District hog prices hit historic lows

"It's just like I stuffed a $50 bill in the ear of every one of them hogs as they went on the truck." That mildly expurgated statement by a Minnesota farmer expresses the frustration felt by many district hog producers in late 1998 as prices dropped precipitously.

Several producers expressed dismay with hog prices at a special ag crisis meeting convened by South Dakota governor Bill Janklow in mid-September. Prices had just dropped below the $30 per hundredweight level at that point. By the end of November prices were well below $20, with one buyer quoting a price of $14.52 in Thanksgiving week. And in December prices fell still further, dropping below $10 at scattered points on several days.

These are the lowest prices in current dollars since mid-1965, and, adjusted for inflation, the lowest prices ever in the history of the United States, well below those of 1933 when the incoming Roosevelt administration took the step of killing baby pigs in a controversial effort to curtail supplies. While current prices had recovered to about $20 per hundredweight by mid-January, they were still well below 1997's average price of about $53.

Supply is the key issue in this price trough. The U.S. Department of Agriculture estimates that 1998 production will hit 18.1 billion pounds of pork, up by 2.7 billion pounds over 1997. That translates to a 17.5 percent increase. And while grain producers can blame reduced demand in Asia for at least some of their price woes, this is not true for pork. Exports through September are reportedly up 28 percent over the same period in 1997.

Americans are eating more pork, too, as sharply lower prices at the farm translate into modestly lower prices in supermarkets. In the first 9 months of 1998, Americans ate 7.6 percent more than in 1997, a large increase considering that prices have dropped only 2 percent at the meat counter.

Canadian imports

As producer anger about low hog prices spreads, the issue of the impact of hogs imported from Canada is becoming a hot one in parts of the Ninth District. It is a much bigger issue in eastern South Dakota and southwestern South Dakota than in other pork-producing areas such as Iowa, Illinois, Missouri or North Carolina. That is because many Canadian hogs are slaughtered at the John Morrell plant in Sioux Falls, S.D. While hog imports are not large relative to domestic production, they are highly visible when they roll down Interstate 29, which parallels the Minnesota-Dakotas border.

Furthermore, following protests earlier in 1998 on grain imports from Canada, some political leaders have seized on Canadian hogs as the primary reason for low U.S. prices. Just how important are these imports?

There is little evidence that such imports are a significant factor in low prices. Hog imports have increased in recent years, from around 1 million per year in the early 1990s to nearly 4 million in 1998. That is a lot of hogs, but still only about 4 percent of total U.S. slaughter. Moreover, the increase in shipments from 1997, when hog prices were quite favorable to producers, to 1999 is less than a million head. It is hard to make a convincing case that an increase in imports equal to 1 percent of total slaughter is responsible for a 60 percent or more drop in prices.

Contract prices

The changing structure of the hog industry (see the April 1996 fedgazette) may contribute to a gap between the publicized "spot" prices paid for hogs in open markets and the average received by all producers. As hog production has shifted into larger-scale facilities, an increasing proportion of total production has come under some form of vertical integration involving contractual relationships with feed suppliers or with hog processors. Such contracts usually contain price provisions, including some minimum price or some formula linking prices to market conditions and feed costs. These contractual price provisions are frequently not disclosed to the public, though individual producers sometimes share such information with friends and neighbors.

There is concern on the part of some in the industry that as the proportion of all hogs sold in public markets becomes a smaller fraction of total output, market prices are becoming more volatile and more susceptible to manipulation by large buyers or sellers. These concerns have been a matter of public discussion for some time, but recent low prices have added fuel to the fire.

Regardless of whether publicly quoted prices are manipulated, the increasing degree of contracting does mean that many producers are getting more for their hogs than the spot prices quoted in the media. Several bankers responding to the Minneapolis Fed's fourth quarter agricultural credit survey noted this difference, commenting that some of their customers who are in contract relationships are doing better than the purely independent producers who sell their hogs on a day-by-day basis. (See survey report.)

Public policy questions of pricing and structure aside, the current price drop once again illustrates the interaction of biology and economics. In late 1996 and through most of 1997, hog producers were doing quite well in comparison to cattle ranchers and pure grain farmers. Hog prices in the high $40 to low $50 range were high enough to motivate ongoing construction of large facilities and, at the same time, increase production by "swing" producers with low input or fully depreciated facilities. It was a simple textbook example of producers responding to a favorable price signal.

In comparison to cattle, hog production can be ramped up quite quickly. Cows grow slowly and are not physiologically ready to calve until they are more than two years old. They have nine-month gestations, and virtually all births are singles. Hogs can give birth at a little over a year, and their gestation is only the "three months, three weeks, and three," learned by every Midwestern farm boy. Rather than single births, pigs come in litters with an average of nine or more pigs surviving. A hog can be sold for slaughter at 230 pounds at less than six months of age. The potential for a rapid increase in hog output is tremendous. Unfortunately, it means that hog prices can drop precipitously, especially as thousands of uncoordinated producers all respond to the same price signal at the same time.

Low prices, heal thyself

Low prices usually bring an end to low prices, just as high prices cure high prices. The extreme low prices experienced at the end of 1998 will force resources out of production in one way or another, and production will drop sooner or later. Prices will then rise. It is not clear how long this will take, or what proportion of resources will be "forced out of production" through the bankruptcy or liquidation of the resources' owners. In January 1999, futures contract prices indicated market expectations of substantial price increases by July of this year. That may well occur, although futures markets did not give six months' warning of the low prices received in late 1998.

And one of most baffling problems for producers has been that the "basis," or difference in price between a contract for lean hogs on the Chicago Mercantile Exchange and one at country hog buying sites, recently seems to have broken down. Futures markets are one way producers can reduce price risk in marketing their output. But hedging production through use of futures contracts is only a useful risk-management tool as long as the basis is consistent or predictable. That simply has not been true in the chaotic market conditions that prevailed in many recent weeks.

As hog production has structurally changed, different opinions have been expressed in the relative financial resilience of large, capital-intensive units vs. more traditional family-farm sized operations. Existing farmers with paid-for or fully depreciated facilities may be more able to ride out low prices than some of the capital-intensive, highly leveraged new operations. On the other hand, now that these new facilities exist, their construction costs are sunk costs. Even if the initial owners go bankrupt, someone may be able to buy the facilities at enough of a discount to earn cash-flow. The current price trough may put the industry to a wrenching, but information-producing, test of these hypotheses.