AgDM newsletter article, December 1997

Long run planning prices for pork producers

John LawrenceBy John Lawrence, Extension Livestock Marketing Specialist, 515.294.6290, jdlaw@iastate.edu

Pork producers considering investing in production facilities are basing cash flow projections on expected hog selling prices over the next several years.  No one can predict prices for the coming 5 to 10 years with perfect accuracy, but we can form forecasts that factor in changes occurring in the industry.

Often cash flow projections are based on historic prices such as the 10-year average.  For example, the 1987-1996 average price for Iowa - Southern Minnesota barrows and gilts is $47.37/cwt.  However, given the changes in the pork industry, this figure may be too optimistic. We only need to look at the 5 year average price (1992-1996) of $45.19 to see that things may have changed.

Declining profit margins

The growth in the pork industry is coming from producers whose cost of production is lower than average.   As these firms expand and increase supplies, prices will likely decline.  The budgeted cost of production for new facilities using specialized management and current production technology is in the low $40s.  With this level of cost, it is doubtful that supplies will stay small enough to hold prices in the upper $40s as they have been for the last 10 years.  With these favorable profit margins, firms will likely continue to expand, driving prices downward.

Strong export demand

Many in the industry believe that growth in pork exports will increase demand enough to keep up with the expansion.  U.S. exports will continue to grow, but we are starting from a small base.  Exports in 1997 are projected to be only 6 percent of U.S. production.  However, U.S. production in 1998 is expected to be 7-8 percent higher than 1997.  Domestic growth will consume 1 percent of this expansion.  So a 100 percent growth in exports would be required to offset the planned expansion.  It is unlikely that exports will grow that fast in one year, but they will continue to grow.

Premiums and discounts

In addition to the $47-48 forecast prices, some cash flow projections add a perpetual lean premium to bring the selling price to near $50/cwt.  It is questionable whether individual producers will continue to be able to receive a predictable premium over the average selling price.  The industry is on the verge of paying a premium or discount based on variables other than leanness.  Pork color, texture, pH, water holding capacity, food safety, and other measures will impact the net price received.  Hogs receiving a lean premium today may be discounted due to other measures tomorrow.

Cycles and seasonals

There is also a general belief that the industry has consolidated to the point that price cycles no longer exist and that, due to modern production technology, seasonal variation in production and prices will disappear. However, the last 25 years of data suggests that neither statement is true yet. 

As indicated before, the 10 year average price is $47.  It moved from $55 to $40 and back to $55 in 7 years.  Also the annual variation is as extreme as any in recent history. 

In December 1996, 33 percent of all hogs were on farms with less than 1,000 inventory (marketing less than 2,000 head a year).  Many of these farms will exit the industry when margins are tight over the next 10 years.  When they do prices will rise.

The range in prices within each year from the high to the low is an indication of the seasonal variation in prices during the year.  The range has been as small as $10/cwt to a high of over $20/cwt.   The range was greater in the last 3 years than it was in the previous 6 years. 

Seasonal infertility problems are often cited as a source of seasonal variation in production and prices.  While these problems are reduced in modern breeding and gestation facilities, they are not eliminated.  Also, even if there was a steady supply of hogs every day of the year, there would still be seasonal variation in demand that may result in higher and lower prices at certain times of the year. 

This seasonal variation in price is particularly important for producers buying into a system that provides them pigs every so many weeks to run their buildings all-in all-out.  They may not always get the high prices of the year.

Conclusion

For planning purposes I prefer to use $45/cwt as a long run price and treat quality premiums as a pleasant surprise rather than guaranteed revenue.  I also plan on seasonal high and low prices and cyclical ups and downs in prices for at least a couple more cycles.

 

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