The recent upheavals in grain markets were threatening to drive feed costs sharply higher. At least that was what we thought the week before last when Russia’s wheat problems drove wheat and other grain markets sharply higher.
All of that has settled down a bit, but last week’s USDA Crop Production and World Agricultural Supply and Demand Estimates (WASDE) reports did little to squelch concern. The reports’ key numbers were bearish, but the markets reacted by rising sharply – carrying corn prices to their highest level (except for the wheat-driven spike the week before), since January. Near-time August soybean meal set a contract life high as well.
So, what does this mean for pork producers? Higher feed costs, of course. Not the ridiculously high feed costs of 2008 or even the sharp run-up during 2009 planting season (Figure 1). But, still, the highest levels since mid-2009 and, according to futures prices, yet higher feed costs into next summer.
Those higher feed prices have, in turn, pushed projected production costs steadily higher as 2010 has progressed (Figure 2). The increase has not been huge, but it has put pressure on projected margins. My model, based on Iowa State University’s (ISU) Estimated Costs and Returns parameters and futures as of Aug. 11, predicts margins of roughly $13/head for the rest of 2010 and $18.68/head for the first half of 2011. A “normal” seasonal downturn in the second half of 2011 would leave profits for the year in the $13-$15/head range.
Acceptable Margins?
Should we be happy with these levels? I’ll let you be the judge of that, but the ISU records since 1990 show the record annual profit was $25.51 in 2005, followed by $22.56 in 2004, $17.83 in 1991 and $15.83 in 2006. The roughly $15/head that is now a likely outcome for all of 2010 would rank fifth, and a slightly lower result for 2011 would rank sixth.
Obviously, that $15/head today doesn’t go nearly as far as it would have in 1991 when making house payment, saving for college or taking a decent vacation. Still, it beats most of the years we have witnessed recently.
Then there is the “entry incentive” question. I have maintained for some time that a primary factor in swinging the industry back to expansion would be prospective feed costs. Even with this year’s excellent planting season, uncertainty about feed costs has engendered some degree of hesitancy about filling empty sow spaces, whether that involves 5-10% of capacity being under-utilized or entire sow farms currently setting empty. Some of that uncertainty had waned until this recent brush-up with the Russian heat wave. It may be enough to discourage expansion, or at least mitigate its size.
As Figure 3 shows, producers’ financial positions – measured by the proxy of accumulated monthly profits – have improved significantly since it bottomed out in February. Last week’s futures prices say that about half of the September 2007 through February 2010 decline can be recouped by next July. I expect that position to keep improving through most of 2011, assuming no H1N1-type catastrophes come our way.
To Hedge or Not?
Should producers be hedging these profit levels? That depends on the usual factors – risk preference/tolerance, financial position, personal expectations for the markets, how agreeable one’s banker is, etc. Q4-2010 and Q1-2011Lean Hogs futures prices are higher than the USDA’s June Hogs and Pigs Report and stable hog demand would suggest. Futures look like a good bet for those two quarters, at least for some portion of production.
Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.
e-mail: steve@paragoneconomics.com