Cover Story: Are the big American hog integrators losing their competitive advantage?
Monday, February 4, 2008
A combination of economics and environmental regulations make small to medium-sized hog operations in the American Midwest more competitive with the pork-producing giants, says a specialist in global development and the environment. Whether Ontario's pork producers will also benefit is not so clear
by DON STONEMAN
Demand for corn to make ethanol means that the good times are over for pork integrators in the United States. Will that translate into prosperity at some time in the future for today's hard-pressed Ontario pork producers? Opinions are divided.
Pork industry watcher Kevin Grier of the George Morris Centre in Guelph believes that "there's reason to be hopeful" that the difference between grain costs in Canada and the United States will disappear.
For his part, Stratford-area producer Phil Anwender says that Ontario producers have to survive their own economic storm: feed that costs too much and pig returns that are too low. He is skeptical that pressure on producers south of the border will help farmers here. Even if integrators are squeezed and lose money now, producers here will lose even more.
"The next few years are going to be interesting. In the short run, it is hell," says former Ontario Pork chairman Larry Skinner.
The U.S. Farm Bills in 1996 and since were very good to the hog-producing companies built up by Wendell Murphy and other integrators, says Timothy Wise, director of the Global Development and Environmental Institute in Medford, Mass.
Wendell Murphy built Murphy Farms, which owned six million hogs in 2000. Taken over by Smithfield Foods in 2001, the combined giant company was four times as big as its nearest American competitor and the largest single pork producer in the world. It claimed that integration and economies of scale made it profitable.
Wise says that other forces encouraged the growth of American pork production giants. In the years after the 1996 U.S. Farm Bill took effect, the big American hog companies bought essential feed ingredients, corn and soybeans, for an average of 26 per cent less than it cost farmers to grow them, saving US$8.5 billion over nine years, and adding $945 million annually to the bottom lines of their companies.
In terms of overall costs, integrators produced pork for 17 per cent less than traditional farmer-feeders in cornbelt states. With ethanol demand driving up corn prices and soybeans following, the shoe is now on the other foot, Wise says.
Medium-sized operators in Iowa, for example, who give pigs corn fertilized with pig manure, can feed their animals for the same cost as integrators. Wise says that the scales may now tip in the traditional hog raisers' favour as regulators target Concentrated Animal Feeding Operations (CAFOs), the same operations that took advantage of all that cheap feed in earlier years. (See sidebar story, page 13.)
"Hog CAFOs may struggle to be cost-competitive with mid-sized, diversified operations," Wise writes. Nationally, 19 per cent of small hog operations produce at $40 a hundredweight or less and 55 per cent of large and industrial operations operate at those costs.
So the big operators in the United States are under pressure and farm feeder operators may benefit. Can producers in Ontario, who have operated under stricter environmental regulations for several years, and survived on the wrong side of a feed cost differential even though they didn't get subsidies to counter the U.S. Bill, benefit when the big integrators don't?
Ethanol over-billed
The Canadian pork industry was competitive with the United States until the 2002 Farm Bill came into place, says Kevin Grier, senior market analyst at the George Morris Centre in Guelph. U.S. subsidies hurt Ontario's grain farmers. "They reduced production because the market was telling them to," Grier says. "One of the key contributors to this, we believe, was the U.S. Farm Bill."
While Grier believes that ethanol has been over-billed, both environmentally and as a replacement for oil, he says that the subsidies in the United States "could be beneficial to us as long as we aren't as goofy as they are" in subsidizing ethanol.
Producer Phil Anwender points out that many Ontario producers benefited from the low grain prices created by the Farm Bill. Anwender, an Ontario Pork director, finishes pigs from 500 sows on his family's farm and also feeds American pigs in the United States. High grain prices will depress livestock production in Ontario and abroad, Anwender says. The issue Ontario producers face is that feed costs too much compared to the current value of a pig.
"The success of the Ontario pork industry was built on feeding $125/tonne corn and $275/tonne soybean meal to $150 pigs. Corn at $180/tonne and $400/tonne meal will not work."
Doug MacLeod, a pork producer from Embro and a founder of the Progressive Pork Producers marketing co-op that owns a plant in Kitchener, says reduced pork production might be a good thing. Cheap feed has never been good for the pork industry, he says, and there are too many pigs being shipped in Ontario and elsewhere in North America.
MacLeod is concerned that Maple Leaf Pork may not find a buyer to run its Burlington plant and the province's largest processor may go out of business. In his view, weekly hog runs in Ontario must be reduced to about 65,000 head from the current 115,000-120,000 range. On one day in the first week of January, Ontario Pork sold 50,000 hogs.
Clare Schlegel, chair of the Canadian Pork Council, says that grain prices vary from region to region. Ironically, from a feeder's point of view, grains are more reasonably priced in Ontario than on the Prairies, where high prices for wheat - at nearly $10 a bushel - have pulled up feed grain prices. Ontario corn is now priced on an export basis and "is as reasonably priced as anywhere," other than perhaps Iowa, Schlegel says.
Schlegel talks to producers who feed pigs in the United States and they tell him that the difference in feed costs is minimal between southwestern Ontario and many parts of Illinois, Indiana and Michigan.
Bob Hunsberger, another 3-P founder, agrees with Anwender that Ontario producers likely benefited from the American subsidies that kept grain prices down, even if a penny from a government cheque never went into their pockets. "It is a continental market for grain," he notes. "So when they drive down their feed costs, they drive down Canadian feed costs as well."
Buying manufactured feed isn't all bad, Hunsberger allows. Large feed manufacturers can more easily use low-cost ingredients and can meet the Canadian Food Inspection Agency's requirements for putting in feed additives. "Nevertheless, the guy that has a silo full of corn has about the cheapest corn he can get."
Costly regulations
Ontario has to decide where it fits into the North American market, Hunsberger says. On one side is the land-based model feeding high moisture corn, on the other side is the large multi-site commercial operation, and many variations on those themes. "We need to figure out which model is most suited to Ontario's production capabilities and go with that."
Hunsberger says that the industry has to decide which business model best fits conditions in Ontario. And, even if feed costs come into line, he says that there are regulations - some self-imposed by the industry, such as routing all pigs through the provincial marketing board - that he asserts cost producers money.
In a presentation made in November, Hunsberger said that American producers save $1 a hog because they don't have trucking and delivery regulations. And then there is over-capitalization - paying more to construct each sow space and pig space. That costs $8.50 a hog more than in the U.S. Midwest, Hunsberger estimates. This is really going to hurt some producers, he says.
Ontario Pork says that about 55 per cent of pigs are produced with farm-fed grains.
In 1990, there were about 9,300 producers shipping hogs through the board. At the end of 2007, there were only 2,900 hog producers in Ontario. While there may be some respite from the American integrators, it may have come too late.
Skinner, who farms in Perth County, says that more than half of Ontario's pigs are raised by farmer-feeders. "If we can get through this current crisis, we may be positioned better than some other areas to compete. Someone who builds a huge pig barn in Oklahoma or Texas does not have a ready supply of feed. He has to buy it in."
The question remains whether the changing economics will drive some American integrators out of business or halt their expansion plans, "or whether it will drive pig prices to higher levels. Most people think it will drive pig prices to higher levels."
Adds Skinner: "If the ethanol subsidies are here to stay, it will keep corn and soybean prices elevated and that will translate into higher feed prices. It will probably restore some balance.
But nearly every day brings a new challenge. Oil prices hit a new high in early January, topping $100 a barrel. "The cost of growing a bushel of corn has gone up a lot, too," Skinner says. "I don't think the cost of growing it has gone up the same amount as the market price of a bushel of corn has gone up."
American hog production rose 10 per cent in the last year, but packers seem to be able to handle all of the pigs coming to market. Some American farm economists think the five per cent reduction in hog numbers in North America that is required to bring up prices might come entirely from Canada, and that bothers Skinner.
Wise says that the hog business isn't like the poultry industry, where economies of scale are everything. The economies of scale in pig production have an effect on costs between 500-head and 2,000-head units, but advantages are minimal in larger operations. He notes that more than 25 per cent of hogs in the United States are still being produced on operations with fewer than 2,000 head. Operations of this size produced most of the pigs in the United States before 1996.
That economies of scale aren't a benefit to all sizes of production units comes as a surprise to Will Nap, who was pork board chair during the 1998-99 crisis. Still, he has great faith in the family farm and thinks that it can survive the current challenges, although they don't seem to stop coming.
He says he never understood why producers in Ontario couldn't seem to compete with the Americans. He was also intrigued to hear that there isn't much advantage in economies of scale beyond 5,000 hogs.
"A corporation has to look at the bottom line much sooner than a family farm," Nap says. BP