For the past five years, the western Canadian hog price has fluctuated erratically. The seemingly age-old problem of hog price volatility has become worse in a context of ever-increasing costs of production and, more recently, with the economic effects of COVID-19.
Within the past year, Olymel, the largest hog buyer and pork processor in Alberta, has introduced new contracts to address the pricing problem. Comparing hog farmers’ actual financial returns over the past five years with hypothetical scenarios using these contracts, it becomes clear that short-term improvements have been made, which are worth acknowledging.
Starting in May 2020, Alberta Pork, as part of the Western Pork Boards’ Pricing Committee, issued a joint invitation to executives from Donald’s Fine Foods, Maple Leaf Foods and Olymel to have an open and frank discussion on the state of the industry and encourage pricing reform. For more information, read the full meeting summary.
As part of the discussions with packers, a $185-per-head cost of production was used as an approximation for the average hog farm in western Canada. While every farm business is different, $185 can be considered a reasonable five-year benchmark for comparing contract options relative to profitability. In reality, some producers’ costs in those five years have been lower, while other producers’ costs have been higher.
Profitability plunges in last half-decade
In 2014, the spread of porcine epidemic diarrhea (PED) in North America caused a short upward surge in hog prices, followed by five years of returns that were often below the cost of production for many producers. In that time, prices have risen and fallen with seasonal changes in supply and demand.
|Graph 1: Hypothetical comparison of OlyWest 2010, OlyWest 2017, OlyWest 2019 and OlyWest 2020 with a $185 average western Canadian cost of production between January 2015 and May 2020.
Since the beginning of COVID-19, in March 2020, prices have swung wildly in between $140 per hog and more than $220 per hog. The average price received in the five-year period prior is estimated at around $174 per hog (as noted in Graph 1). Using a cost of production of $185 per hog over that same time, the net loss would have been more than $11 per hog. While each producer’s circumstances and costs may differ, the average accumulated losses for this example were close to $1 million for a commercial farm that has not experienced any major costs over-and-above usual production and maintenance needs, such as managing a disease outbreak. This translates to a return on investment of negative 3.27 per cent. The result of these type of losses would have certainly diminished lender confidence and discouraged any reinvestment into the industry.
|Graph 2: Hypothetical comparison of OlyWest 2020 with a $185 average western Canadian cost of production between January 2015 and May 2020.
In 2019, Olymel offered a new contract to producers, the OlyWest 2020 contract. Like the previous OlyWest 2019 contract, it was based on the U.S. cash market for hogs using the U.S. Department of Agriculture’s (USDA) daily negotiated whole hog carcass price (LM_HG204).
In addition to the base price, premiums under the OlyWest 2020 were paid for weight (up to $4 per hog), loin depth (up to $6 per hog) and term contracting (up to $2 per hog). On top of that, a novel proximity bonus came into effect. This proximity bonus pays at least $3.50 for a 98-kilogram hog, depending on the producer’s distance from Olymel’s Red Deer facility. In addition, a new forward contracting system was also offered to cover up to 50 per cent of a producer’s contracted pigs.
Compared with the previous five years, had the OlyWest 2020 contract been available, prices and producer profitability would have improved (as noted in Graph 2). For starters, the five-year average price would have improved by $14 to $188 per hog. Instead of an average loss of $11 per hog, there would have been profits of more than $3 per hog. This would have resulted in a positive return on investment of slightly less than one per cent.
Shared value discussions spur change
During the Western Pork Boards’ Pricing Committee’s meetings with packers this year, the case was made that industry sustainability is significantly at risk.
Donald’s presented a temporary solution in the form of a $1.40 per kilogram pricing floor for 11 weeks, while Maple Leaf added a $20 per pig ad hoc premium for 13 weeks for producers who signed a one-year extension to their existing delivery contract.
|Graph 3: Hypothetical comparison of the original (July 2020) OlyWest 2021 with a $185 average western Canadian cost of production between January 2015 and May 2020.
Olymel’s response was somewhat delayed but included the new OlyWest 2021 contract. This new contract was a blend of the LM_HG201 cash hog price and the LM_PK602 pork cutout value, with a revamped grid structure based on 100-index and set premiums for weight and quality, each up to $4 per hog. The OlyWest 2021 also maintained the proximity bonus introduced previously and added another forward contracting option. If the OlyWest 2021 contract had been in place over the previous five years, the average price would have remained roughly the same as the OlyWest 2020, but there would have been an approximate $7 lift in the price paid during the 2020 calendar year to date (as noted in Graph 3).
In November 2020, Olymel modified the OlyWest 2021 contract by instituting a $1.60 per kilogram pricing floor, except for the case when the cutout price equivalent falls below $1.60 per kilogram, at which time the price is set by the cutout equivalent. The contract revision also introduces a wider grid and adds a dollar to both the weight and quality premiums, taking them each up to $5 each per hog.
|Graph 4: Hypothetical comparison of the revised (November 2020) OlyWest 2021 with a $185 average western Canadian cost of production between January 2015 and May 2020.
If the revised OlyWest 2021 contract had been in place over the previous five years, the average price per hog would have increased to almost $192, generating profits close to $7 per hog or more than $500,000 for the average commercial producer (as noted in Graph 4). The return on investment over the previous five years would have improved over the OlyWest 2020 and original OlyWest 2021 contracts, reducing most of the pricing valleys without taking away the peaks along the way.
Continued efforts toward greater equity
Does the revised OlyWest 2021 contract offer returns as favourable to western Canadian producers as the pricing structure in Quebec offers to producers there who sell hogs to Olymel? Not quite, but the new contract represents a positive step in the right directions as it relates to equitable pricing.
In western Canada, other packers besides Olymel are hopefully working on finding pricing solutions, and Alberta Pork will further explore that work in upcoming articles. An additional area to consider will be how input costs, such as feed, play a significant role in equitable pricing and packer marketing, yet this consideration is visibly absent in hog pricing.
When it comes to benefitting your business, Alberta Pork needs to understand both parts of the equation – cost and revenue – to provide effective support. Simply put, the better we can speak about our producers’ collective costs and revenue, the better we can reason for improved pricing, business risk management tools, and focus resources on important production issues. To this end, Alberta Pork continues to pursue Canadian cutout values and producer settlement data in order to clarify these types of issues.
If you are interested in helping us help you with some of the economic challenges you are experiencing, please contact Bijon Brown, Production Economist, Alberta Pork by email at firstname.lastname@example.org or by phone at 780-440-8460, toll-free at 1-877-247-PORK (7675).