Market Preview: Rehashing Hog Pricing Categories

US - Weekly US Market Preview provided by Steve R. Meyer, Ph.D., Paragon Economics, Inc.
calendar icon 9 February 2010
clock icon 6 minute read

On 12 March, the USDA and the Department of Justice will launch a series of “Competition Workshops“ in Ankeny, Iowa. The focus of the first workshop will be crops and seed, but the session will also include hogs and pork. The hogs and pork segment will also be included in a livestock workshop planned for August in Fort Collins, Colorado. A schedule of all workshops can be found here.

One topic that will almost surely be addressed in the hog/pork workshops will be the changing mix of pricing mechanisms for barrows and gilts. Figure 1 shows the per centage of total weekly barrow and gilt sales accounted for by the four different pricing mechanisms, as well as packer-owned and packer-sold pigs.

The pricing categories were defined in the Livestock Mandatory Reporting Act of 1999, and the rules that USDA promulgated to enforce that act. As they stand now, the categories include the following:

  • Negotiated – Pigs sold through direct buyer-seller interaction and agreement on a price and delivery date.

  • wine/Pork Market Formula – Pigs whose price is determined by a price taken from a hog or pork market. These would be pigs prices using, for instance, the afternoon Western Corn Belt weighted average or the USDA Blue Sheet 51-52 per cent lean hog cutout value.

  • Other Market Formula – Pigs in this category have been defined for several years to include almost exclusively those whose price is tied to futures prices on the Chicago Mercantile Exchange.

  • Other Purchase Arrangement – This is a catch-all category in which mechanisms not covered in the other three are placed. Most of these pigs represent feed price or cost-of-production contracts. Some may involve price floors or window mechanisms.

  • Packer Sold – Animals that are sold from one packer to another. These are primarily hogs that are out of place with regards to a packer’s plant locations. The best example is the pigs owned by Circle Four Farms (part of Smithfield Foods) in Utah that are sold primarily to Clougherty/Hormel in Los Angeles.

  • Packer Owned – animals that are raised by a packer and slaughtered in the packer’s own plants. No prices are reported for these pigs since the prices are internal transfer values that do not impact the combined profits of the integrated company. Including that transfer price in the total weighted average would, thus, provide an opportunity for a packer to manipulate the weighted average without impacting its own profits at all.

Negotiated Pricing Trend Continues Downward

As can be seen, the per centage of total hogs for which prices are negotiated each day has declined by about two-thirds since January 2002, and has trended down steadily since early 2008. There are reasons for this decline and I suspect they include negotiating ability, transactions costs and operation size. It is quite likely that managers in this production-driven sector do not have the skills or, more importantly, the time to negotiate the prices of very many hogs. And larger operations mean that there are far more pigs for which to negotiate a price than there once was. It is much easier and less time-consuming to just let someone else do the negotiating and tie one’s price to the result of that process. An added benefit is that you will never be wrong because you can always blame the other guy!

At the same time, the packer-owned per centage has continued to grow. The rapid increase in 2006 corresponds to Smithfield’s purchase of Premium Standard Farms, but the trend has been slowly upward both before and after this quantum increase. And the trend may pick up speed in months to come as packers are forced to take over some suppliers in order to keep pigs flowing from those farms. Packers must have pigs and they will own farms if the only alternative is to let farms fail and lose the pigs they supply.

Lest anyone say that packers should not have let producers fail in the first place, remember that it has not been pig prices that have caused the 2007-2009 financial debacle. It has been costs. Does anyone think it is fair to expect packers to cover costs that they had no role in driving higher?

Natural Evolution

So, do either of these mean that markets are uncompetitive or inefficient? No. In fact, they both may be the natural evolution of competitive markets. Perhaps transaction costs, quality risks, food safety risks, and the like, say that the hog business can no longer rely on negotiated or spot-market transactions and must use longer-term formal systems to transact hogs. Such a system works in other commodities like fruits and vegetables and wine grapes. But there must be a relatively open and transparent market for the longer-term agreements/contracts and that sector is far from transparent in the pork industry at present.

Rising packer ownership is, to me, either a matter of opportunity (i.e. profits in raising hogs) or necessity. The growth up to now has been the former, while growth from this point forward may well be the latter. Can packers manipulate prices using owned supplies? Yes, but only to a degree, because any owned or contracted hog brought to the plant to keep spot market prices lower today cannot be used to do so tomorrow. The supply of these “captive supplies“ is not unlimited so neither can be their impact.

All of this will be hashed and re-hashed many times this year it appears. I only hope that facts and well-done research get the attention they deserve in the process. I worry that fear and innuendo may receive higher billing, and neither will accomplish anything worthwhile in the long run.

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