Livestock > Outlook & Prices > Prices
October 2023
Pork industry structural changes possible
Returns to farrow to finish production posted a sharp loss of $58 per head in April 2023 according to the Iowa State University Estimated Livestock Returns model and are projected to average a loss of $32 per head in 2023.
The next year continues to look difficult financially for hog producers. An average annual loss of $18 per head is forecasted for 2024. If realized, 2023 and 2024 will go down as the worst two year stretch for profitability in hog production, even eclipsing the infamous losses in 1998 and 1999. But profits will eventually return to the pork industry.
When we look back, we will likely see continuation of two trends: more contract production and more packer owned hogs. Such structural changes provide both challenges and opportunities to everyone in the pork supply chain. Those who manage through this tough time will earn rewards.
Who does what under contract production?
The total number of hogs under contract owned by operations with over 5,000 head, but raised by contractees, accounted for 52% of the total United States hog inventory, up 2% from 2022 (Figure 1). This is according to the latest Hogs and Pigs Report, published by USDA’s National Agricultural Statistics Service, and reporting inventories as of September 1, 2023. This contract production statistic has been included in the narrative of the quarterly Hogs and Pigs Report since December 1996 when it was 21%.
Production contracts deal specifically with the production and management of hogs.
A production contract is an agreement between a contract grower or contractee and a contractor or integrator. It sets terms, conditions, and fees the contractor will pay to the contractee to produce pigs. A production contract shifts some risk and control from the grower to the contractor. Most production contracts include written terms for length of contract, terms for renewal, conditions for termination and specific language defining which party is responsible for certain inputs in the production of pigs.
Typically, a contractor provides pigs or breeding stock, feed, and other services to a grower. The grower manages the hogs at his or her farm operation until they are ready for market or transfer to other farms. Contract growers have large capital investments in specialized buildings and equipment. Fixed costs to operate such facilities have a major impact on the profitability and net returns to the grower’s investment and management. Growers also face other business risks including rising interest rates, changes in fuel and utility rates and counter-party risk.
Complexity heightens counter-party risk
Hopefully production contracts reduce risk exposure for both parties. But contracts also make both parties more vulnerable to actions, or failures to perform, by the other party. That’s counter-party risk.
Rising use and increasing contract complexity bring potentially more counter-party risk for producers. Counter-party risk was minimal when producers were more or less stand-alone businesses. They purchased inputs and sold hogs through arms-length transactions in spot markets with many buyers and sellers.
Integrators also face financial risks and economic pressures. Risk exposure includes potential hikes in grain, soybean meal and other feed ingredient prices, changes in hog prices, changes in transportation costs and production risks associated with disease or other factors that reduce pig performance and efficiency. Sometimes contractors provide contractees incentive bonus payments for better feed conversion or lower death loss to share some of this risk but also some of the reward.
The integrator’s goal under the contract is cost effective hog production. The integrator’s intent is to pay the grower for management and services to produce pigs and transfer facility maintenance and manure management responsibilities to the grower. The business expectation of both parties is that the arrangement will provide both parties an opportunity for return on investment.
Earlier profits drive current losses
Many producers realized record high profits in 2014. Estimated annual farrow to finish profits were $51 per head, beating the previous annual record of about $35 per head in 1975, 1978, 1987, and 2005. Everything in agriculture is cyclical. Profit levels help predict future investment and production levels. Hog producers plowed money back into their operations that brought them to the dance in 2014. This helped contribute to larger operations.
However, significant investment in the pork industry during the last decade brought considerable asset fixity and asset specificity. Producers keep producing in tough times because they cannot sell specialized facilities for what they have invested in them. That’s asset fixity. Producers also keep producing in tough times because costs to convert facilities to alternative uses exceeds their value to produce hogs. That’s asset specificity. Both delay production cuts in response to losses. One could argue this continues to play out in current survey estimates of the number of sows, gilts, boars, and young males for breeding on US farms.
The US breeding inventory on September 1, 2023 was 6.079 million head, down 1.2% from September 1, 2022 (Table 1). During the 1970s, year-to-year breeding herd changes of +/- 10% were not unusual. Even during the late 1990s year-to-year declines in the breeding herd were over 5%. Technology developments and industry structure has changed a lot since then.
Producers were not the only ones expanding during the last decade. In 2012, the US had 600 federally-inspected hog slaughter plants, according to the Livestock Slaughter Annual Summary report published by USDA’s National Agricultural Statistics Service. This number rose to 636 in 2017, fell to 619 in 2019, before increasing to 659 in 2022.
Changes in the number of producer-owned and packer-owned hogs
Vertical coordination includes all the ways that output from one stage of production and distribution is transferred to another stage. Vertical integration is one of several strategies that falls under the vertical coordination umbrella.
The decision to integrate vertically depends on many factors, including the change in profits associated with vertical integration, the risks associated with the quantity and quality of the supply of inputs (or outputs) before and after integration, and other factors. A vertically integrated firm, which retains ownership control of a commodity across two or more levels of production, represents one type of vertical coordination. Vertical integration in agriculture often involves ownership of both farm production and processing activities, particularly in certain parts of the livestock sector, including hogs.
The term "packer-owned swine," as defined in the Code of Federal Regulations, means swine that a packer (including a subsidiary or affiliate of the packer) owns for at least 14 days immediately before slaughter. USDA’s Agricultural Marketing Service summarize producer-sold, packer-sold and packer-owned transactions in the National Daily Direct Hog Prior Day Report - Slaughtered Swine (LM_HG201)
So far this year, 40.4% of the total barrow and gilt volume included in the LM_HG201 report was packer-owned, up from 28.4% of the volume in 2016 (Figure 2). What changed? Two new pork processing plants opened in 2017 and another new plant opened in 2019. Producers own these new plants. Hogs that were once categorized as producer-sold are now packer-owned.
Reductions in the number of hog operations and increases in farm size have also occurred alongside increases in production contract use and packer ownership of hogs. According to data from the Census of Agriculture the number of hog operations with inventory declined 45,994 operations, or 37%, between 1997 and 2002 and continued to drop through 2012. In 2017, the number of hog operations with inventory actually increased. There were 66,439 hog operations in 2017, which was up 3,193 operations or 5% higher than in 2012, but still 47% less than in 1997.
The average hog farm size roughly doubled over those two decades, as measured by the number of hogs in inventory per farm. The share of the U.S. hog inventory on farms with 5,000 or more head rose from 40% in 1997 to 73% in 2017. Overall, the US hog inventory increased by 18% over the 20-year period, and the average farm size rose from 490 hogs in 1997 to 1,089 hogs in 2017.
The 2022 Census of Agriculture data is set to be released in February 2024. This data will capture some of the structural changes currently underway in the pork industry.
Commercial slaughter and price forecasts
Table 2 contains the Iowa State University price forecasts for the next four quarters. Prices are for the Iowa-Minnesota producer sold weighted average carcass base price for all purchase types. Basis forecasts along with lean hog futures prices are used to make cash price projections. The table also contains the projected year over year changes in commercial hog slaughter.
Lee Schulz, extension livestock specialist, 515-294-3356, lschulz@iastate.edu
