A series of unfortunate events

Economic crises at two of the Prairies’ largest hog companies are the latest events in a tumultuous 15 years for the industry. While the number of hog operations contracted, the number of hogs soared and then contracted. Low cost feed and a cheap loonie initially prompted expansion but a currency now at par, expensive feed and trade barriers in recent years wiped out profits.
In this first installment of a two part special series, Karen Briere and Ed White examine the history of the industry and the volatile economic forces at work that have made it such a challenging business.

Producing pigs on the Prairies is highly efficient, ideally suited for the environment and better placed relative to production in almost all other countries.

It’s been that way for decades, according to most economists, so why does the industry keep suffering catastrophic financial crises?

It’s something agricultural economists are studying, and while some answers seem generally accepted, solutions are tricky to find.

“Whether you make it through (this present crisis) is all about finance,” said Al Mussell of the George Morris Centre in Guelph, Ont.

“Our capitalization levels have proven inconsistent with the kind of volatility we have run into.”

Dermot Hayes of Iowa State University agreed, but also noted the string of unexpected events that have hit Canadian farmers since 2006, including country-of-origin labelling, the repeated escalation of feedgrain prices and events such as the H1N1 outbreak.

“It’s just been a series of bad luck,” said Hayes.

“It’s possible to hedge six months out, nine months out, but given what’s happened, it would have been hard to hedge against all of this.”

Chris Hurt of Purdue University thinks feedgrain price volatility is enough to explain most of the industry’s problems. There’s lots of demand for pork, and the market is not oversupplied.

“What has been the biggest source of variability (in profitability?)” said Hurt.

“It hasn’t been overproduction (of pigs and pork). It isn’t producers trying to be greedy and producing too much. It’s feed prices.”

Feed can make up 75 percent of the cost of producing a pig, which results in surging production costs and massive losses when feed prices increase by 60 percent in less than two months.

Mussell, who has been trying to find the underlying cause of long-term financial vulnerability in the hog industry, said the source appears to be too little working capital for a heavily cash-consuming industry. Many standalone hog production farms don’t have enough cash cushion to absorb unexpected periods of huge losses, even if profits are expected soon after.

Modern hog barn systems tend to be built with large amounts of debt that needs to be serviced. They also employ workers who need to be paid and buy feedgrains for cash rather than produce feed themselves.

That combination creates a never-ending need to earn money from hog sales to cover obligations. Operations like that can quickly run out of gas when sudden, short profit collapses occur.

“This stuff soaks up cash,” Mussell said.

The troubles of Big Sky Farms in Saskatchewan and Puratone in Manitoba, which recently ran into financial trouble, had a large proportion of paid staff and heavy debt loads but no large grain production base.

The state of diversified mixed grain and livestock farms is less well known, but there are reports of much better conditions at farms that combine large-scale grain production with hog production. That is common with Hutterite colonies and a minority of modern hog operations, especially family-operated farms.

Grain produced on-farm can be used to feed the pigs, which reduces the need for cash flow to buy feed.

As well, sales of high-priced grain can compensate for losses from hog production.

“Maybe we need to go back more to that land-based model that by nature shields us from some of the risks around cash flow and working capital,” said Mussell.

However, that would likely undermine some of the efficiencies developed in the prairie hog industry because farmers who grow large acreages of grain and raise hogs are unlikely to be as proficient or attentive as farmers who specialize in one area.

“There are some economies of scale and economies of efficiency lost if you do that,” said Mussell.

However, farmers need to balance those production efficiency losses against the risk of requiring large amounts of working capital to survive sudden downturns.

Mussell said one solution is for farmers to build up capital and keep it there.

Many of today’s problems developed because the 2006 cyclical price slump was followed by only a brief period of recovery before skyrocketing feedgrain prices in 2007-08 drove farmers back into losses.

The 2008-09 world market meltdown then hammered down hog prices in what should have been a profitable year.

Having a supportive banker is essential when facing that sort of “double whammy” situation. Hedging future feedgrain purchases and hog sales is also crucial.

Hurt said the industry’s financial vulnerability to shocks imperils producers who should otherwise have a positive financial outlook.

“This is a strange situation (right now): losing a lot of money, but the losses are going to be relatively short in duration, while very intense in magnitude,” he said.

“It will be up to their lenders or their creditors to decide whether they will continue to provide additional financial flow of funds to keep them going through this loss period.”

The real answer to the hog industry’s woes is for feedgrain prices to drop significantly and for hog prices to stay strong.

The best way to achieve that is to grow normal crops in the next year or two and see a few people quit or be forced out of the industry.

“Somebody somewhere is liquidating, but it’s not enough yet,” said Hayes.

“Until somebody liquidates enough, the pain continues.”

Will the U.S. Midwest and Canadian Prairies be what they have seemed before — an ideal place for profitable hog production — once feedgrain prices drop, the sow herd has shrunk and surviving farmers are able to rebuild their finances?

“Absolutely,” said Hayes.

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