One of the driving forces behind the Livestock Mandatory Reporting Act of 1999 was a desire of producers to know the prices that were being paid for hogs purchased by some means other than the daily spot or cash market. The suspicion was that there were many "sweetheart" deals in which packers were paying favored suppliers more money than was available to others.
I have to admit that I always had a problem with that suspicion. Packers are generally good businessmen and their job is to buy hogs for the lowest possible price. They do not pay anyone, favored or not, money that they do not have to pay. Generally, they only pay extra for value. While the people who work for packers are just like the rest of us, and many are very generous in their personal dealings, they are not benevolent benefactors in their work in procuring hogs.
Such suspicions were still a driver when the mandatory price reporting system was created. So, the question remains: What have the data taught us?
Figures 1 and 2 show daily prices for the four purchase classifications from Jan. 1, 2002 through June 30, 2006. Note that Figure 1 shows base price data while Figure 2 shows net prices, which include premiums and discounts.
These graphs appear just as I expected they would and they are really quite logical. Consider:
Base prices appear much more volatile from day-to-day than do net prices. At day's end, packers have to end up paying, on average, about the same amount for hogs. If they are priced too low, they simply do not get enough bought. If they are priced too high, they will find themselves uncompetitive at some point in selling pork. So, while the various base price bids vary, when we look at the average cost of each day's slaughter (a retrospective view because those hogs are purchased over several days), the prices are much more stable.
Risk managing contracts actually manage risk. The Negotiated and Swine or Pork Market Formula pricing mechanisms offer no risk protection. They result in the highest and lowest prices paid over time. The Other Purchase Agreement category includes window contracts and feed-cost based contracts that manage risk by eliminating highs and lows and tying price to costs, respectively. Finally, Other Market Formula prices are almost all based on Chicago Mercantile Exchange (CME) Lean Hogs Futures and thus reduce risk quite markedly.
The recent upside of the hog cycle has resulted in higher levels of all of these prices. Even the risk-limiting prices based on CME Lean Hogs Futures have averaged about $60 carcass ($45 live) since early 2004.
The average prices paid under these various methods reveal the "risk premiums" of producers. Other Market Formula prices, from January 2004 through the end of June, averaged $4.28/cwt. carcass lower than Negotiated prices. Other Purchase Arrangements reduced risk by a smaller amount and trailed Negotiated prices by $2.02/cwt. carcass. Interestingly, Swine and Pork Market Formula prices were $0.49/cwt. carcass higher than the Negotiated price. The likely reason for that premium is that these animals are committed to packers and thus reduce the packers' throughput risk. That means that packers pay a risk premium to producers for these hogs.