Corn clouds optimism

by Steve Kay
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What a difference a few months make. The US meat and poultry industry early this year was looking at a fairly bright future for all participants. Now the horizon is clouded with uncertainty. That’s not good news for producers, meat processors or consumers.

The biggest uncertainty comes from the US Dept. of Agriculture’s proposed livestock and poultry marketing rule, which was published in June. Supporters and opponents agree on only one thing, that if implemented as proposed, it will change the way the industry buys and sells cattle, hogs and chickens. Whether that is positive or negative is being fiercely debated.

The other great uncertainty is rising feed costs. Corn prices were already ratcheting higher before USDA, in early October, shocked the markets with a reduction in its forecast of the size of this year’s corn crop. It put the crop at 12.664 billion bushels, down 4 percent from its forecast in September and down 3 percent from 2009’s record 13.110 billion bushel crop. This pushed corn prices the second week of October to a level 50 percent above the same time last year.

Food vs. fuel
Next came the announcement from the Environmental Protection Agency that it will allow a 15 percent ethanol in fuel blend (E15) for cars and light trucks made from 2007, up from the current 10 percent. EPA’s decision had been expected, but it re-ignited the food vs. fuel debate and provoked condemnation from a coalition of food industry trade groups. When fully implemented, EPA’s decision could result in more than 40 percent of the corn crop being diverted to ethanol production and is certain to accelerate the dramatic rise in corn prices, the coalition said.

Corn buyers next expect an announcement on the use of E15 in model year 2001 to 2006 vehicles. EPA says it will decide after it receives the results of additional Department of Energy testing, expected to be completed this month. EPA has in the past said a congressional mandate for increased ethanol use can’t be achieved without allowing higher blends. Congress requires refiners to blend 36 billion gallons of biofuels, mostly ethanol, into auto fuel by 2022.

EPA’s decisions mean even more corn will be used for ethanol production, analysts say. Price will ration usage, and livestock and poultry producers will have to bid corn away from ethanol producers and corn exporters, they say. Most analysts say corn prices will exceed $6 per bushel in the coming months.

Higher corn prices mean livestock producers have dropped plans to expand their herds, analysts say. The US cattle herd was already set to shrink this year, the 12th year of contraction in 15 years. Cow-calf producers have been reluctant to expand herds despite profits in 11 of the past 14 years. Drought, escalating operating costs, aversion to risk and the average age (59) of ranchers have been the main inhibiting factors.

Continued cattle liquidation will likely mean a herd of 92.2 million head on Jan. 1 next year. This would be the smallest herd since 1958 and a 3.8 million head decline in three years. The decline in numbers means cattle producers are set to enjoy record-high cattle prices in 2011. But this won’t be enough to prevent further liquidation, analysts say.

“Calves and feeder cattle still face the price-depressing burden of high feed costs,” says Chris Hurt, extension economist at Purdue Univ. “In the longer-run, current high feed prices will keep the industry in a liquidation phase and smaller beef supplies in coming years will be positive for returns for years to come.

“The cattle industry continues to adjust to high feed prices not only from the last three years but also from the most recent increases in corn, distiller grains and soybean meal costs,” Hurt says. “The longerterm adjustments continue to play out in the reduction of cow numbers. The most recent surge in feed prices will likely keep producers from expanding until feed prices moderate. That will not be until the 2011 US crops are assured, which is still at least 10 months away. This means cow numbers will not likely expand until 2012 and that beef supplies will not start to grow until 2014.”

Hog numbers expanded rapidly in 2007 but declined in 2008 as extremely high corn prices began to cause enormous production losses. These losses continued in 2009 and producers reduced their sow herds. This allowed them to return to profitability earlier this year and entertain the possibility of modest herd expansion. But higher feed costs are likely to kill any expansion plans, analysts say.

Shrinking herds
Livestock herds are shrinking because of ethanol’s increased corn usage, says the University of Missouri’s Ron Plain. “You can’t grow the livestock industry without having the feed to do it,” he adds. All of the increased corn usage in the last 12 years has been to ethanol, he says. Feed and residual usage in 1988 totaled 5.468 billion bushels of corn. The same usage was 5.400 billion bushels in 2010.

Many had anticipated an expansion of the sow herd into 2011, but that now looks very iffy, Plain says. The whole livestock industry has little confidence about what the future holds, especially in relation to feed costs and GIPSA’s proposed rule, he says.

Cattle and hog herds will continue to shrink as long as there is less, not more, corn to feed livestock, analysts say. That’s one of the biggest flaws in continued federal support for ethanol production from corn. This support both increases consumer food prices and is a disincentive to expand livestock numbers. The US will become more and more dependent on imports if it wishes to prevent the ongoing per capita decline in total red-meat supplies, they say.

How the shrinking livestock herds and surging feed costs will affect meat and poultry companies is unclear. Extremely high feed costs in 2008 contributed to heavy poultry-processing losses, but this sector has now returned to profitability. Beef and pork processors continue to enjoy record or nearrecord profits despite the lingering effects of the worst recession in many years. That’s because there has been a paradigm shift in the way in which processors operate. In the past three years, all realigned their production capacities to better match supply and demand. Margin management replaced market share as the operating mantra.

Tyson Foods’ beef division in 2009 had operating income of $214 million, twice what it made in 2008. In the first nine months of 2010, it had income of $421 million for an operating margin of 4.9 percent. It will report record beef earnings for the full year. Tyson’s pork business is highly profitable as well, and its chicken business has rebounded strongly from losses in 2008 and 2009. Its latest quarterly results showed that its chicken margins at 7.4 percent had returned to within their normalized range.

JBS USA Beef, which includes its US and Australian operations, is also set to have a record year. It had EBITDA (earnings before interest, taxation, depreciation and amortization) of $365.5 million in the first six months of 2010. JBS Pork has also been highly profitable, with EBITDA of $73.4 million in the first six months. Meanwhile, National Beef Packing had record net earnings in fiscal 2009 of $142.9 million and likely far exceeded that record in fiscal 2010, which ended August 31. National’s net income for nine months of 2010 was $170 million.

Consumers pay the price
Meat and poultry companies in the coming year will work even harder to pass on the effects of higher feed costs, analysts say. This might help them preserve their operating margins, but a likely negative is higher red meat and chicken prices for consumers, they say.

“Some analysts miss the fact that higher feed prices eventually are reflected in higher meat prices,” Purdue’s Hurt says. “In the beef industry, feed prices that began to move higher late in 2006 are now reaching consumers as record-high beef prices. Consumers are in for many years of much higher retail beef costs.”

The retail price of beef to the end of August this year averaged $4.37 per lb., exceeding the previous record of $4.29 for the same period in 2008, Hurt says. Early forecasts of retail prices in 2011 are $4.60 to $4.65 per lb., an increase of about 6 percent over the 2010 record price. This compares with an average retail beef price of $3.84 per lb. for the five years from 2002 to 2006, before the period of much higher feed prices, he says.

USDA’s Economic Research Service forecasts that retail beef prices will rise 2.5 percent to 3.5 percent next year. Pork prices are expected to go up 3 percent to 4 percent and dairy product prices will increase 3.5 percent to 4.5 percent. These forecasts, however, don’t take into account corn’s latest price surge.

“Overall food-price inflation yearover-year is still relatively low, but the trend is turning around as commodity prices rise,” says ERS economist Ephraim Leibtag. “If commodities were to increase or even settle at a higher rate than they’ve been at the last couple of years, that would put additional pressure on food prices in the upcoming year.”

Food industry groups highlighted higher food prices in response to EPA’s blending decision. EPA’s action barely puts a band-aid on the oil dependency it intended to alleviate, said Barry Carpenter, CEO of the National Meat Association. Yet, it negatively impacts food security by further raising food and feed prices. Higher feed prices will eventually be passed on to consumers in higher meat and poultry prices, he said.

Rising grain prices driven by the voracious demand for feedstock from the heavily subsidized ethanol industry caused a 6 percent increase in the retail price of fresh, whole-broiler chickens from 2008 to 2010, noted the National Chicken Council’s soon-tobe-retiring president, George Watts. Channeling even more corn into ethanol will in time only drive up the cost of chicken even more, he said.

The EPA decision also provoked growing alarm that the federal government doesn’t care about the livestock industry. It seems contradictory that the Administration has the avowed aim of revitalizing Rural America, industry officials say. Yet, USDA’s proposed marketing rule, EPA’s E15 decision and its proposal to regulate dust levels all threaten to make it harder for livestock, particularly cattle producers, to survive. These measures all add to the uncertainty that will cause livestock operators to continue to reduce their herds rather than expand them. There appears to be no government recognition that this is a consequence of its latest moves, they say.

In response to EPA’s decision, the National Cattlemen’s Beef Association questioned the Obama Administration’s commitment to livestock producers’ quest to sustain their family operations. NCBA noted that from December 2007 to February 2010, the cattle-feeding sector lost a record $7 billion in equity due to high feed costs and economic factors that have negatively affected beef demand. Between 2005 and 2008, corn prices quadrupled, reaching a record high of more than $8 per bushel. According to USDA’s ERS, feed costs in 2008 for livestock, poultry and dairy reached a record-high $45.2 billion, an increase of more than $7 billion over 2007 costs, said NCBA.

Hog producers lost $6 billion between October 2007 and March this year, according to the National Pork Producers Council. Livestock producers cannot afford to sustain such losses again, analysts say. So they will keep shrinking their herds. This will mean fewer producers, fewer jobs in rural America and more expensive meat for consumers in 2011 and beyond.

Steve Kay is editor and publisher of Petaluma, Calif.-based Cattle Buyers Weekly (www.cattlebuyersweekly.com).
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