Swine Industry Economics Report

Mark Greenwood
April 2008 

Background
This report outlines the economic situation the U.S. swine industry is currently facing. It is important to note that a large-scale liquidation of swine producers large and small will not only dramatically impact family farms, but will have a ripple effect on businesses relying on the swine industry. This in turn will cause a loss of jobs in rural America and will affect entire communities.

At the outset, it is vital to understand the current situation has no resemblance to the short-term hog market crisis of 1998-1999. This earlier crisis was caused primarily by hog overproduction and a lack of sufficient slaughtering capacity. In contrast, the current situation has more to do with dramatically higher feed prices than the oversupply of hogs. While the U.S. swine industry is producing and slaughtering a record number of hogs, it is also exporting a record amount of pork. Demand for US Pork has increased in the US and worldwide. In February of 2008, the U.S. Pork industry exported 20% of its supply which helped bolster prices. Current hog prices would be at breakeven which historically occurs during this time of year for many producers if their input costs were near what they were a year ago. The issues hog producers are facing today was not of their own making. This ‘perfect storm’ has been caused by dramatically escalating feed prices encountering stagnant pricing during a time of unexpected increases in productivity.

Economics
Since October of 2007, the swine industry has lost on average $30 per head for every hog slaughtered. These losses have already been incurred for almost 7 months. During this period, there have been approximately 30 weeks of slaughter, with an average slaughter per week of 2.3 million head, for a total of about 69 million head. Weekly losses for US producers are averaging $69 million, bringing the total equity lost by U.S. producers to almost $2.1 billion in a 7 month timeframe. On farms choosing to forego hedging feed costs for 2008, losses have approached $40-$50 per head. So, there’s a significant group of producers being economically challenged at an even faster pace than the average. For producers that hedged feed costs for 2008, 2009 appears to be more challenging because corn costs have now risen to levels beyond any hope of economic sense for hog production. The prospect of “locking in” feed costs at such levels only locks in near-certain huge losses on every head produced.

Impact on a Typical Producer
A real world illustration can shed some light on the scope and scale of the current situation. Take a mid-sized producer with 2,500 sows that finishes about 50,000 pigs a year. Almost a decade ago, this producer decided to specialize in pork production because of continued low commodity prices. An operation of this size would be considered typical or ‘moderate’ in size in today’s swine industry. This operation would support three or four families in an average year for revenue. Now they purchase all of their feed, a model that worked well for years. This producer is very good from a production standpoint. In late September of 2007, the farming operation was breaking even on the pigs they were selling and had no outstanding debt on the operating line with their lender. Their available operating line was $1.3 million, based on values of the sows and pigs owned. Since last October, this operation has been losing an average of over $30 per head. By the end of April, they will have sold over 29,000 head of hogs during this 7 month period.

• 29,000 @ $30 per head loss = $870,000; leaving $430,000 available on his operating line.

In addition to the almost $900,000 the producer has lost simply finishing pigs to market, they have also incurred dramatic cost increases to feed the livestock that are on feed – costs that have increased by at least $20 per head.

• 25,000 head of inventory on hand @ $20 loss = $500,000.

With the losses and the increased feed costs outlined above, the producer went from having $1.3 million of available borrowing capacity to having exceeded his available borrowing line by $70,000 in only 7 months. And, there is no relief in sight as far as the future months indicate. While all of the above has played out, the cost of labor, propane, transportation, and any cost tied to energy prices has also escalated.

Cost Dynamics
Here’s a snapshot of the rising feed costs encountered by a typical producer:

If we compared feed costs today versus what they were 18 months ago, the industry is spending on average a $100,000,000 more dollars per week. The poultry people are spending a similar amount same amount. This is a combined total per year of over $10 billion in extra costs than a year and a half ago. Faced with this cost – price situation, the obvious answer would be to curtail or cut-off production immediately. Most producers are doing what they can to limit production, but almost all have finishing units that are full of hogs and many have contracts for feeder pigs they must honor. Keep in mind that empty barns bring in no income either.

Longer-term Economic Impact
Demand for pork is strong and expected to remain strong. Even though pork sales are excellent, the industry must and will contract because breakeven costs far exceed what producers are receiving for their livestock.

Supply must be reduced by at least 10% to shrink production enough to get pork prices to a profitable level. Keep in mind, however, shrinking supply may have unintended consequences, such as closure of older packing plants and reducing available manure to fertilize crops (thereby increasing crop producer’s dependence on anhydrous ammonia made largely from foreign-produced natural gas and potash imported into the US – the cost of which has more than doubled in price in the last year).

The economic impact of a 10% reduction in U.S. pork production extends well beyond the impact on the hog producer. If the U.S. supply of hogs is reduced by 10%, which equates to roughly 10 million hogs a year, the number of sows must be reduced by 600,000. It is estimated this will lead to the elimination of 2,160 jobs for those who care for sows. These employees are presently paid more than a living wage in rural American and most of them receive benefits such as health care and 401(k) retirement plan contributions.

Further, if production declines by 10 million head, the facilities used to raise those pigs to market, which generally produce two groups of pigs in a year, will not be needed. This equates to about 2,100 barns that hold 2,400 head each. The average contract rate most producers are receiving on these barns is about $36 a space. The loss of this $180 million in revenues for farm families means it will be difficult for those families to remain on the farm. In addition, if the 2,100 barns have debt on them at a 50% leverage ratio, which is probably on the low side, there’s approximately a half a billion dollars in loans outstanding. Those loans are likely to go into default, creating another liquidity and credit crisis in rural America.

Other effects of the reduction in hog production include the loss of jobs in the feed industry, packing plants, lending institutions and others who provide products and services to the entire livestock industry. If supplies are reduced by 10 million, which is the suggested amount, this would likely lead to closing two processing plants and eliminating 5,000 jobs. (The economic impacts go beyond just the hog industry because the beef and poultry segments are facing the same negative impacts of high feed costs.)

Ironically, the net effect of this cost driven liquidity problem and herd liquidation will be to dramatically accelerate the vertical integration of the U.S. livestock sector. Only those with access to public equity markets or with huge balance sheets will survive. Pork processors will need to decide how they can insure their supply of product for their plants as their long-time farmer suppliers go broke and their herds are liquidated. The processors will effectively only have two options. One, they can own all of their own livestock and vertically integrate, passing rising costs through to consumers which will accelerate rising food costs. Two, they can “virtually integrate” by forming key alliances with livestock producers and provide credit assistance to those producers to insure they can keep them supplied with product. Based on the vertical integration that has occurred to date, the decision for most processors is clear – if you are going to have to provide the credit and take the risks to keep production going, you might just as well own the production. The swine industry cannot withstand the losses being incurred now and for the foreseeable future without this occurring. At a minimum, processors will work with larger producers because of their supply numbers and they will be the “survivors”. This will further hurt the small producers in rural America.

Summary
In summary, U.S. and global food prices are now rapidly rising and must keep rising in order for any of the protein sectors to continue to exist. Protein sectors with short production times, such as milk and eggs, have already dramatically increased pricing. The poultry sector is likely to follow. Protein sectors with longer production periods – hogs and cattle – must also follow. The livestock sector has no means to protect all the losses that are occurring other than the futures markets and still if you are using them it still equates to losses. Food riots in developing countries and significantly higher grocery store prices for the American consumer are already here and will continue to accelerate. We need leaders to discuss ideas on how the U.S. protein sectors can effectively manage and survive these difficult times. There is no doubt that the U.S. swine industry is the most competitive in the world today. However, despite the competitive advantages we enjoy, the U.S. industry is not sustainable in its current form if revenue cannot keep up with rising feed costs.