If You Know Your New COP Using the Leftover Corn Out There, No Need to Read This.

If you want to know the impact of increased corn prices on your cost of production, chose a forecasted corn price (take your pick of forecaster between $3.40 and $3.85 with some as high as $5.00+ if drought develops) and crank through your feed cost calculation. If you do this and it actually turns out to be your new cost of production, you will be one of the last few producers in the pork industry with absolutely no imagination whatsoever.

One thing we know for certain is that people do not face adversity sitting still. All kinds of secondary strategies, impacts, cost cutting, substitutions, new research and experiments, adjustments in weights and plain ingenuity immediately move to the forefront. In addition, poultry producers and other meat animal species that consume corn are making similar adjustments as are tortilla makers, users of high fructose corn sweeteners and even elevator/feed mills that used to get the corn. As they do, the prices of their products change relative to the price of pork and demand shifts begin to take place at the grocery store and throughout the chain.

Let’s think through this for a moment in its most basic path, and then we will look at making it a little more complex. As corn prices rise, pig production will initially decrease in response to this higher input cost. This can take the form of the least efficient producers exiting and/or pig producers simply adjusting marketing weights down. Remember if we sell 100+ million pigs a year, a few pound decrease in live-weights means a few hundred million pound decrease in retail pork on the market.

This decrease in supply will bring up the price of pork which filters back to producers. In response, producers will bring the pounds produced back up but not to the original level. This process is normally a kind of converging circle so that at the end of the day, the cost of the corn increase is passed on up the chain, but not fully, which leads to a new average pork price somewhere between the original price (prior to corn price increase) and the full increase that would have happened if the supply reduction had been sufficient and pass through was total.

That’s the typical pattern but definitely not the only possibility. The amount of pass through depends on the market structure of the chain and the shape of the demand curves. All outcomes are possible, for instance, the new net price of hogs could exceed, be equal to or less than the cost increase due to corn. In the typical outcome above, where the pork price increase doesn’t fully fund the increased corn price remember pig producing firms that remain are the more efficient ones (lower COP) and have adjusted weights downward to compensate.

What happens if we add the reaction of substitute products for pork like poultry and beef to the equation? They are also affected by the corn price increase. Some stuff has been done to estimate this impact and you will find it interesting assuming you have some imagination.