Hog producers face another challenging landscape in 2013, with costs projected to remain high through the balance of the current crop year. As most producers are well aware, feed expenses have been the principal driver behind soaring production costs over the past few years.

From the demands of ethanol to surging Chinese imports, to drought in Argentina and, more recently, a historic drought in the United States, feed prices have had many catalysts to maintain their lofty prices over the past several years. Unfortunately, hog prices have not always kept pace with higher costs of production.

Margins in the last quarter of 2012 were exceptionally poor, dipping to levels last seen in the disastrous years of 2009 and 2010. The first quarter of 2013, while improved from earlier projections, is still projecting a loss for producers selling hogs on the spot market and paying current feed prices.

The main challenge for pork producers today is significantly higher breakeven levels. For example, an operation in southeastern Minnesota that might have faced breakeven levels around $68/cwt. (carcass) in 2009-2010 now faces a breakeven closer to $80/cwt. (carcass) in the first quarter of 2013. Obviously, when corn was trading around $7/bushel vs. $4/bu. back then and soybean meal was priced at around $430/ton compared to $300/ton or less in those years, the challenge was much greater.

Most producers closing out their books on 2012 and preparing their marketing plans for 2013 are no doubt concerned not only about feed costs but also availability as they head into the new year. Many wonder if it makes sense to book feed forward despite high prices, given the shortage in this year’s crop. Should they extend coverage further out into the summer given the real possibility of spot shortages developing in the cash market later in the year?

While there are no easy answers to these questions, there are a few guidelines that may help producers navigate the uncertainties over South American production this winter, U.S. crop acreage in the coming year and, ultimately, how high or low prices may be as a result of all of the unknown variables.

Building a Plan

As a starting point, given the other costs of production — including non-feed expenses as well as feed costs not associated with corn or soybean meal — are first-quarter hogs priced attractively enough to justify booking corn and soybean meal at current levels? Acknowledging that margins are already negative, committing to a firm price for corn and meal needs probably isn’t the best choice today.

What about looking ahead to Q2? Here, finishing margins are positive at around $10.50/cwt. (carcass) and are currently around the 75th percentile of the past 10 years. This means that the margin has only been stronger than $10.50/cwt. about 25% of the time over the previous 10 second quarters. While every operation will view their risks and opportunities through the prism of their unique circumstances, being able to secure a positive margin by committing to both input costs and revenues, simultaneously, may well make sense with a historically strong profit margin available to capture based on current prices.

This positive margin could be accomplished either through the local cash market or the use of exchange-traded derivatives. One major distinction between the two would be the consideration of the “basis.” This has been a big discussion point recently as there is a huge premium built into forward-basis values for those looking to book feed needs deep into 2013. What it essentially comes down to is there is no carry built into the futures spreads. In other words, the market is actually inverted in both corn and soybean meal with deferred futures contracts trading at a discount to nearby expirations.

By contrast, those who hold the physical commodity (corn, soybeans) in storage are asking you to pay for them to keep it there, and they are not willing to give up their right to sell to someone else now without consideration (since the Chicago Board of Trade is not paying them to store it through spreads). This situation is exacerbated by the fact that we are coming off of a short crop and there is real concern that there will be a supply squeeze if problems develop with next year’s production.

Unfortunately, there is no easy way to manage this forward-basis risk exposure, although again, there are guidelines to fall back on. What has been the historical variance of corn and soybean meal basis in the local market during the spring and summer? How strong (high) has it ever been? What would it cost now to book feed needs ahead into these periods? Does it make sense to commit to that forward basis in consideration of one’s history?

This brings about another topic of concern — availability of supply. Obviously, this is a bigger issue for larger operations trying to manage the logistics of their feed supply. Again, some common sense may help to avoid making rash decisions. Where is the supply most likely to come from? How can one help assure this supply stays local and remains available later in the year when it is needed? Perhaps there are arrangements that can be worked out with local growers that are mutually beneficial and addresses both party’s needs. 

Returning to the issue of price, even though margins are strong in Q2, what if a producer doesn’t want to commit to $7/bu. corn or $400/ton soybean meal? In that situation, it might make sense to include flexible price contracting alternatives in the marketing plan.

There is an old saying: “Short crops have long tails.” What this means is that price typically reacts early (spikes) to the realization that there is a production shortfall and then slowly tails off (retreats) as the market adjusts to the actual supply. While no one knows for sure whether the recent weakness seen in corn and soybean meal prices will continue, there is no doubt that prices will remain very high from a historical perspective. Choosing contracting alternatives that allow for lower prices to be achieved over time is something well worth considering in the current market environment.

Chip Whalen is vice president of education and research at Commodity and Ingredient Hedging, LLC.