

April 2008