Livestock Price Outlook - Lots of Pork Will Keep Margins Thin

By Chris Hurt, Extension Economist Purdue University. Pork production is going to surge by 5 percent this fall and remain 2 to 4 percent higher through 2008. Slaughter rates this fall will be near capacity at times.
calendar icon 9 November 2007
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There will be comparisons to the fall of 1998 when slaughter rates exceeded capacity, but that situation is not expected this fall. Unfortunately, low hog prices and high costs will likely depress margins into the red this fall and winter. Profit prospects for next spring and summer are near breakeven with considerable uncertainty regarding corn and especially soybean meal prices.

Export expansion has been an important demand stimulate for the pork industry in recent years. However in 2007, pork exports may fall a bit and are expected to grow at a slower rate in 2008. A slower export growth rate may mean the industry needs to slow down the rate of production growth. In addition, the industry has not adjusted production to higher feed and other input costs. Some downward adjustments in supply may be necessary in late 2008 or early 2009.

Feed price uncertainty and volatility are expected to continue into 2008. Corn prices may have an upper limit established by weak ethanol margins. However, soybean meal and other protein ingredients may present greater threats for upside price movements.

The Numbers

Higher than expected hog numbers were released in the latest Hogs and Pigs report from USDA. Fall slaughter is now expected to be up 4.5 percent with slaughter rates near capacity. This has generated discussion of the similarities to the disastrous fall of 1998 and has cast a bearish tint on price expectations.

In addition to more market hogs than anticipated, the USDA’s Quarterly Inventory report found a few more sows than expected. The sow inventory was up about 1 percent and demonstrates how the pork industry has continued to expand output even in the face of dramatic increases in costs of production led by feed prices and other inputs.

The breeding herd was up by 7 percent in Missouri, by 4 percent in Nebraska, by 3 percent in both Minnesota and Kansas, and 2 percent in both Illinois and North Carolina. Notable decreases were a 6 percent decline in Indiana and a 1 percent drop in Iowa.

Compounding the slaughter capacity issue this fall will be continuing record live hog imports from Canada. Canadian live imports are up 10 percent so far in 2007 which is composed of 20 percent more slaughter hogs and 7 percent more SEW pigs. Live imports from Canada are projected to reach 9.5 million head and will represent over 9 percent of total U.S. slaughter this year, a new record.

Current slaughter capacity is estimated by Dr. Steve Meyer of Paragon Economics, Inc. to be 428,000 head per day. In the first two weeks of October, actual slaughter has run very close to that number assuming one-half day of capacity on Saturday’s. Slaughter for this short period has been a surprising 8 percent above year-earlier levels. This high rate in early October continues to raise concerns that hog numbers could be higher than the 4.5 percent projected in this report.

Supply, Demand and Prices

Growing export demand has enabled the industry to continue on its expansion path in recent years, but that support is giving way this year. From 2000 to 2006, growing pork exports required an average annual increase in U.S. production of 1.2 percent per year. In 2007, exports so far are down 1 percent (data through August). Mexico represents the largest portion of reduced exports and were down 29 percent through August. On a positive note, shipments to China are growing and will help exports end 2007 on a more optimistic note. For 2007, USDA expects pork exports for the year to be down slightly less than 1 percent. In summary, the pork industry continues to expand for growth in the export market that has not occurred in 2007. In 2008, the industry will need to monitor export growth closely and adjust the size of the breeding herd accordingly.

Pork supplies are expected to be up about 5 percent this fall, 3 percent this winter, 4 percent next spring, and 2 percent in the summer of 2008 (see Table 4). With slowing growth in export sales, this means that pork availability for U.S. consumers will be higher by about 2 percent. Pork will also face added competition from chicken production, which is expected to be up 3 percent in 2008, but beef supplies will remain moderate. Overall domestic per capita supplies of red meat and poultry are expected to rise by 1.7 percent in 2008 which again will keep some downward pressure on pork prices.

Prices and Production Returns

Hog prices this fall are expected to average in a range from $43 to $47 on a live weight basis for 51-52 percent lean carcasses. Absolute daily lows could move into the lower $40s. Late October or early November tend to be the time of the historic seasonal lows. Winter prices are expected to improve about $2 and to average in a range from $44 to $48. Spring and summer prices should be much better and are expected to average in the very low $50’s.

Concerns have grown once more about feed prices in the upcoming year. Using current futures prices for corn and soybean meal and adjusting for the expected basis, costs of production are expected to be $47 to $48, resulting in losses this fall and winter of $2 to $4 per hundred. Costs are expected to move higher into the spring and summer reaching the higher $40. If hog prices do average in the very low $50s, this may provide a modest positive return during this time. The industry may operate at a loss of about $.50 per hundred in the next 12 months compared to an estimated profit of $3.50 per hundred over the past 12 months, see Figure 1.

The pork industry has escaped making adjustments to higher feed prices so far. However, some downward adjustments in the breeding herd may be needed in the coming year as the industry is forced to respond to both higher feed and other input costs and to the potential slowing of export growth.

Implication for Industry

The pork industry has had a long profit run dating back to early 2004. Losses are expected this fall and winter, with modest returns next spring and summer. The growth of exports has been a critical component that has enabled the U.S. industry to expand at a faster pace. However, modest declines in exports in 2007 raise the caution that the industry needs to closely monitor the export pace in 2008. At this time, prospects for increasing exports to China put a positive tilt on export growth into 2008.

The industry has not yet reduced production in reaction to higher feed and other input costs. The coming year, may be a time when margins thin and the industry needs to slow production growth. That slowing will probably not occur until margins move into the red, and the profit outlook fades.

Feed costs are expected to be highly variable in the upcoming year. While corn inventories are comfortable, acreage reductions in 2008 will keep both 2007 and 2008 crop prices relatively strong. The ethanol industry will likely experience growing pains for much of the next year. Ethanol output is likely to mushroom as new plants open, yet ethanol blending capacity appears to be lagging. This likely means a period of narrow margins for ethanol producers, and could result in both slow-downs in plant construction and in reduced usage of corn compared to current estimates. As cash corn prices move above $3.50 per bushel, some ethanol plants could begin to slow-down or consider shutdowns. Ethanol margins are of course dynamic and the levels at which plants will consider shut-down will vary with ethanol prices, distillers grain prices, natural gas prices, and of course corn prices. The point, however, is that the ethanol industry probably cannot compete with high corn prices $4.00 per bushel or higher.

While corn prices may have upper limits due to weak ethanol margins, the same cannot be said for soybeans and soybean meal. Soybean inventories will be very tight this marketing year. Another bullish run on meal prices could occur if soybean exports are larger than USDA’s current forecast of 975 million bushels and/or if weather threats develop for the South America soybean crop. The biggest swing factor may well be the final size of the South American crop. This means that both planted acres and yield will be important, but the biggest of these will be yields. Thus, there is the potential for wide volatility late this fall and winter based upon weather patterns in the Southern Hemisphere.

Further Reading

- You can view the October 2007 Tables by clicking here.

October 2007
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