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US Hog Market: Contract Sales Study

by 5m Editor
17 March 2001, at 12:00am

by Glenn Grimes and Professor Emeritus, University of Missouri and NPPC, March 12, 2001 - Most US hogs are sold under contract, with more than half being sold by a formula, according findings reported during the National Pork Industry Forum March 8 to 10 in Orlando, FL. Glenn Grimes, agricultural economist with the University of Missouri, surveyed 11 packing companies in early February, asking them to classify their purchases during January. The results of the study are detailed in this report.

In early February the following pork packers were surveyed: Smithfield/Morrell, IBP, Swift, Cargill/Excel, Hormel/Rochelle, Farmland, Seaboard, Premium Standard/Lundy, Indiana Packers, Hatfield, and Clougherty. All packers responded to the survey. The survey asked them to classify their purchases during January 2001 regarding pricing methods.

The total slaughter under Federal Inspection for January 2 through January 27, 2001, was 7,442,297 head. The responding companies accounted for 6,466,273 head or 86.9% of FI slaughter.

In Table 1 we show data from similar studies in 1999 and 2000. We also show data regarding marketing agreements from the 1997 Pork Industry Structure Study by Lawrence, Grimes, and Hayenga. The 1997 data were derived from a producer study. Table 1. Percent of U.S. Hogs Sold through Various Pricing Methods, 1997-2001

Pricing Method
1997
January
1999
January
2000
January
2001
Formula (a reported price plus some amount)
39.1%
44.2%
47.2%
54.0%
Fixed price tied to futures market price
(i.e., a cash contract)
2.9%
3.4%
8.5%
5.7%
Fixed price tied to feed price,
no ledger maintained
5.3%
2.9%
3.3%
6.4%
Fixed price tied to feed price,
Ledger maintained
6.9%
9.0%
9.8%
Window, risk sharing, no ledger maintained 3.1%
3.6%
3.8%
4.6%
Window, risk sharing, ledger maintained
1.0%
0.8%
2.0%
Other (packer owned, internal transfer)
6.1%
2.3%
1.7%
0.2%
Total non-spot market purchases
56.6%
64.2%
74.3%
82.7%
Total spot market purchases
43.4%
35.8%
25.7%
17.3%

Non-spot or non-cash purchases in January 2001 accounted for 82.7% of the purchases of these firms. The 2000 study showed 74.3%, the 1999 study showed 64.2%, and the 1997 showed 56.6% of total marketings were non-spot market transactions.

By adding the percentage of hogs purchased in spot markets to the percentage purchased on a formula, the current survey suggests that the price for 71.3% of the survey hogs was determined by the spot market price. This is down from 72.9% in 2000, 80% in 1999, and 82% in 1997. Note that formula pricing may raise the average price by a few dollars (likely $1-$3 per cwt.) but does not reduce the variance of price since the formula moves dollar for dollar with the spot market price.

About 28.5% of the hogs in this year's survey were purchased under some system that supposedly reduces price risk to producers. 5.7% were bought on a cash contract tied to the futures market -- down from 8.5% in 2000 but up from 3.4% in 1999. These contracts usually extend no more than 13 months into the future. This year 22.8% were purchased on a longer-term, supposedly risk reducing, pricing system. These contracts grew from 16.9% in 2000 and 14.3% in 1999.

"Supposedly" is used in the paragraph above because some of the pricing systems to not actually affect the variance of price received by the producers. Only cash contracts (the ones usually tied to futures) and contracts without ledgers reduce producers' price risk. These contracts may or may not result in a realized average price that is different from the actual average spot price. These classes of agreements account for 16.7% of the hogs covered by this survey, up from 15.6% in 2000 and 9.9% in 1999.

Ledger contracts accounted for 11.8% of the hogs covered by this survey, up from 9.8% in 2000 and 7.9% in 1999. Any amount by which the market price falls short of the contract's lower critical price must be repaid in at least a portion of these contracts. Some of these contracts contain a sunset clause several years in the future.

Notice in Table 1 the "other" category, which includes some packer-produced hogs, was only 0.2%. Most of the packers who also produce hogs are pricing them using a formula contract with the production unit of their firm -- or in a few instances one of the other contracts. These hogs are included in the pricing categories listed in the table. For those interested in packer-owned hogs, Figure 1 shows the percent of U.S. hog production owned by packers.

Figure 2 shows the percent of hogs sold on the spot market, which has several implications for the industry.

Table 1.
Percent of US hog production owned by packers or companies with packing plants
Figure 1

Table 2.
Percent of hogs sold on spot market
Figure 2