The hog industry that arises from the current crisis will need to be fundamentally different from the one that’s dying today, hog industry economists say.
If producers who survive this downturn hope to survive the next one, they need to reengineer their production systems, financial foundation and marketing approach.
“Recognize that the world has changed,” said Iowa State University economist John Lawrence.
Key assumptions of the past that are being discarded include:
- Feed grains will be cheap.
- High debt levels can be sustained.
- Farmers can assume the market will be reasonable and rational.
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To survive the next big downturn, barns will need to:
- Be highly feed efficient and located in a feed surplus zone.
- Have low debt.
- Be carefully hedged for market risk.
Many operations built in the past 15 years were based on cheap feed grains and cheap energy, which means producers focused mostly on a barn’s structure and capital efficiency rather than selecting the right location and pig efficiency. The radical rise in the cost of feed grain and energy has reversed that view.
“The business model of the 1990s and 2000s that focused on throughput and economies of scale loses ground to production systems that have more efficient hogs and location advantage,” Lawrence said.
When feed grain and energy were cheap, hog producers could operate their barns far from the grain-surplus areas of the U.S. Midwest and still be efficient and profitable.
However, once feed grain and energy prices began rapidly rising in 2006, the relative cost of feed grain became the single biggest factor in a hog barn’s profitability, economists say.
Farms outside of grain surplus areas will be at a permanent disadvantage if high feed and fuel prices continue.
“With higher energy prices, the advantage that farms and regions that are grain surplus have over grain deficient regions increases,” Lawrence said.
“The cost of transporting grain from surplus to deficient regions is higher. The value of the manure nutrients that can be utilized in grain-surplus, nutrient-deficient regions are now more valuable.”
That means there should be a long-term trend back to the diversified farm and away from stand-alone hog operations.
“Integrated crop-livestock farms will regain advantages that were lost during periods and policies of cheap oil and cheap grain,” Lawrence said.
University of Missouri hog industry analyst Ron Plain said stand-alone barns require lower debt than mixed farms, yet many recently built barns are debt-intensive.
“If you’re just starting in the hog business, you need to keep your debt to asset ratio under 50 percent,” Plain said.
“As you diversify you can go a little bit lower on that number.”
Economists argued in the mid-1990s that Western Canada should be a feed grain surplus area and ideal for competitive hog production,
However, George Morris Centre economist Al Mussell has said this is not occurring because the biofuel industry is swallowing the feed surplus.
He called it the greatest threat to Canada’s red meat industry and denounced federal aid for biofuel development, which he says negates the value of federal aid for hog producers.
“The pork segment should see the grain-based ethanol industry for the menace it is,” said Mussell and meat industry consultant Ted Bilyea in a recent report.
“The notion of opening the throttle and applying the brakes at the same time is that something must give, eventually.”
Mussell said the assumption of cheap feed grain was the main rationale for expanding the Canadian hog industry in the 1990s and 2000s. But cheap feed was short-lived, and that has transformed the hog industry in Manitoba’s Red River Valley.
“Hog production in Ontario and Western Canada was established based on feed grains that were priced low relative to the U.S., or the prospect thereof,” said Mussell and Bilyea’s report.
“Indeed, one way to interpret the expansion of the weanling pig export segment in Canada earlier in this decade was an erosion of precisely this feed cost advantage.”
Lawrence said the feed share of hog production costs has increased and will continue do so because the hog industry is shrinking, which results in producers having less money tied up in capital costs. With many surplus barns on the market, capital costs should decline greatly as producers stop building barns and amortize existing new facilities.
That should lessen the debt burden on producers after this crisis but will shift the emphasis onto feeding efficiency.
Farmers will need to make sure each pound of pig is produced for the least cost, rather than each barn producing the most pounds of pigs, which was the main focus when long-term debt management was the key consideration.
Lawrence said raising weaning age to 24 days from 17 makes each pig more feed efficient, allows the use of cheaper starter diets and reduces the cull rate. That reduces the number of pigs in the barn because each grows larger, which also reduces the number of sows needed.
“The end result is lower cost of production per pounds sold,” Lawrence said.
“If your only goal is to maximize pigs or pounds to reduce fixed cost, you miss the efficiency gains.”
Even if farmers manage to reduce their operations’ debt burden, increase feed efficiency and operate mostly in feed-surplus regions, there’s another essential area they need to master or risk losing the other gains: risk management.
The dramatic rise in energy prices since 2003 and the sudden rise in grain prices in 2008, as well as the volatility of those prices, have revealed much greater risks to hog profit margins than producers have traditionally expected.
Margins can now swing so much that getting feed and pig price expectations wrong can be a bankrupting situation.
Lawrence said margin squeezing should continue more intensely than in the past because the industry has reversed its recent course of growth.
“Remember, we are not cycling through a growing industry. We are downsizing an industry,” he said.
“It … includes capturing shorter margins between feed and hog prices when they exist. Because of the volatility in feed prices, (you must) manage both sides of the market and not just hogs.”
He said farmers also need to be more rigorous with what they consider hedging. Handshake agreements and even written contracts have proven untrustworthy in a crisis, which is when hedging is most needed.
“Counterparty risk is also increasingly important as someone that you have a relationship or contract with may not be able to honour it,” Lawrence said.
“Mandatory country-of-origin labelling is a good example, as are feed price contracts that could not be honoured.”
