Hog marketing is a margin game. The objective is to manage quantities and prices of inputs used to produce hogs, and volume and sales prices of hogs sold, so as the revenue per head or per cwt. exceeds the cost per head or per cwt.
In recent years, hog farmers, and particularly wean-to-finish growers, have started calculating a “crush margin.”
Hog marketers borrowed the “crush margin” concept from the soybean processing sector. Bean processors crush soybeans to produce oil and meal. Processors use soybean, soybean oil and soybean meal futures to find and manage profit opportunities as the three related markets trade months before the beans are physically processed.
“In the case of wean-to-finish pigs, the margin is the value of the market hog less the cost of the pig and the corn and soybean meal to raise it,” explains John Lawrence, an Iowa State University economist. Wean-to-finish producers can use futures to lock in the feed and hog price when the margin is favorable.
Regardless of the name, the margin is the remaining revenue used to pay all other costs and, hopefully, return a profit. The crush margin provides an indicator of return that takes into account the variables with the greatest price risk. It is also tied to futures market prices that producers can use to manage the price risk for several months before the hogs are sold.
Suppose the projected crush margin for wean-to-finish pigs placed in April is $45.91 per head. Further suppose the non-feed and non-pig costs to finish the pigs add up to $43.65. The projected crush margin covers costs, leaving $2.26 per head expected profit. That knowledge positions the producer to make an informed decision on whether to use futures to lock in the margin.
The Iowa Pork Industry Center at Iowa State University provides a crush margin analysis tool on its website with the following objectives:
● Calculate and report the crush margin based on Wednesday futures closing prices for wean-to-finish hogs that will go to slaughter a year or more in the future.
● Track how the margin for each contract has changed over time.
● Report the margin average and variability by month over the last 10 years.
“The crush margin calculation and history can serve as a quick indicator of risk management opportunities,” explains Lawrence. “It can help farmers monitor the hog and feed markets for current and future marketings.”
Visit www.econ.iastate.edu/margins/swinecrush.htm for calculations using current prices.
“One key is to understand how your costs compare to the defined crush margin,” explains Lawrence. In his analysis, Lawrence defines the crush margin (CM) as the value of the hog less the cost of the pig, corn and soybean meal to finish the pig. Specifically,
CMT = (2 x LHFBT) - WPT-5 - (10 x CFBT-5) - (.075 x SBMFBT-5 )
● LHFBT is the lean hog futures that expire in month T (or one month after T, in the case of off-contract months) adjusted for the basis (B) for month T. This price is multiplied by 2 for a 200-lb. carcass.
● WPT-5 is the weaned pig price at placement, five months prior to slaughter. Prior to buying the pig the first week of the placement month, the pig price per head is estimated to be 50% of the five-month-out lean hog futures price not adjusted for basis. Fifty percent is the average ratio of USDA reported national weaned pig price per head and the five-month-out LHF.
● CFBT-5 is the corn futures price at placement adjusted by the North Central Iowa Basis multiplied by 10 bushels.
● SBMFBT-5 is the soybean meal (SBM) futures price at placement adjusted by the Iowa soybean meal basis multiplied by 0.075 tons, or 150 lb.
At placement, the first week of the month, Lawrence assumes that the weaned pig, corn and soybean meal are purchased in the spot market (S) at the weekly average price. The CM then becomes:
CMT = (2 x LHFBT) - WPS- (10 x CS) -(0.075 x SBMS)
When the hogs are sold in the spot market at time T, the selling price is the weekly average price of Iowa– Southern Minnesota barrows and gilts, and the final margin is calculated.
The purpose of the CM is to serve as a simple indicator of potential returns and not as a measure of profit or loss to any one farm. The CM can differ from an individual’s return in two places. First is the weighting in the CM equation. Individuals may have different carcass weights, feed requirements or pig pricing formulas.
Second is in the remaining cost that the CM must cover to sustain the enterprise. The weightings will differ among producers and even among groups of hogs, but the key is to use weightings that are accurate enough to signal the general direction and magnitude of margins.
An individual may have different weighting of pig price and feed use, and different costs that must be covered.
Producers should evaluate how well the CM matches their own costs. For example, the pig pricing formula may add $2 per head to the cost, and the use of distillers’ dried grains with solubles (DDGS) may reduce the feed costs by $1.50 per head for a net difference of $.50 per head.
Regardless, the CM can act as an indicator of hedging opportunities by alerting the producer when futures prices are in the desired range.
However, it is important to note that the CM accounts for hog, corn and soybean meal prices together to protect a margin.
For example, locking in only hog prices and not corn and/or soybean meal prices leaves the producer exposed to margin risk.