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Hogs Prices and Outlook - Hog Producers 'Strive To Survive' In 2007-8

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

By Chris Hurt, Extension Economist, Purdue University - In his latest Outlook report, Chris Hurt says that the nation’s breeding herd continues to exhibit small amounts of expansion.

Chris Hurt
Extension Economist
Purdue University

After three years of favorable returns, 2007 is expected to be a year with losses of $1 to $2 per live hundredweight with grave concerns of even higher feed prices and greater losses.

Total costs of production in 2007 are expected to be about 24 percent higher than in the two previous years with corn costs up an estimated 81 percent and soybean meal a more modest 8 percent. In addition, large uncertainty surrounds feed costs in 2007 as the corn and soybean sectors adjust to the rapid explosion in corn demand for fuel ethanol.

Little Adjustment Yet

The pork industry has not adjusted much yet to the new realities of corn and soybean meal prices. The breeding herd remains in a slow expansion and is higher by about 1 percent. Market herd numbers are also higher by about 1 percent. Winter farrowings are expected to be up 2 percent and next spring farrowings up 1 percent. The number of pigs per litter is expected to be high this winter due to the mild weather and may continue to set new records throughout the year.

Over the past two years, the breeding herd has risen by a modest 2 percent, representing 120,000 more animals. Regionally, this expansion has come in two locations. The first is in the Eastern Corn Belt (Indiana, Illinois, Ohio, and Wisconsin) where breeding herd numbers have been up 80,000 head. The second is the Central Plains (Colorado, Kansas, and Nebraska) where numbers were up 40,000 head. Most other areas have seen only slight changes.

Record pork production of 21.4 billion pounds is expected for 2007. Slaughter numbers are expected to reach 107.3 million head. This will be the sixth consecutive year of record pork production. The growth of pork exports is the reason for the continued U.S. industry growth. Exports rose by 1.4 billion pounds from 2002 to 2006, while domestic consumption was about unchanged. A critical question for the future of the U.S. pork industry is how will the diversion of so much corn to fuel impact the U.S. industry’s ability to grow the export market in coming years?

Hog Prices Remain Strong

Hog prices are expected to remain relatively strong in 2007 given record high production. Prices for live animals are expected to average about $48 per live hundredweight, or $64.50 on a carcass basis. This compares with $47.34 in 2006 and $50.10 in 2005.

Prices are expected to average in the mid-$40’s, in the first quarter of 2007 and then move up to averages near $50 for the second and third quarters, before falling back to the mid-$40 in the final quarter. Yearly price highs would be expected in late-May and June with prices reaching the low-to-mid $50’s. Yearly lows would be both at the beginning of the year and at the end of the year, in the very low $40s.

Anticipated cost of production based upon closing prices of corn and soybean meal futures on January 29 are expected to average near $49.50 in 2007. This compares with a $40 average for 2005 and 2006 combined. Given expected prices at $48, this means an expected net loss of about $1.50 per live hundredweight with the largest losses in the first and the last quarter of the year.

Feed Costs Eliminate Profit Potential

The dynamics of corn and meal prices in 2007 now appears to be a larger concern than hog prices. Now that the $4.00 futures ceiling has been exceeded, upside objectives could well come in $.50 intervals at $4.50, $5.00 and $5.50. Volatility is likely to remain high and this may mean opportunities to buy corn and meal on the dips. At this writing, July 2007 corn futures are $4.185 per bushel and the options market determined odds of prices moving to $4.50 are 38 percent and to $5.00 are 20 percent. These are reasonably large odds and many producers will want to consider some price protection measures.

There are four pricing strategies that come to mind to protect against corn and meal upside price movements. The first is to acquire as much cash corn as is possible this winter for feeding needs through mid-summer. Ownership costs are generally less than premium corn bids through mid-summer. One central Indiana elevator has a $.41 per bushel premium for July delivery corn versus February 1, as an example. Interest costs at 8 percent per year totals about $.15 per bushel until July 1. If one has storage space, ownership now appears advantageous. In addition, as more ethanol plants come on-line, basis levels are expected to strengthen. Owning corn now may help avoid a higher than expected basis this spring and summer.

A second corn pricing strategy is to buy corn futures on the breaks. A third is to buy corn call options on the breaks. For the July futures, an at-the-money call is about $.32 per bushel while the $.50 out-of-the-money calls are about $.18 per bushel. This is a strategy that establishes a maximum futures purchase price, but also allows lower futures purchase prices if the market should move downward.

A fourth strategy is to set a purchase price range on futures by both buying calls and selling an equal number of out-of-the money puts. The Chicago Board of Trade has a short two page description of this strategy which establishes a maximum and a minimum futures price range available at http://www.cbot.com/cbot/docs/71647.pdf Spring and summer growing conditions will be a major concern as well. Since 1975, the odds of having U.S. corn yields drop by 5 percent or more has been 22 percent. Unfortunately for corn users, if that were to happen in 2007 corn prices would be expected to rise sharply, perhaps to record levels.

Longer Term Adjustments

While 2007 and early 2008 appear to be a period of some losses for pork producers, there have been much more difficult financial times for the industry. Some cut-back in the breeding herd is likely into mid-and-late 2007, along with lighter marketing weights. This should help hog prices to recover in late 2008 and 2009. Higher retail and farm prices may mean that the industry can return to a profit in 2009 and 2010.

Feed price volatility is also expected to be extreme in coming months. This means there will be dips in the market that may provide buying opportunities. However, it also means there will be wide price swings. Emotion often becomes an worst enemy when price moves up and down sharply. Buying programs which have breakevens as an objective and a diversified strategy which splits buying into several decision periods can help reduce the negative impacts of emotional market decision making.

For the next year and one-half, producers may need to think more about surviving this narrow margin period rather than hoping for a turn to lower feed prices. Survival over the next 18 months may go a long way for being in position to take advantage of much better margins in late-2008 and 2009.

Keep in mind that ethanol margins have eroded since their peak last summer. Current estimates are that the breakeven levels for new ethanol plant construction are about $4.25 per bushel, but this could drop to $3.75 by this summer if ethanol prices drop as anticipated by futures markets. This means that ethanol plants will be part of the corn rationing process as well. Some still believe ethanol plants can pay $7.00 for corn. While that was true last summer, it is no longer the case.

Hopefully, more ethanol investors will decide to put their ethanol plant construction plans on hold and provide some time for the livestock and poultry industries to adjust to the new realities of high feed prices.

Further Information

To view the set of tables click here. (PDF)

February 2007