The quest for a 'made-in-Canada' price

Thursday, May 21, 2020

Pork producers are lobbying for a fair pricing model that reflects the quality of their products.

by Kate Ayers

When an automobile manufacturer dedicates extra time and effort to ensure its vehicles are safe and of high quality, customers are often willing to pay a little more for this attention to detail. Shouldn't a similar premium pricing model apply to the Canadian pork production marketplace?

While Canadian pig farmers produce safe, nutritious and even premium pork, stakeholders argue the current pricing system doesn't reflect the quality of the product. Margins are tight – or even negative – for producers, and premiums aren't evenly distributed across the value chain.

The creation of "a price tailored specifically for a Canadian product could see profitability return to producers and would result in renewed optimism and investment in the Canadian pork industry," says Stan Vanessen, a partner-owner of AVE Farms Ltd. in Picture Butte, Alta., and a member of Alberta Pork's board of directors.

As a result, industry stakeholders are examining the possibility of a new pricing system that enables the sharing of losses and profits across the value chain.

Better Pork speaks with farmers, an economic consultant, an agribusiness professor and other industry representatives to learn about the current system's limitations and how the sector aims to develop a new formula. Industry stakeholders must update Canada's pork pricing system to reflect our stringent animal welfare standards and production practices that result in high-quality pork, supporters of the project say.

System limitations

The current system has existed since 2003, says Ken McEwan, a production economics and agribusiness professor at the University of Guelph's Ridgetown campus.

Within the pricing formula, "all prices for live hogs in Canada are based on a U.S. reference price," says Bertrand Montel, a consultant in economic studies at Groupe Agéco in Montreal.

This consulting firm specializes in economic studies and sustainability in the agri-food sector, and its team conducts environmental life cycle analyses.

Along with the U.S. base price, the formula includes "a conversion factor and the currency exchange," says Vanessen.

"The U.S. base price varies depending on the slaughter plant but will be a purchased hog price or slaughtered hog price.

"The conversion factor considers that Canadian plants include the head of the hog in their total carcass weights and lowers the Canadian value. This factor then converts weights from American imperial to Canadian metric numbers," Vanessen adds.

"The last part of the formula, the currency exchange, has played the most significant role in reducing our ability to generate profits. The pricing model was created when the Canadian loonie was significantly lower than the U.S. dollar. Over the course of two decades, we have witnessed the Canadian dollar go above par for a while and settle at levels which make the formula unworkable."

Because of the mechanics of the model and the economic changes since it was introduced, this pricing system has benefits and drawbacks.

One benefit: the ease of access to the American pricing infrastructure makes the pricing index simple.

"The U.S. price is publicly available and is representative of the U.S. market," McEwan says. Because the American pork sector must report to the U.S. Department of Agriculture (USDA), "the conditions for reporting and confidentiality are upheld."

In addition, the "North American hog markets are integrated, and the U.S. is our largest customer for pork and pigs," he says.

However, our close ties with our southern neighbours can present market challenges for Canadian swine producers.

"If something happens that impacts the U.S. price – positively or negatively – then Ontario's price changes," McEwan says.

Ironically, Canadian hog producers "need their largest threat and competitor to do well in order to be profitable," Vanessen says.

And using the U.S. price as a point of reference inhibits "Canada's hog industry from differentiating itself in the global market," says Brent Bushell, the general manager of the Western Hog Exchange Inc. in Edmonton.

"For example, Western Canada has a very strong connection with the Japanese market, and we get paid a premium because of barley-fed pork. But the problem is that, while Western Canadian packers receive the niche market premium, it is not shared in U.S.-based price formulas and therefore none of that premium comes back to producers."

The Western Hog Exchange is a non-profit organization. It is held by hog producer shareholders, the group's website says.

While Canadian pork exporters receive consistent premiums in the Japanese market, the "U.S. reference prices reflect the market conditions faced by U.S. stakeholders," Montel says.

But "the base price used in Canada should reflect, as closely as possible, the market conditions of Canadian market players."

Because of interprovincial pricing mechanisms, farmers and packers across the country market their pigs and pork differently.

"In Quebec, hogs are sold and priced according to a collective bargaining agreement that is valid for three years within the framework of Quebec's Act respecting the marketing of agricultural, food and fish products. The agreement is negotiated between the producers and the packers," Montel says.

The Régie des marchés agricoles et alimentaires du Québec arbitrates, he adds. This group's mission is to promote efficient and orderly marketing of agricultural, food, fishing and private forest products, its website says. The regulatory body also helps develop relationships between stakeholders, and plays a role in production and marketing resolutions.

"In Ontario, until 2009, all hogs were sold through Ontario Pork, which acted as a sale agency for hog producers. Since then, hogs have been marketed directly by the producers, although some of them are using the marketing services of Ontario Pork. Hog buyers in Ontario are mandated to report the price of live hogs paid to producers," Montel says.

"In Western Canada, hogs are sold directly by producers to the packers," he says. Packers "essentially use formula pricing or sell under contract through an integrator," he says.

So, even if a harmonized reference price appeared across Canada, the price paid to producers very likely would differ between provinces and between buyers (meat packers), Montel adds.

New formula considerations

In November 2019, the Canadian Pork Council (CPC) released its report on the made-in-Canada hog price. This document explores the feasibility of a domestic hog price indicator. The council's seeks to determine the value of Canadian and major export competitors' pork and to identify and quantify factors that influence the value of Canadian pork in American, Mexican, Japanese and Chinese markets.

Industry members must consider many factors when developing a new formula.

For example, the formula must be "based on data that is accurate, timely, publicly available, reflective of market conditions and prices, representative of a large volume of hogs and the market, and easy to understand and calculate," says McEwan.

The industry also needs to determine the qualities of Canadian pork products that demand premiums and the value of these premiums.

To discern this information, industry members must compile data from international markets, Vanessen says.

Some production factors that could contribute to a premium price include the industry's use of "quality assurance programs and their associated costs to producers, reduced competitiveness by withdrawing growth promoters like ractopamine and abiding by specific dietary requirements," he says.

Pork product labelling is a factor "to consider, as there are stringent requirements for packers in some markets, and they incur additional costs to satisfy these demands," Vanessen adds.

Tyler Fulton points to the premiums that Canadian pork garners in the Japanese market.

Fulton is the director of risk management at Hams Marketing Services and a cattle producer in Birtle, Man. Hams Marketing Services is a producer-based cooperative which has offices in Manitoba and Saskatchewan, the company's website says.

In addition to market premiums, a realistic cost of production is also worth study.

"For any system to work, there must be an incentive for producers to see the benefit of reinvesting in and expanding production. Creating a pricing model which does not exceed the cost of production will not be of any more benefit than the current broken model," Vanessen says.

However, using a straight cost-of-production-based pricing would not be feasible in Canada's swine industry, Montel says.

"It would exacerbate the risk borne by packers because of the volatility of the cost of their hog supply and the asymmetrical price transmission along the pork value chain. These factors limit the ability of packers to manage any margin squeeze," he says.

"To avoid any hog marketing misalignment between the Canadian and U.S. pork industries, we would prefer not to use a price reference based only on hog cost of production. A cost of production reference, however, could be used as a floor price to protect against a surge in grain price."

Pricing challenges

While pork producers stress the need to improve the pricing system, creating and implementing new pricing indices will be no easy feat. It will take time for all industry stakeholders to reach an agreement.

"The main limitation is the overreliance on U.S. price references to establish live hog prices while Canadian meat packers negotiate their prices more directly with their customers," Montel says.

"Another limitation is the lack of transparency of market information about the cutout value of Canadian hogs. While the North American market is quite integrated, all market participants do not benefit from the same level of transparent market information," Montel says. This inequality "affects their bargaining power."

McEwan agrees.

"We are export dependent. We export pigs and pork to the U.S., and we compete with the U.S. in other markets such as Japan, China and Mexico," he says.

To develop a Canadian price for pork products, our industry needs to set up a mandatory price reporting system, Montel says.

"Such a system must ensure that data collected meets a set of requirements for adequate coverage," he says. "Enough players must report prices for enough products over a long enough period without compromising the confidentiality of the data."

"Considering the very small number of players in Canada, I think meeting all these requirements consistently could be a major issue and would require consultation between stakeholders," Montel adds.

Indeed, collaboration and discussions between industry stakeholders have been challenging across the value chain.

"That is the disconnect within the system. You can come up with a plan to share the value of pork or create a made-in-Canada price, but the biggest challenge is getting producers and processors to work together collaboratively and share in the value of pork rather than a price for a hog," Bushell says.

"As producers, we would be prepared to lose $10 a head if packers would be also prepared to lose $10 per head in December, for example. But when summer comes and there is a profit of $60, then we each get $30," he says.

"Processors say they want to work with producers, but what jurisdiction is there to get processors to pay for a fair share of the pork? In Quebec, law created that equality," he says.

Vanessen agrees.

There is enormous potential for growth, but year after year of net losses on producers' balance sheets has decimated the number of hog operations still in business. For the better part of a decade, packers have been able to take advantage of the current pricing model by purchasing hogs at or below the cost of production," he says.

"Packers have been extremely reluctant to engage in discussions that potentially would increase their payment value for hogs to producers and reduce slaughter margins. It has proven difficult for producers to unite and lobby together for better value. The lack of communication and planning is contributing to an increasingly adversarial relationship between packers and producers," Vanessen says.

But Quebec's new model could be a good starting point for negotiations that will come over the next few months and years, Fulton says.

Bushell agrees.

As of last April, Quebec's pork sector decided that producers and processors should share the value that the pork is worth rather than use a pricing formula. They still use USDA numbers, but they use the pork cutout value rather than the value when live hogs are sold. This (value) has averaged an extra $20 to $45 per head, which is the difference between producers staying in the industry or leaving," he says.

"Processors in Quebec are not closing their doors because they are paying producers too much. We need to look at the actual value of the pork, and then we must share the value of profits and losses between producers and processors. That is how we build a vibrant and progressive industry." BP

What hog pricing index is right?

While the industry endeavours to create a made-in-Canada hog pricing index, the Canadian Pork Council (CPC) is doing its part by examining three price reference options.

In a cutout only reference price, the value share corresponds to the percentage of the cutout paid to the producer, the CPC's website says. While this percentage needs to be determined, this pricing option aligns the price of live hogs in Canada with the American cutout and reduces market volatility.

A composite reference price (weighted average) consists of a live hog reference and a cutout reference, the CPC's website says. Industry members would need to determine the weight that is attributed to each component.

A composite reference price (live hog price with cutout window) is based on a live hog reference; floor and ceiling prices are based on a share of the cutout reference. This reference price option corresponds to the one in the new Quebec formula, the CPC's website says. Members would need to determine the value share for the floor and ceiling prices.

Ideally, a combination of live hog prices and cutout values would benefit producers. They would share some value and see reduced volatility in the marketplace, says Stan Vanessen, a partner-owner of AVE Farms Ltd. in Picture Butte, Alta., and a member of Alberta Pork's board of directors.

However, using the cutout value to determine a reference price could have consequences.

"The shift toward cutout price referencing in formula pricing for hogs means that price discovery for live hogs occurs downstream and may not involve hog producers" as much as people usually think, says Bertrand Montel, a consultant in economic studies at Groupe Agéco in Montreal.

"The price paid to hog producers is usually based on a reference price that is adjusted to reflect local market conditions and the business strategy of the buyer," he says. BP