Readers are probably tired of hearing about the impact of ethanol on the livestock industry and I'm certainly tired of writing about it. I would rather write about a.) something good that is happening and b.) something that I think we have a fighting chance of changing. Ethanol-induced corn prices certainly do not fulfill the first of those, and I fear that they do not fulfill the second either. So I will not linger on the subject this week.
Last Friday's Crop Production Report and World Agricultural Supply and Demand Estimates from USDA, however, deserve some attention, especially in light of the new rocket they have lit under corn prices. USDA's final and smaller estimate of the 2006 crop (10.535 billion bushels vs. the December estimate of 10.745 billion bushels and a crop of 11.114 billion bushels last year), and a 50-million bushel increase in exports (to 2.25 billion), resulted in projected year-end stocks falling to 752 million bushels. That is the second-lowest carryover on record and nearly 200 million bushels lower than last year. USDA increased its estimate of the season average farm price of corn by 10 cents/bushel to $3.00 to $3.40/bushel.
What was the market response? The Chicago Board of Trade futures for 2006 crop corn all went above $4.00/bushel with July trading near $4.30. Even new-crop 2007 corn futures are now approaching $4/bushel. That's about all I can handle for now.
Analyzing Price Spreads
Farm-to-wholesale and farm-to-retail price spreads don't get much attention when hog prices are high. There's never a need for anyone to blame when things are going well, so we tend to leave well enough alone. That probably makes such times when heads are cool and finances are good the proper time to study spreads and what they may mean for our business.
Figure 1 shows price spreads from pork for 1986 through November 2006. USDA's Economic Research Service publishes these estimates monthly. They are useful from a descriptive standpoint but, in my opinion, are limited from an analytical standpoint by the way in which the retail price series is computed. The USDA retail price series is based on a rather small sampling of pork cutout prices gathered each month by the Bureau of Labor Statistics. Each cut's prices are averaged and are not weighted, thus, meaning that a low price that may move large quantities of product counts the same as a high price at which very little quantity may be sold. This tends to smooth out the price data and makes it very unresponsive to times of low hog and wholesale prices.
Another less serious shortcoming is that the conversion factors that USDA uses to adjust 1 pound of retail pork to some equivalent amount of wholesale pork and, eventually, an equivalent amount of live pig, are very old. This problem should be solved soon as USDA is nearing the completion of a project to update its conversion factors for many agricultural products.
Even with those shortcomings, these price spreads are interesting to study. A few features of the spreads should be noted.
- They are not profits. These are gross margins from which all costs of transformation, transportation, packaging, marketing, etc. must be paid. There may or may not be a profit left after all of those are deducted.
- They tend to make discreet shifts and then remain relatively constant. It happened in the late '70s and again in the late '90s. I attribute the shift in the '90s to the Hazard Analysis and Critical Control Point programs and much higher food safety scrutiny. Some would attribute it to consolidation at the packing and retail levels. I don't think that was the major factor but would agree it had an effect, especially over short periods of time.
- Their trend has been flat since 2001. These spreads have been moving sideways during this past period of higher hog prices. The variability of the farm-to-wholesale margin is apparently smaller than in the past, while the variability of the wholesale-to-retail margins appears to be larger. I would attribute the former to more coordination in the producer-packer relationship and the tendency for wholesale and producer level prices to move together better than in the past. The latter is likely due to more competition from other species and higher volatility of those species' prices than in the past.
Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.