When my eldest son was 5 years old, we saw a giraffe being born at the St. Louis zoo. His response was something along the lines of: “Eeewww! That’s yucky! It has really long legs. Can we find the arcade now?”
His response was, of course, completely unacceptable to me as I tried to convince him of the rarity of this occurrence, especially its being witnessed by a kid who at the time lived in central Missouri. He might grasp that concept now, at 25, but I’m not certain he would even today.
We may be witnessing something about as rare as the birth of that long- and wobbly-legged spotted baby 20 years ago – that being the equally rare and dramatic reductions in chicken output. Figures 1, 2 and 3 show three perspectives on this noteworthy occurrence.
Figure 1 shows actual egg set numbers for 2007, 2008 and the average for 2002-2006. Broiler egg sets dropped below year ago levels in late March and have been lower, year-over-year, in every week but one since. The magnitude of the reductions grew in early July and then exploded in early September.
Figure 2 shows the year-over-year percentage changes for broiler egg sets. Note that much of 2006 saw small reductions in egg sets before higher broiler and chicken parts prices encouraged a resumption of growth for much of 2007 in spite of higher feed costs. Growth rates of roughly 4% for Q4 ’08 and Q1 ’09 finally came home to roost this past spring and summer when steady chicken prices ran head-long into record-high feed costs.
Those factors have done monumental damage to Pilgrim’s Pride, the nation’s largest broiler producer and have hurt Tyson Foods, Sanderson and others as well. The economic pain has finally driven some producers to reduce output even though Dick Bond of Tyson stated over and over last week that Tyson views the supply-demand balance position in the broiler industry as about right. I think that is code for “We did the cutting back in 2006. It’s y’all’s turn now.”
Figure 3 puts this in the proper historical perspective, which is: “The U.S. broiler industry has never seen anything like this!” In fact, the industry had hardly ever (at least since 1987 when my data set begins) seen any weeks below one year earlier until late 1999. It had never seen a 5% year-over-year reduction until October 2002, when it finally responded to Russia’s chicken embargoes – and then there was a whole two weeks of draconian cutbacks.
This appears to be the “real deal” and it will have some major impacts on U.S. chicken prices. The lower sets since March have already driven slaughter reductions this year and the summer cutbacks have caused slaughter to be 3% lower since Sept. 1. Part of that reduction has been offset by an increase in bird weights, but even production is lower by 2.6% over that period. And the slaughter and production reductions will get larger any day now as the birds from those lower September egg set weeks reach market age.
Propping Up Pork
What does this mean for pork? I think it means some much-needed help in the meat case. Checkoff-funded research conducted by Texas A&M University in 2005 showed that the substitute relationship between pork and chicken has increased over time. That relationship is a big reason that the Russian embargo on chicken imports in 2002 had such a huge impact on pork and hog prices. This situation should be the opposite – higher chicken prices will cause some consumers to switch to pork, thus driving up prices. The big question is whether that positive impact will outweigh slowing exports as the U.S. dollar increases in value.
Then There’s Ethanol
What is going to happen to the ethanol industry? That’s a widespread and important question at the moment. Falling oil prices beget falling gasoline prices which beget falling ethanol values. And, ethanol plants are getting caught between falling output prices and nasty corn prices.
Figure 4 illustrates a point that I think we are going to see repeated often. It contains a simple computation of the profitability of converting a bushel of corn into ethanol. The parameters come from a spreadsheet developed by Iowa State University’s Agricultural Marketing Resource Center (www.agmrc.org/), although I was unable to find the spreadsheets on the site Thursday night. The conspiracy theorist in me wonders why they are no longer there. But alas! I had saved a copy a few weeks ago and plugged in corn, ethanol, DDGS and natural gas prices for last week.
Isn’t it curious that the price of corn last week was such that the net profit from turning corn into ethanol was practically ZERO? That is exactly what a competitive economic model would suggest. Ethanol makers should bid enough for corn that their “economic profits” (i.e. profits above “normal” returns on invested assets) are zero. Economic returns in this instance are actually slightly negative since this model does not include a payment (i.e. normal return) to the 50% of investment that is assumed to be debt capital.
The result may not happen every week, but efficient markets should result in corn being priced off its highest valued use and that is still ethanol. Neither $50/cwt. carcass hogs, nor $80 broilers, nor, for sure, $90 and lower fed cattle would support $3.75/bu. corn. But even a struggling ethanol business will. Don’t expect corn to go much lower unless oil and gasoline do so. That could happen, but the point is that ethanol is still driving the corn price train!
CORRECTION: In the Nov. 14, 2008 North American Preview, I incorrectly listed JBS-Swift as a company that plans to use the multi-country label for pork and thus would buy Canadian-born market hogs. They have not done so since mandatory country-of-origin commenced and do not plan to do so. I apologize for any inconvenience the error may have caused.
Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.