The hog price rally that I wrote about two weeks ago has now carried U.S. farm-level hog prices to near-record highs (see Figure 1). This week will almost surely best last week’s $82.04 national negotiated net price for the high for 2008. Thursday’s price was $84.04. The only prices between these and a clear-cut all-time record are those of the summer of 1990 when live prices reached a level just over $89 on a carcass weight basis.

At a meeting this week, a woman asked a very good question – one you will likely hear fairly often if these prices remain high. She asked: “How can we argue that higher corn prices due to ethanol are causing these higher hog prices?” The answer is: “We can’t.” And, I would add: “We shouldn’t even try!”

I firmly believe that we are headed for higher hog and pork prices in 2009 and beyond because our costs will be higher. Part of that increase is feed costs, but some of it is also higher costs for buildings and capital costs. The latter of those is not due to interest rates, but rather due to the dramatically higher amount of capital that will be required to raise pigs.

Ethanol is primarily responsible for the higher feed costs we see today and will continue to see in the future. Prices must rise to cover those costs. They simply have to.

But this price rally is not being driven by costs. Cost-driven price rallies are caused by lower production. Slaughter is still running 6% higher than last year with year-to-date slaughter still 10% higher than in 2007 (Figure 2).

This rally is being driven by demand, pure and simple. Further, it is being driven by export demand. University of Missouri professor Glenn Grimes’ index of domestic consumer-level demand was down again in June, falling to -2.3% from the 2007 level. (You might recall that May’s index was down 1.9%). This only leaves exports and by-products as possible sources of strength for live hog demand; by-product values are highly dependent on export trade.

We will get a more quantified read on this situation when June export data and July retail price data are released on Aug. 13 and 14, respectively. But I think wholesale pork prices clearly tell the story. Notice in Figure 3 that prices for the more “American” wholesale cuts (loins, butts, spareribs and bellies) have moved sideways or downward since hitting their seasonal peaks in mid-May.

On the other hand, the more “export-oriented” cuts, at least for this time of year, have kept rising steadily since that time. In fact, prices of these export cuts began a steady climb at the beginning of this year and the climb shows little sign of slowing. I do not recall ever seeing the prices of all of the major wholesale pork cuts falling within this tight of a price range. One of the benefits of trade is the ability to sell less-preferred cuts in markets that value them more. The beauty of the deal is that, in doing so, we offer consumers in those markets something they want and need. If not, they would not be buying.

RFS Waiver Request Nixed

Those are the good news items for this week and they are indeed good. The bad news item is yesterday’s announcement by the Environmental Protection Agency (EPA) that it has denied Texas Governor Rick Parry’s petition for a partial waiver of the renewable fuel standard (RFS) mandate for biofuels. In making the announcement, EPA Administrator Stephen Johnson said that the evidence did not support the claim that the RFS would cause “severe harm” to the economy or the environment. He did point out that EPA concluded that biofuels had been a cause of higher corn prices, but he also concluded that the RFS mandate, specifically, had not been a factor in those higher prices.

Technically, he is correct. The RFS has not actually caused fuel blenders to use more ethanol than they would otherwise have used. In economic-speak, “the constraint has not been binding.” Ethanol output has stayed ahead of the mandated level – sort of. This year’s production may actually be just short of the mandated 9-billion-gallon level, but blenders can apparently use credits (called RINs) they have received for above-mandate blending in past years to satisfy the shortfall this year. We may hear more about these RINs in the future.

Regardless, the RFS has contributed to the growth of the ethanol industry and, therefore, higher corn prices by guaranteeing a government-enforced growing market for ethanol. The RFS says that blenders will be required to use (translated: BUY) 10.5 billion gallons of ethanol in 2009, 12 billion in 2010, and then 0.6 billion gallons more each year until 2015, when the requirement levels out at 15 billion gallons.

What would pork producers and packers do if the government said that retailers and restaurants would be required by law to use 5% more pork each year for the next six years? Do you think that might spur a building boom for hog farms and processing plants? A guaranteed growing market is the stuff of business managers’ dreams. But government fiat does not necessarily make good economic sense. Let’s hope those dreams do not turn to nightmares.