Confusion surrounding hog pricing formulas has somewhat hindered producer understanding of contracts for a long time. By breaking out the components of the formulas, it is possible to observe some of the drivers behind the different formulas and thereby provide clarity.
Canada prices pigs using U.S. data
Historically, the U.S. has been Canada’s primary market for hogs and pork products. With the U.S. market significantly larger than our domestic market, Canadian pig prices have consequently been dictated by U.S. market prices. However, many different hog prices are reported in the U.S.
In general, U.S. prices can be reported on processor purchase data or slaughter data. When looking at this data, it is important to know that purchased data reflects only the base prices (in U.S. dollars per 100 pounds) and does not incorporate any carcass characteristics, premiums or discounts, whereas slaughter data includes all the information on the carcass and the base price, as well as the net price (the quality-adjusted price or the final price paid to the producer). Regardless of the type of data used, the Canadian price is based on a core U.S. price.
How are formulas composed?
After establishing the U.S. core price, Canadian packers make some adjustments to create a Canadian price. U.S. prices typically account for the head in the carcass price, which is not the case in Canada. This adjustment is captured by taking 7.5 per cent off the U.S. price (or by multiplying the U.S. price by 74/80).
The U.S. uses an imperial measurement system, while Canada uses the metric system. So, we convert the imperial price in hundreds of pounds to the metric price per 100 kilograms by use of the conversion rate of 2.2046. After that, the converted price is multiplied by the exchange rate between U.S. and Canadian dollars.
The final component of the Canadian price could be called the “index factor,” which has been the source of much confusion. While some packers in western Canada have not explained its origin, one packer explains that the index factor represents a quality adjustment. In this case, the index factor of 100 over the grid index normalizes each producer’s index to the average index received at the plant. Therefore, if the producer provides above-par-quality pigs, he will receive an incentive through a higher grid index. But if he provides sub-par-quality pigs, then he would be discounted through a lower grid index.
For those packers that use the U.S. net price, why is there a quality adjustment made to a quality-adjusted price? If the argument is that the Canadian minimum quality is less than the average U.S. quality, then this may be valid. However, it then begs another question: since quality is not static, how is it that this adjustment does not change daily or that it has not changed over time to reflect quality variances?
How does the index factor affect your price?
A simplified example best illustrates the effect of an index factor. Let us assume that the U.S. price is USD $50 per 100 pounds and the exchange rate is 1.35. Then, without the index factor, the Canadian price would be:
The table below shows the conversion with the associated index factors for three western Canadian packers. The western Canadian producer’s price is docked anywhere from seven to 13 per cent due to the index factor. One might argue that the U.S. base price is lower than the average net price. Looking at the LM-HG201 report since 2001, the U.S. base price has only been on average 3.2 per cent below the average net price, not seven or 13 per cent. So, if we compare U.S. base prices to Canadian base prices, the Canadian producer is paid less on average. The packer contends that the producer will be able to earn it back, plus more, if the quality delivered is high. But is this always the case?
Under Olymel’s new 2021 contract, the producer is docked seven per cent, but if the producer achieves the optimum of the grid, the producer will only be able to recover three per cent, at best. In fact, the producer would need an average index of 107.5 (which is not on the grid) to get the average U.S. equivalent price. Here, the average index represents what is received on each shipment of market hogs and not on the average shipment over time. The producer will be exposed to changes in the U.S. price and the exchange rate if averaging is done over time. More analysis can be done with an industry-wide inspection of settlement statements.
In the example above, the producer will receive only $132 out of $138 that would have been available to the U.S. producer. Under the Olymel 2020 contract, the producer initially loses 10.3 per cent. The producer would need an average index of 111.5 to get back to the U.S. equivalent price. If the producer can achieve the optimum on the grid, then the producer will obtain a four per cent uplift in prices.
For Maple Leaf Foods contracts, producers would need an average index of 113.04, 114.89 and 111.25, respectively, under the Signature 5, 4 and 3 contracts to attain the U.S. equivalent price. A producer under the Signature 4 contract would receive only $135, which is almost $3 less than U.S. producer with average quality.
As for Donald’s Fine Foods, producers need an average index of 114.89 to get the U.S. equivalent price. If the producer achieves the optimum of the grid, the producer will receive a price uplift of almost two per cent from the U.S. equivalent price.
The packer might counter by saying this is not the final price. There or other premiums and bonuses that would lift the final price higher. This is true. But, if we were to compare the maximum price paid out relative to the average price paid out to U.S. producers, U.S. producers could receive a premium in excess of CAD $50 per 100 kilograms over the average net price, while the maximum premiums paid out by Canadian packers would scarcely surpass $25 per 100 kilograms. (U.S. estimates are based on the LM_HG201 Report for July 21, 2020.)
As described above, much of the analysis is founded on whether the producer can achieve the optimum grid. But if not, does it mean Canadian producers are offered less than the U.S. base price?
Base prices to western Canadian producers should be equivalent to the base prices U.S. producers receive. Premiums and bonuses should reflect the higher quality produced for the Canadian packer program and should not be used to offset unexplained deductions. Producers should compare their average index against the index factor deduction to see if they are on the positive or negative side of the U.S. base price.
Are you interested in helping Alberta Pork better understand indexing for producers? If so, consider contributing to our cost of production study.
For more information on indexing and other economical inquiries, please contact Bijon Brown, Production Economist, Alberta Pork by email at email@example.com or by phone at 780-440-8460, toll-free at 1-877-247-PORK (7675).
If you have any other questions or concerns, please contact Darcy Fitzgerald, Executive Director, Alberta Pork by email at firstname.lastname@example.org or by phone at 780-491-3529, toll-free at 1-877-247-PORK (7675).