The pork industry is in one of those once-in-a-decade traps that positions it inflexible to additional short-term output reductions while literally everything else that determines profitability is whirling around and lining up to signal the requirement of more cuts in production. We are at that point in the evolution of the industry where those remaining are very good at what they do and have no intention of voluntarily throwing in the towel. The capital intensity of the industry combined with a slow moving biological production function simply structuralizes overproduction when market forces push hard for rapid reductions. Some fine tuning is attempted with market weights but beyond that, increasing productivity (a very good thing for the world) eats up downward adjustments coming from farms exiting the industry and market weight reductions.
The nature of the global economic collapse and the turning of the business cycle on a global basis prolong the downward spiral of demand, and tend to lengthen the flat part of the cycle when contraction slows to a stop. As the global recession unfolds, reduction in employment develops sequentially as firms gradually come to the awareness that cuts were unavoidable. The first waves of unemployment reduce household consumption purchases, which then lead to other firms needing to contract supply and lay off workers. This yields a cascading downward spiral of demand and increasing unemployment over a period of many months until inventories are exhausted and price levels adjust downward to a point which finally slows the plunge through bargain hunting first and then a re-established price level. Even on the upswing, firms that have reduced workers do not add them back very fast as they wait to make sure the recovery is well underway and their efficiency gains from fewer workers is overtaken by an inability to meet the new and growing demand. This is what leads to the longer, flatter bottom in a major global recession vs. a mild recession primarily located in a few sectors of an economy that is often “V” shaped.
With 20% of production destined for overseas buyers, the total demand for U.S. pork is a mix of relatively stable domestic demand, (though a single pound reduction per capita lops off 300+ million pounds of domestic demand in
a year) and a highly volatile stream of revenue originating overseas. The problem is that our usually stable domestic demand is dampened, too. With official unemployment nearly 9% in the United States, it is probable that well over one in 10 people are actually unemployed (the U.S. employment number does not include “discouraged workers,” who have seemingly given up searching for work either permanently or temporarily). Yes, people have to eat every day, but they can reduce consumption of meat, and track toward the same calories with a lower cost mix on the plate.
With operating credit extended to near the breaking point, top U.S. swine lenders are saying the industry has about 90 days left at current conditions before the willingness to extend any more cash is extinguished. Regulators are breathing down their necks to justify extensions, even in the presence of balance sheet equity since the value of hard assets has at least temporarily declined (in some cases) substantially. It appears now that the only way current participants will stop production is if lenders stop the cash, but lenders are not going to stop production in farms where they hold substantial debt and there is at least some cash flow. So, the structuralized overproduction is essentially intransigent. We will not produce less pork unless a true breaking point occurs where lenders take a huge bath. If that happens, the supply of pork from the U.S. will fall substantially. Our belt is tightened to the last hole as far as flexible supply reduction is concerned, and nothing short of a major, lender-led restructuring of the industry will reduce production from current levels by an economically significant amount.
Signs of hope, though, are on the horizon. It appears that the cascade of increasing unemployment is slowing substantially, signaling we are entering the final phase, which is the bottom segment. As we reach the bottom, asset values stabilize and optimism returns signaled by increased purchasing. During the fearful free-fall phase of a major recession, purchasing is reduced by households farther than is actually warranted by their income and job situation. That part returns fairly rapidly as “green shoots” become visible, especially at the local and regional level. Summer season brings slower growth in pigs, further limiting supply and an uptick in barbecuing which is centered almost exclusively on meat (though a Portobello mushroom or two sharing the grill ain’t a bad thing). Barbecuing is all about optimism, so good news in the economy will bring back the pent-up demand for good times around the pit.
Look for an end to the H1N1 effect in the very near future and a delayed but still reasonable seasonal climb in prices. This will be coupled with a muted decline in the third and fourth quarter seasonal price (and possibly a rise as the cycle upswing pressure on price may overpower the seasonal price in the fourth quarter!) compared to an average year seasonal pattern. Price improvement this summer and fall may mirror the old saying: “I hit myself on the head with a hammer since it feels so good when I quit.” Which is to say, simply restoring breakevens will look like a new dawn for the industry. In fact, it will be just that.
Editor’s Note: Dr. Dennis DiPietre is a swine consultant in Columbia, Missouri. His monthly commentary is sponsored by Elanco Animal Health. For more information, go to: www.elanco.com
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