Industry Overview

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Industry Overview

Expansion and Productivity Growth Run Headlong Into Slaughter Capacity

Cash hog prices have fallen from the record highs of 2014 and the long-feared packing capacity crunch is now upon us, pushing hog prices to their lowest level since 2009. However, the lowest production costs since 2010, continued strong domestic demand for U.S. pork and rebounding U.S. pork exports are mitigating the impact of large pork supplies and extremely high capacity utilization, but losses for producers this fall and into 2017 will be substantial.

Three years of good U.S. crops, including record harvests in both 2014 and 2016, have kept corn and soybean prices in check and pushed farrow-to-finish production costs lower (Figure 1). Costs averaged $67/cwt carcass in 2015 and are forecast to average just over $64/cwt. for 2016. As of early November 2016, CME Group corn and soybean meal futures suggest that costs will be only slightly higher in 2017. The estimates, based on the production parameters of Iowa State University’s Estimated Costs and Returns series, differ from past estimates due to an update of ISU’s cost estimate parameters. The new parameters provide cost estimates that are representative of the best farrow-to-finish operations in the U.S.

Figure 1

estimated farrow-to-finish-hog production costs

Domestic Pork demand grew dramatically in 2014 and maintained the gains through 2015. Real per capita expenditures (RPCE) for pork (Figure 2) are a useful measure of pork demand because the calculations include both the quantity of pork used and the price at which it was purchased. Pork disappearance is the amount of pork available to the U.S. market (beginning inventories + production + imports) that is not accounted for by exports or ending inventories.

Figure 2

real per capita pork expenditures

The pork disappearance (ie. all pork products sold in retail and restaurants) is assumed to all be consumed by end users. Total pork disappearance/consumption is divided by the total U.S. population to determine per capita consumption.

The RPCE calculation also uses USDA’s estimated weighted retail price of pork. That price set a record of $4.215/retail-weight pound in September 2014 due largely to output restrictions and concerns caused by porcine epidemic diarrhea virus (PEDV).

A significant rebound for pig numbers (2015 slaughter was up 8 percent from 2014) allowed prices to fall by 12 percent to $3.696 in May 2015 before rebounding seasonally to $3.979 by October. The average retail price of pork was $3.789 in September 2016, the last month for which data are available.

To put these prices in context, consider that the average retail pork price had never been higher than $3.696 per pound (the May 2015 low) before July 2013, but it has been that high or higher every month since. While the industry always endeavors to bring good value to consumers, it is a testament to improving consumer preferences and the industry’s ability to meet those preferences that U.S. consumers are willing to spend more money for pork.

The RPCE for pork rose 3 percent in 2015, following gains of 5.5 percent in 2013 and 7.6 percent in 2014, making this the best three-year period on record for pork demand. Monthly RPCE levels for pork fell short of year-ago levels in January through March of 2016 but increased slightly, year-on-year, in April and has remained near 2015 levels each month since then. Pork RPCE is down 1.9 percent year-to-date but that decline is from very high levels in 2015

The challenge this fall is with weekly hog availability relative to the capacity of U.S. packing plants. U.S. pork packing capacity has grown by only 1.5 percent since 2008. The U.S. industry has faced a situation where hog numbers would tax that capacity on several occasions in past years only to be “pardoned” so to speak by unexpected, unique developments. The drought of 2012 drove feed costs higher, reducing pig supplies in 2013 and avoiding a capacity crunch that fall. PEDV resulted in a loss of an estimated 6 million pigs in 2013 and 2014, once again reducing market hog supplies from expected levels and preventing a capacity crunch in 2014. Producers’ luck ran out in the fall of 2015 when hog numbers neared capacity in several weeks and exceeded it in one, pushing cash hog prices to the low $50s on a carcass basis.

This fall the situation is much more serious. The hog harvest for the week that ended Oct. 21 set a new record of 2.514 million head. That record is very likely to fall the first week of November and, according to EMI Analytics forecasts, may well fall several more times before the end of 2016.

federally inspected hog slaughter

Pork producers have done a very good job of keeping current on marketings since Sept. 1, but higher hog numbers will impact hog prices in two ways. First, more hogs means more pork, and that extra pork has pushed (and will continue to pressure) prices of individual pork cuts lower, reducing the value of the pork carcass and thus the amount that packers will pay for pigs.

Second, this many hogs being processed through a fixed-capacity harvest system puts all of the leverage in packers’ hands and allows the spread between the carcass value and hog prices to widen. In fact, pork packers’ gross margins (the value of the pork carcass plus non-carcass by-products, such as organs, ears, snouts, skin, blood, etc., less the amount paid for the pig itself) have neared record levels and in recent weeks have exceeded 1998 levels when hog prices fell to all-time lows.

So what does this mean for producers’ bottom lines? Lower costs and continued strong domestic demand are positives for that outlook, but ample supplies and high-capacity utilization have taken estimated 2016 profits to zero and estimated 2017 profits to -$9.03 per head. The estimates are roughly $8.50 per head lower than they were in June (see Figure 3). Hogs sold in November and December could lose roughly $40 per head, with some producers losing even more.

Figure 3

average cost and revenue farrow-to-finish operation

A solution to the extremely high packing capacity utilization situation is on the way but will not arrive in time to alleviate the impacts during the fall of 2016. (See Table) One new plant has already commenced operations in Pleasant Hope, Missouri. Another is now slated to open in Windom, Minnesota, shortly after the new year arrives.

Large increases in capacity will come in the summer of 2017 when plants in Sioux City, Iowa, and Coldwater, Michigan, begin operations. Another large, new plant is now scheduled to open in Wright County, Iowa, in the fall of 2018. All of these will increase the competition for available hog supplies and provide room for industry growth. Note, however, in the weekly slaughter chart that EMI Analytics forecasts indicate that the new

2017 capacity will be largely filled by the fall of next year. The situation is not expected to be nearly as negative as the current situation, but there may not be an abundance of extra capacity even one year from now.

There are two major wild cards for the U.S. pork industry for the remainder of 2016 and beyond. The first is exports, which lagged year-ago levels significantly for much of 2015 due to a much stronger dollar, West Coast port problems in the first quarter of the year and trade restrictions by Russia and China/Hong Kong. A late-year surge drove 2015 exports up 1.8 percent from 2014. Exports for 2016 through August were 1 percent larger than one year earlier. It is likely that this improvement will grow during the last four months of the year due to lower U.S. pork prices. Analysts are forecasting 2017 export growth to be from 1 percent to 4 percent versus 2016 levels.

The second wild card is disease. As expected, the incidence and impact of PEDV decreased in the winter of 2014-2015. Most veterinarians expected losses in 2015-2016 to be greater than a year earlier because there were fewer immune sows remaining in the U.S. breeding herd. However, the incidence of PEDV breaks in breeding herds was lower once again last winter, limiting the impact of the disease on pig supplies. The impact in 2016-17 is as yet unknown as cooler weather conducive to the spread of PEDV is just now upon us. These three winters of experience with the disease and the steady improvements made in sow herd infections bode well, however.

The incidence of porcine respiratory and reproductive syndrome (PRRS) has increased in 2016 after the emergence of a new, serious strain in 2015. Death losses have been higher but did not increase enough to significantly impact hog supplies so far in 2016. Like PEDV, the winter months are the worst for PRRS. The industry will no doubt monitor the situation closely as fall and winter arrive.

U.S. packing capacity under construction

Steve Meyer,

Vice-President, Pork Analysis for EMI Analytics and a Pork Checkoff consultant, helped compile the information in the Pork Stats section.