Cost of Production

     I just returned from about a week in Mexico, in the Jalisco and Sonora regions (western side of Mexico from the USA south to about the level of Mexico City).  Jalisco is the Tequila distilling area and the Agave plants in various stages of development are clearly visible wherever you travel in countryside.  Sonora is prodominately cattle country but the isolation especially has led to many larger swine units developing there in the last 30-40 years.  As in the USA, Mexican producers have been losing money in large amounts for a period probably six to eight months longer than those in the USA.

     I don't think it is an exaggeration to say that a global reset is taking place in the meat production complexes throughout the world.  It was brought about by the political subsidies related to ethanol and bio-fuels coupled with the increased demand from emerging nations.

     For the United States and therefore for everyone else around the globe, the particular factors which have led us to a low relative value of the dollar is making the stew a little more complex.  The sub-prime mess which halted the steadily advancing rise in US interest rates along with the decision by China to raise its own interest rates in the face of mounting inflation and their decision to at least allow their currency rates to change (though not strictly with the market) have led to a mixed bag of blessings for U.S. exporters of pork and beef.

You really have about three options and their variations on procuring feed ingredients at the best possible price. The options which are before you will be somewhat dictated by whether you can make your own feed or whether you must buy it as complete. We will deal with those shortly but before we think about buying feed right, let's take a look at how you are using it currently.

So regardless of your feed procurement strategy, the first thing you should do is to check the following things:

1. Is your feeding program (feed budget) optimized for your genetics and the current ingredient prices.

While there are definitely places to cut costs in your business (and we will be looking at several candidates), a key mistake made in lean times is relying almost exclusively on cost cutting within existing processes, often damaging both short and long-term profits, alientating employees and risking increasing overall costs to eventually "reverse" these poor decisions.

So we begin our series by looking at some of the over-arching principles that should guide your approach at maintaining and improving profits during times of low returns. We will look at these things in general terms first and then get very specific about how to increase your chance at profit improvement.

Everyone is pretty much convinced that 2008 will be a year filled with red ink for those who only produce and market pigs. The bulk of the problem of course is the unfolding and misguided government policy which is supporting the doubling and maybe tripling of average corn prices with little or no impact on the goal the policy is supposed to address, namely: more freedom from foreign oil.

The cost of this miniscule increase in "freedom" will go far beyond the increased prices users of corn are paying world-wide as a result. I am going to take another stab at those costs soon since more and more is becoming known about the unintended and collateral consequences of all of this. But since we find ourselves here, with legislators of every political stripe in agreement that it is a very wonderful thing, we have to think again about how to reorganize the operation to keep from getting sunk financially.

     The seats were still warm on the Board of Governors chairs at the FED as they arose to announce their last interest rate cut this month when the DOW plummeted over 200 points.  The past two cuts were met with at least momentarily rising markets but now the expectation is that the FED will need to be much more aggressive in 2008, perhaps one large interest rate cut or two moderate ones to stem the tide of the economic slow down which seems to be appearing (but has not actually arrived in any benchmark statistics yet)..

     Explaining the big drop, commentators pointed out the huge role expectations have in markets.  If you expect more and bigger cuts, these incremental quarter and half percent moves are just delays in the inevitable and investing will have to wait until the big one comes (and lowers the cost of investing even more).  This is the same pattern that is well documented in inflationary times.  If you expect prices to rise, you buy now and that drives up the cost of goods.  If you expect prices to fall, you delay purchases and collectively, that results in a price decline to move building inventory.

So let’s play around a bit with this variation stuff and see how the future cost of production might look for hogs if we forecast it by first forecasting corn and soybean meal prices and then putting those forecasts into a cost of production model to generate a forecast for future carcass prices.

This hog cost forecast was generated assuming that corn would average about $3.50/bushel and that soybean meal would be about $250/ton on average.  Under those circumstances and some stuff I will share in a minute, the average hog cost of production for a 270lb animal would be about $62.50/cwt on a carcass basis.  However, by using the variances and the correlation between the input prices in the forecast model, we can create a forecast not only of the average price but the range over which it is likely to wander and the probability it will reach any one price in the range.