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Market Preview
A Supply-Demand Short
Course
The entire concept of “demand” is foreign to many
laymans economists. It is even foreign – or at least blurry – to
some trained economists.
One of my missions since beginning my professional career with the
National Pork Producers Council in 1993, has been to help people
understand demand – what it is, what it is not, where it comes from,
etc.
Live hog demand has been nearly unbelievable since mid-2007. While
costs have not been covered since last September, it wasn’t the fault
of hog prices! The remarkable performance of cash hog prices in the
face of huge supplies has been well documented in these editions. The
only way that can happen is for demand to be exceptionally good. But
what is the source of that strength?
Figure 1 shows a conceptual model for the derivation of live hog demand
and retail pork and pork by-product supply. My hope is that it will
give you a mental model to see the relationships between the various
parts, pieces, levels, etc.
Look first at red supply functions and the red arrows that indicate
their influence on successive market level. For supply, everything
starts at the farm level. The supply of market hogs is not the number
of hogs available. It is the number of hogs that could be made
available at various prices. The position of the supply function (the
entire red line) in the P-Q space and its shape is based on the cost of
producing pigs.
Successive supply functions are determined by the supply of hogs and the
costs of transforming hogs into wholesale pork and pork by-products and,
subsequently, retail pork and pork by-products. Thus, the wholesale and
retail supply functions are “derived” from the farm level supply.
The green demand functions and green arrows work just the opposite. All
demand relationships begin at the consumer level and work backward with
upstream demands being “derived” from downstream demands and the
costs of transforming hogs into pork and pork by-products. The demand
for hogs is the last step in that process.
As with supply, demand is not the amount of product purchased. It is
the amount of product that would be purchased at alternative prices. For
example, the entire green line in each diagram, consumer tastes and
preferences, income levels and the prices of complement and substitute
goods determine the position of that green line in the P-Q space.
Note that export demand for both by-products and pork operated at the
wholesale levels. The prices of these goods in export markets differ
from those of domestic wholesale markets, due to differing
specifications and transportation costs.
This model also provides a framework for “what-ifs” regarding
changes in what we economists call “exogenous” variables. The only
variables “endogenous” (or inside) these diagrams are quantity and
price. Any other variable, such as fuel prices, packing materials
prices, the prices of substitute or complement goods, and consumer
tastes and preferences, are called exogenous. When any one of those
changes, it will move one or more of the supply and demand functions
within the P-Q spaces of these charts.
What if corn costs rise? The farm-level supply function would shift up
and to the left. That shift would flow through the red arrows to other
levels, driving all of the red-derived supply functions up and to the
left. The quantity of hogs and all pork products would fall and the
prices of hogs and all pork products would rise. I believe we are in
the midst of such a change at present.
What if fuel costs rise? There would likely be a farm-level cost shift,
such as is described above, but there are more complex impacts. The
cost of transporting hogs and pork products would rise, thus changing
the derivation of downstream supplies (i.e. the red arrows) from the
basic hog supply. Downstream supplies would shift upward by a larger
relative amount than would hog supply, causing the spreads between farm
level price and wholesale price and retail price to grow.
The opposite would be true for wholesale and farm-level demand. The
green derivation arrows would change due to higher energy costs and
upstream demand functions would fall relative to retail and export
demand due to higher transportation and processing costs.
What if export demand for pork rises? It would pull wholesale pork
demand upward and, thus, pull hog demand upward. Domestic demand would
not change, but domestic retail price would rise as more product flowed
overseas, thus reducing the quantity of pork supplied to the domestic
market at any price level.
And finally, what about export demand for pork by-products? The action
would be the same as is described above for pork, but notice that the
change in the by-product market would not impact the domestic retail
pork market. Thus, the foundation for my long-held position that
by-product exports are a win for almost everyone. Foreign customers get
more product, wholesale by-product demand rises, thus increasing hog
demand and prices, all while domestic pork prices are unaffected. There
is, however, a loser even in this case – domestic buyers of pork
by-products who must pay more.
Click to view graphs.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.
e-mail: steve@paragoneconomics.com
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Financial Preview
What a difference
a month makes!
I think anybody who is involved in the swine industry
has breathed a sigh of relief in the last month. A month ago, producers
were getting $105-$110/head for their pigs. Now, we have averaged over
$150/head. That’s an improvement of over $40/head, which equates to an
almost $400 million improvement in revenue to swine producers in one
month. Producers are feeling a little better, but still, they are not
getting rich. Many say they are holding their own. This is a glimmer of
hope for an industry that has been ravaged with a huge cash drain these
past months.
Will prices hold? – Many producers are wondering whether we
can maintain these prices. There is a great demand for exports. In
fact, pork exports were 23% higher in March over a year ago. We are now
exporting one out of every 5.5 pigs raised in the United States. This is
one of the primary reasons that we have seen the price increases. The
United States is the most competitive place to raise pork in the world
and other countries are buying it. The March wholesale cutout value was
$55; today it is over $80. I wonder if the price increase will curb U.S.
pork demand? Only time will tell.
All eyes on the U.S. corn crop – If you want to know what
keeps me awake at night, take a look at the two charts below. The table,
presented by Paragon Economics’ President Steve Meyer this month,
shows how tight our corn stocks are; the pie chart shows how dependent
the world is on the U.S. corn crop. We currently export 53% of the U.S.
corn supply. No one else is even close. My concern is that we already
know we have less corn planted than last year. I am not convinced that
exports and livestock use will be reduced by that amount. We will need a
153.9 bu./acre average yield. If any of those factors change – even a
little – we will have a supply problem. Then, we will have to be very
creative in how to deal with a very short supply. As a livestock
producer, with corn as one of your major costs, managing this risk is of
great importance. You will need some form of risk management strategy to
address all of these factors.
COOL and Canadian pigs – I have read many articles indicating
the label requirements for COOL (country-of-origin labeling) will help
ease concerns about Canadian pigs coming across the border –
especially feeder and weaned pigs. The question that I still have is,
“What will the retailer demand of the packer?” I am not convinced
that retailers will want to have that many labels in their meat cases.
In fact, they might want just one label. Then the question becomes,
which of the labels do they prefer? When Smithfield, the country’s
largest packer, can say they can provide “All U.S. Product,” what
will the rest do? This issue is worth keeping an eye on.
Click to view graphs.
Mark Greenwood
Swine Industry Consultant
Contact Greenwood at mgreenw@agstar.com
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Legislative Preview
Bill Filed to Freeze Renewable Fuel
Standard
Senator Kay Bailey Hutchison (R-TX) has introduced
legislation that would freeze the mandate to produce corn-based ethanol
at this year’s level of 9 billion gallons. Hutchison said, “The
ethanol mandate is clearly causing unintended consequences on food
prices for American consumers. Freezing the mandate is in the best
interests of consumers, who cannot afford the increasing prices at the
grocery store due to the mandate diverting corn from food to fuel.”
Joining Hutchison in cosponsoring the bill are Senators John McCain
(R-AZ), John Cornyn (R-TX), Wayne Allard (R-CO), John Barrasso (R-WY),
Susan Collins (R-ME), Jim DeMint (R-SC), Elizabeth Dole (R-NC), Mike
Enzi (R-WY), Ted Stevens (R-AK) and John Sununu (R-NH). The energy
legislation signed into law last year establishes a mandate of 15
billion gallons by 2015.
Congress Halts Deposits in Strategic Petroleum Reserve —
Congress passed legislation this month that requires a temporary halt to
the oil deposits in the Strategic Petroleum Reserve (SPR). The
legislation temporarily suspends the filling of the SPR through the end
of this year as long as crude oil remains above $75/barrel. Senator
Byron Dorgan (D-ND), sponsor of the legislation, said: “This is a step
in the right direction to put downward pressure on gas prices. With gas
prices around $4/gal. and oil over $120/barrel, it makes no sense to be
putting 70,000 barrels of oil underground everyday, especially when the
SPR is 97% full. When the American consumer is being burned at the stake
of higher gas prices, the government should not be carrying the wood."
Senate to Consider Farm Bill Again — When the Senate returns
next week after its Memorial Day recess, it will consider the farm bill
(H.R. 6124) again with the trade title included. The House passed this
bill before the recess. President George W. Bush can either veto the
bill again or sign it into law. If the president vetoes the bill, the
House and Senate will have to vote again to override. With the strong
override votes in the House and Senate last week, it is expected the
veto would be overridden.
Manure Study — The farm bill provides for a study to look at
the beneficial role of manure in agriculture. Key points in the study
include:
- The extent to which manure is utilized as fertilizer in
agricultural operations, by type, including species and agronomic
practices;
- An evaluation of the potential impact on consumers and on
agricultural operations that could result from limitations being placed
on the utilization of animal manure as fertilizer, and
- An evaluation of the effects on agricultural production
contributable to the increased competition for animal manure use due to
bioenergy production, including as a feedstock or a replacement for
fossil fuels.
Congress in Recess — Congress is taking this week off for the
Memorial Day recess. When Congress returns, the first issue will be to
complete the 2008 farm bill including the trade title. A number of
other issues to be considered for June and July include Amtrak, fiscal
year 2009 appropriations, overhauling the Consumer Product Safety
Commission, housing, higher education, mental health parity, Iraq war
spending, etc.
P. Scott Shearer
Vice President
Bockorny Group
Washington, D.C.
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Pork Industry Calendar
June 17-18, 2008: Farrowing
Basics, University of Nebraska, Lincoln, NE; contact: Duane Reese at
(402)
472-6425 or e-mail dreese1@unl.edu.
June 22-25, 2008: 20th annual
International Pig Veterinary Society Congress, Durban, South Africa;
contact: www.ipvs2008.org.za.
Click
here to get National Hog Farmer's complete pork
industry calendar.
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