As the hog industry evolves, so do packer contracts. Last month, Hormel Foods released its latest contract, Long-Term Hog Procurement Agreement (LTHPA) #3.
No additional hogs will be contracted under this program. Only an extension of expiring contracts or a conversion of existing contracts will be allowed.
In a letter to producers holding previously issued agreements, Ray Bjornson, Hormel's director of pork operations, described LTHPA #3 as "the contract of the future" that "provides hog producers a fair price while continuing to supply Hormel Foods with quality hogs."
With processing plants in Austin, MN, (daily capacity about 16,000); Fremont, NE, (8,500); and Rochelle, IL, (7,100), Hormel is the nation's sixth lar gest hog processor, processing about 8% of the nation's hogs. Hormel says that half of its hogs were procured under a long-term agreement in 1998. Industry analysts estimate the number could approach 75% in 1999.
LTHPA #3 eliminates the ledger concept Hormel used in its first two contracts. In those contracts, Hormel offered a contract price based on a matrix of corn and soybean prices. When market prices went below the matrix price, Hormel paid the full matrix price but maintained a ledger of the difference between the two. If market prices move above the matrix price, the difference or a portion of the difference is deducted from the ledger.
Length of the contracts vary with contracts commonly offered for a five- to 10-year term, with a five-year extension available under some conditions. Most of the existing Hormel contracts dissolve any remaining ledger at the end of the extension. Despite this dissolvement option, some creditors, accountants and producers were uncomfortable with the ledger accounts. "This contract addresses the concern many groups have expressed over the large negative balances in many producers' ledger accounts," Bjornson states in the letter.
Whereas the previous contracts had paid the full matrix price if the market price was lower, under the new contract, producers will have to split up to $4/cwt. on the downside. For example, if the matrix price is $40/cwt. live and the market price is $10, the producer is paid $36. If the matrix price is $40/cwt. live and the market price is $38, the producer gets $39.
A transition plan under LTHPA #3 allows a four-year phase-in of the $4/cwt. producer contribution by $1/year. And, the new contract provides for the elimination of current ledger balances in five years or less. The ledger continues until either 50% is paid back or five years, whichever comes first. If the producer defaults prior to ledger elimination, Hormel Foods may call producers' negative ledger balance due and payable.
The contract incorporates a 50/50 split of prices above the matrix. Therefore, if the matrix price is $40/cwt. live and the market price is $46, the producer receives $43.
The new matrix uses a 20-week average of Omaha corn and Decatur, IL, meal (44%). Previously, Hormel used an eight-week average. The new matrix price provides coverage of feed costs about equal to the period it takes to finish pigs. The longer period means the matrix price is less subject to feed price volatility.
The new matrix offers a 30 cents/cwt. live bump for each $10 move in meal and a 40 cents/cwt. live bump for every dime move in corn. For example, at $160/ton 44% soymeal (basis Decatur) and $2/bu. corn (basis Omaha), the matrix pays $39.80/cwt. live. With corn the same, and meal at $170, the matrix goes to $40.10. The first matrix moved 40 cents and 50 cents/cwt. live for corresponding moves in meal and corn.
The new live matrix is converted to a carcass matrix based on the actual yield and the actual carcass performance of all long-term contract hogs. This conversion factor will be updated yearly or whenever the carcass buying program changes.
Future carcass buying program changes are also addressed. If premiums go down, the carcass matrix price goes up and vice versa.
"I don't know if these contracts are helping or hurting us," says Max Waldo, DeWitt, NE, producer. "I have a contract myself. It gives me some security that I can operate with a positive cash flow but it also plays into the hands of the packers and the captive supply concept. If we all get contracted, the packers have little incentive to competitively bid," says Waldo.