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Hog Producers Show Little Sign of Retreat

by 5m Editor
30 April 2007, at 12:00am

By Chris Hurt, Extension Economist Purdue University. In his latest Outlook report, Chris Hurt says, producers need to realize that national pork supplies will have to be reduced before the industry will recover back to profitability.

Hog producers reported in the latest USDA update that they increased the size of the breeding herd by 1 percent. This means pork production will continue to increase by about 2 percent in 2007, and establish the eighth consecutive year of record pork production. All in all, pork producers seem to have ignored, at least so far, the massive increase in costs.

Production in 2007 is expected to be 21.4 billion pounds, an increase of 1.8 percent over last year's record production. The number of head slaughtered is expected to rise by over 2 percent for the year, but weights are expected to be down about .4 percent due to high feed prices.

Growth in exports is expected to slow this year, but still be up 5 percent. This rate of growth is a considerable slow down from the 75 percent increase in exports in over the three previous years.

Liveweight prices are expected to average near $48 for 2007. This is slightly higher than the $47.30 of 2006. The big change, however, is cost of production. In 2006, estimated cost for farrow-to-finish operations was about $40.40 and this year it is $47.50. This means the year is expected to be near breakeven for hog producers with almost all the change in producers' bottom lines related to higher feed costs.

Lean hog futures are expecting higher prices than forecasts by our models, and are providing profitable hedging opportunities for 2007. Producers should seriously consider both covering corn purchases and pricing lean hogs if they can generate an expected profit from doing so. Hedging profits are available at this writing, but lean hog futures prices may also improve somewhat more in the next four to five weeks

The Numbers

Pork producers in the U.S. say they have continued to increase the size of the breeding herd by about 1 percent. The national breeding herd is 56,000 animals higher than last year on March 1. Most of the increase occurred in the Eastern Corn Belt (ECB) where numbers are up 50,000 head. The increases by state in the ECB are: Illinois 20,000; Indiana 10,000; Michigan 10,000; and Ohio and Wisconsin each 5,000 head. In the Western Corn Belt, Iowa's herd was down 20,000 head, but was offset by a similar increase in Minnesota. The nation's market herd was up by a bit over 1 percent.

Farrowing intentions are down modestly for the spring quarter, but unchanged for the summer quarter, perhaps finally indicating some slow down in the growth in pig crops. These numbers are shown in more detail in Table 1.

Supplies and Prices

The table at the end of this section shows anticipated supplies and prices by quarter. Pork supplies in the remainder of 2007 are expected to be up about 2 percent, but only 1 percent higher in the first quarter of 2008.

Prices for 51 to 52 percent lean carcasses on a liveweight basis are expected to be near $50 in the second and third quarter this year and close to $46 for the last quarter of 2007 and the first quarter of 2008. See Tables 2 through 5 for more details.

Lean Times Coming for Producers?

The break in corn prices after the March 30th Prospective Plantings report was welcomed by hog producers, giving them added hope that crop producers could provide enough corn for both fuel and feed for the 2007-08 marketing year. However, one week after the report, anticipated costs of production are still expected to increase from around $47 per live hundredweight currently to near $49 by late 2007 and early 2008, see Figure 1.

In the one week after the report corn prices dropped sharply, but recovered substantially, while meal prices are little different from their pre-report levels. In addition, while the decline in corn prices for the nearby corn futures contract was about 20 cents, the decline in the more deferred corn futures have been closer to 5 cents per bushel. After all the excitement of the March 30 reports, estimated costs of hog production are down less than $.50 per live hundredweight over the coming 12 months.

Depending on how weather affects yield potential, it now appears producers will have a bit of profitability in the second and third quarter this spring and summer, perhaps averaging about a $2. However, those positive returns will be surrendered in the last quarter of 2007 and first quarter of 2008, when margins are expected to turn to a loss of about $3 on average as shown in Figure 1.

Lean Hog Futures More Optimistic

Lean hog futures as of the close of trading on April 5, 2007 are more optimistic for the coming year than are my forecasts, Figure 2. These represent the lean hog futures as of the close and the average Eastern Corn Belt basis in the five years from 2002 to 2006. These are based on weekly observations. The horizontal scale represents weeks from April of 2007 through March of 2008.

The average is $50.71 compared to a forecast of $47.77 per live hundredweight from my computer models. Futures are about $3.00 more optimistic than model forecasts.

The Hogs and Pigs report released March 30th provided inventory numbers that were close to expectations. Yet, lean hog futures in the first week after the report rose about $1.50 per hundredweight. This strength did not seem to be justified on the basis of smaller potential supply numbers coming from the report. The strength in futures seems to have been supported by two factors: one, the start of a major seasonal increase in hog prices and two, the relief pork producers felt from the large potential corn acreage. The ultimate questions will be whether these higher lean hog prices will become reality.

Implications for the Industry

Why haven't producers made more adjustment to the nearly $7 per live hundredweight higher hog costs? There are a few signs that adjustment is beginning. One sign is that carcass weights were down almost 1 percent in the first quarter of 2007. Weights are expected to continue lower for the rest of the year. Secondly, while the breeding herd is reported to be up 1 percent, the actual rate of sow slaughter has been up about 4 percent since last fall. In addition, farrowing intentions for this spring are down fractionally. Finally, there may not have been enough time to see much reaction yet. Hog producers were in "shell shock" over high corn prices last fall and, like other end users, hoped prices would drop back down.

Producers need to realize that national pork supplies will have to be reduced before the industry will recover back to profitability. So far, the cost increases have been absorbed by reductions in pork producers' bank accounts. Assuming costs are now about $7 higher, U.S. pork producer returns will be reduced by about $2.0 billion in 2007 alone.

How will that be recovered? Pork producers will need to cut production and reduce the total supply of pork available. Once these cuts are made, retail and farm level pork and hog prices will recover and the higher feed costs will be transferred to consumers. Alternatively, since pork demand is growing modestly, keeping pork production constant for a period of time will also encourage retail and farm prices to rise.

Current lean hog futures exceed my estimates of hog prices for the coming year by about $3.00 per live hundredweight. In addition, current futures for lean hogs, corn, and soybean meal would provide a modest level of profit based on our estimates of current costs. Now would be a good time to add to hog margins taken for the year. There is a strong seasonal tendency for lean hog futures prices to rise in April and May. Taking some margins now and waiting to take additional margins on potential improvement in lean hog prices over the next four weeks might be considered.

Everyone has ideas on the future direction of corn prices. But the sell-off in the post-March 30 period may be an opportunity to add to corn feed coverage for the rest of 2007. From here on, it's up to weather and how rapidly the dramatic number of ethanol plants that are under construction come on-line. Volatility will be the key word for the next two months.

To view the April 2007 tables, please click here

April 2007