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Valuing Market Hogs: Information and Pricing Issues

by 5m Editor
29 February 2004, at 12:00am

By James Mintert and Ted C. Schroeder, Kansas State University and Eric P. Berg, University of Missouri-Columbia - This report was published by the Kansas State University Agricultural Experiment Station and Cooperative Extension Service and looks at the rapidly changing hog market structure and other pricing issues.

Executive Summary

Rapid and dramatic changes in hog industry structure have led to substantial changes in the way hogs are marketed and valued. Once common, live-hog negotiated cash markets have been largely replaced with marketing contracts. Under marketing contracts, each hog carcass value is comprised of a base price augmented with a premium or discount reflecting carcass quality attributes. These changes have created several issues that deserve industry consideration.

Most marketing contracts rely on prices negotiated in cash markets to establish base hog price. However, declining trade in cash hog markets (representing less than 20 percent of hog marketings) makes using these markets as a base problematic. In particular, concerns regarding how representative cash prices are of market conditions make their future use questionable. We evaluate several alternative base price methods and find that all alternatives have benefits and drawbacks. Given continued thinning of negotiated cash hog markets, however, moving toward formulas reliant on wholesale carlot pork price to establish base price is recommended. This means carlot pork price reporting, which is not included in mandatory price reporting, needs to be more comprehensive. In addition, variability in packer margins over time means that base prices linked to wholesale market values will be greater than cash hog prices at times and lower than cash hog prices at other times.

The USDA has attempted to keep up with these rapid changes by instituting mandatory price reporting for slaughter hogs, which facilitates base price reporting, and by publishing packer premium/discount schedules. However, the price and premium/discount schedule information reported by USDA is aggregated across such a varied set of carcass attributes that it is of limited value to producers. Further, additional contract details provided in the Swine Contract Library have not resolved the problems in interpreting the information contained in USDA price reports. We recommend additional work be done with USDA to improve price reports so they become easier to interpret and use.

As carcass merit pricing systems have become the norm, accurate pork yield and quality measurement have become more important to the industry. A variety of technologies have been, and are being, developed to objectively measure yield and quality attributes. The pork industry successfully increased lean meat yield over time. However, at the same time pork quality concerns associated with pale, soft, and exudative pork increased. On-line technology currently evaluates individual pork carcasses for lean meat yield. Ideally, technology could also be used to assess pork carcass quality. Functional pork quality can be determined by laboratory methods evaluating various physicochemical aspects of the lean tissue, yet rapid, on-line methods of evaluation have yet to exhibit a high degree of accuracy. Until technology is developed that predicts fresh pork quality accurately and quickly, every level of the pork production chain should strive to use existing production and processing techniques to develop a system that assures every pig will possess excellent pork quality.

Introduction

Hog production and marketing have changed dramatically. An industry once characterized by a large number of diversified operations rapidly evolved to one where specialization is the norm. Average operation size has been increasing for decades, but the pace of change accelerated during the 1990s. By 2000, 80 percent of the nation’s hogs were produced by farms marketing 5,000 or more hogs per year and the top 156 firms produced 52 percent of U.S. hogs.

The way hogs are valued began to change at the same time specialization in hog production increased and industry structure became more concentrated. A little over two decades ago, less than 10 percent of U.S. hogs were marketed via carcass merit pricing systems. Now more than 75 percent of U.S. produced hogs are sold via carcass merit pricing systems. Carcass merit pricing values each hog carcass separately, thereby allowing processors to send clear signals regarding desirable or undesirable carcass characteristics.

Concurrent with the shift toward carcass merit pricing was a major shift away from use of daily cash markets (terminal markets and negotiated sales) to marketing contracts. Net price received for hogs sold via marketing contracts is a function of a base price and premiums/discounts associated with hog carcass characteristics. Base price, the premium/discount schedule, and hog carcass characteristics are all important determinants of price received for hogs marketed via a carcass merit pricing system. Most marketing contracts use a negotiated cash market price to establish the base price. Daily cash market volume has declined dramatically to where it represents a small share of total hog marketings raising concerns of how representative cash prices are of market conditions.

Several aspects of carcass merit valuation and marketing hogs via contract need additional consideration. This report focuses on four major issues in changing slaughter hog market structure and pricing:

  1. Rapidly changing hog market structure has created dramatic changes in the way hogs are sold and valued. New technology, size economies, and the need to provide consumers consistent pork products at competitive prices motivated the structural change. Economics will continue to drive change in this dynamic industry. This is important to keep in mind as policy positions are established.

  2. Current USDA hog price reports do not provide a transparent view of market prices and may even mask whether observed price changes are attributable to changes in hog market fundamentals or simply a shift among firms purchasing hogs on a given day. Recommendations for changes are identified.

  3. Declining negotiated cash market hog volume creates concerns about levels of competition in cash markets and whether the quality of hogs sold via negotiated trade is representative of the industry. We review alternative methodologies for base price establishment, highlighting pros and cons of each method.

  4. Rewarding producers for production of leaner, heavier muscled pigs has resulted in an inadvertent deterioration of fresh pork quality. Electronic carcass grading equipment was developed to determine carcass lean meat yield and subsequently solve the industry’s former problem with over-fat carcasses. Currently, the industry is struggling to identify electronic techniques capable of accurately evaluating pork quality. We review current and evolving technology used for evaluation of various factors associated with pork quality.

To read the full report, please click here.

Source: Kansas State University - January 2004