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Why did it have to come to this? "The answer has many
dimensions, but in general there were just too many major demand
and cost shocks in the past two years for an industry that had
become too inflexible to downsize," said Purdue University
Extension economist Chris Hurt.
"That downward adjustment is now a forced adjustment, with
bankruptcy for a few just revealing the ‘tip of the iceberg’ of
the lost equity across the sector. The industry will now likely
drop another 3 to 5 percent of the breeding herd to get small
enough to return to break-even."
Hog prices have improved from their lows in August, but the
$40 live price in the final quarter this year is more than
offset by production costs estimated at $48 per live
hundredweight. In September there was some optimism that feed
costs would be moderate for 2010, but that optimism has faded
with a 90-cent-per-bushel increase in corn prices. Now the
anticipation is that hog production costs next year for farrow-to-finish
operations will be around $50. This seems to be an
insurmountable climb for prices from $40 today, Hurt said.
The outlook is for hog prices to average about $46 to $47
next year, moving from about $44 in the first quarter, to near
$50 in the second and third quarters, and back to the mid-$40s
in the final quarter.
Given the assumption of $50 costs, this would still leave $10
of loss per head, the third year in a row of losses. However,
the current financial reality likely means the herd will
decline, demand will improve and hog prices will be higher than
the current forecast.
There are others who believe hog prices will be higher --
most important, futures traders. Using lean hog futures at the
close on Nov. 20 and the average eastern Corn Belt basis level
over the last five years, the futures market is suggesting
$50.50 for a farm-level price next year, suggesting a break-even
price for 2010.
"If there is an unfortunate side to these higher prices, it
is that it may increase producer-lender optimism, resulting in a
smaller-than-needed reduction of the breeding herd. If so,
selling lean futures now will be positive," Hurt said.
According to Hurt, those producers and lenders facing the
difficult decision of whether to continue or call it quits
should consider these futures market pricing opportunities. Most
lenders want their hog operations to at least cover cash
outflows. That is to say, they do not degrade their current
financial situation.
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What about the overhead costs, such as depreciation and debt service
on buildings and equipment, taxes, etc.?
Hog buildings and equipment probably have little value right now
in a forced liquidation. The lender may be better off to continue to
work with hog producers if they do not worsen their financial
situation over the next year. If they make it through, then the
value of the buildings and equipment may be positive in another
year.
"Clearly some operations must reduce production, or shut down, to
reduce total production. There are still operations with high costs,
have low efficiency, are dramatically undercapitalized or no longer
willing to risk more equity erosion. That is where the additional
downsizing will come," Hurt said.
Producers in a weak financial position who decide to hedge lean
hogs with a live equivalent near $50 must cover feed costs as well.
"As bleak as the outlook seems, it is ironic that the futures
market provides a way to at least get through 2010. Old-timers used
to say that you don’t want to be short lean hog futures when the
price cycle is ready to turn up, and that has been true in the past.
When prices turned up, they tended to go much higher than
anticipated, providing handsome rewards to those who stayed unsold
on hogs," Hurt said.
"But, this is a new era and old maxims may not hold. In addition,
hedging today may enable some operations to continue over the next
year when the lender is ready to give up. For them the new maxim may
be: Survive in 2010 for an opportunity to be around in 2011."
[Text from file received
from the University
of Illinois College of Agricultural, Consumer and Environmental
Sciences] |
