Price discovery is always difficult and it becomes especially challenging when the normal pricing benchmarks are removed overnight. In our letter on 4 October we noted how some packers were proposing to price beef and pork that was supposed to be priced off formulas using USDA prices.

The situation with hogs, on the other hand, appeared to be a bit more challenging but there appears to be some change in that regard. According to a Reuters wire story, two of the largest pork packers are proposing different ways in which to price hogs. In the case of Smithfield, according to the Reuters story, the company will use "daily changes in the Chicago Mercantile Exchange lean hog market close for the day of harvest will most closely approximate changes in the USDA reported price during the period of time until the USDA resumes publishing."

So Smithfield will tie the hog price paid to farmers to the CME futures contracts. It is unclear how this method will be affected by the changes to the settlement period. Also, we do not know the exact mechanism for pricing hogs. It would appear that company will take the last USDA price and apply the daily changes to come up with an implied cash hog price. But will there be an adjustment for basis, especially once the October contract gets off the board? Again, we only have the wire story to go by and the story itself did little to answer those questions.

According to Reuters, Cargill on the other hand will use the pork cutout value quoted by Urner Barry to calculate an implied lean hog price. Normally the cutout and lean hog carcass value move together so using some kind of relationship between the two could make sense as a stopgap measure. The question will always be what kind of factor/ premium to use for the cutout vs. the lean hog price. Much will depend on basis values and likely that will be negotiated between packers and producers.

Again, we did not see the letter and only have the wire story to go by. But using Urner Barry prices to price hogs is something we have heard being considered. The chart shows the relationship between the IA/MN Lean Hog Carcass Price (USDA Wt. Avg.) vs. the Urner Barry Pork Cutout Value. In four out of the last five years, the spread between the two during the Sep - Dec period (keep in mind seasonality) has been between $6 and $6.8/cwt.

While the spread was negative in early September, the last quote pegged it at $7.94. What is a fair premium of carcass to UB cutout will be something that packers and producers will determine. Much will depend on how current producers are in their marketings and also the number of hogs on the ground. Last Saturday hog slaughter appears to have been very light (55-60k), implying that the USDA 180lb+ hogs inventory was off by a significant amount.

Notice: CME Group announced a potential change to the way the Lean Hog carcass price will settle in the absence of pricing data from USDA. The potential alternative settlement mechanism will use “volume weighted average price of the October 2013 futures contract for trades occurring during the 2-day period of 11 and 14 October 2013, incorporating both Floorbased and Globex-based trading activity during Regular Trading Hours only (9:05 a.m. to 1:00 p.m. on 11 October and 9:05 a.m. to 12:00 noon on 14 October). This alternative final settlement methodology will be applied to all open positions on October 16. You can read the full CME announcement on page 2. (See link below)

Further Reading

You can view the full report by clicking here.