Feed costs make up about 60 per cent of the total cost of hog production. Therefore, movements in feed prices could determine which side of the profit ledger a farm operates on. As the industry inches toward more equitable value sharing, should there be more consideration for feed costs?
Feed prices on the rise
After being relatively subdued for the better part of a year, Alberta feed prices surged in the last quarter of 2020 (Chart 1). Feed barley prices surged 38 per cent from a low of $192.51 per tonne at the end of August to $265.64 per tonne in the first week of December. Similarly, feed wheat and feed pea prices jumped by 20 per cent during the same period. Put into context, assuming a 550-sow farrow-to-finish operation uses just under 160 tonnes each of wheat and barley per month, the price surge in the last quarter would have added close to $30,000 in feed wheat and barley costs or an additional $2 per market hog sold.
The increase in feed cost has been mainly driven on the international side by rising demand for feed inputs coming from China, as the country continues to rebuild its hog herd after culling nearly half of all sows due to African Swine Fever (ASF). Tighter supplies have also contributed to the cost increase, based on expectations of lower crop yields in South America due to dry conditions, as well as a less-than-ideal harvest in countries like Ukraine.
Closer to home, Alberta had a better-than-average harvest, in which around 99 per cent of the crop was cleared by the last week in October. Despite weather variability during the season, overall yields were up and so were the grades. With higher yields and better-quality grain, as well as tighter supplies internationally, it stands to reason that the domestic feed grain industry will also have tighter supplies as more grains will be diverted to export markets. The result is higher feed prices.
This increase in feed cost has been made worse by declining hog prices. Since the middle of October, Alberta hog prices have steadily fallen. As a result, the share of grain costs to the farmgate price has risen sharply. In the past three years, this ratio generally fluctuated at around 35 per cent. However, in the space of six weeks, the ratio climbed from around 30 per cent to near 40 per cent (Chart 2). This means that, for every dollar currently earned on a hog produced, nearly 40 cents are used to pay for wheat and barley used to feed that hog.
Wheat and barley are major components of the prairie hog diet. However, there are other components to the diets, including protein feeds such as peas, faba beans and soybeans, whose prices move with the price of wheat and barley, as well feed concentrates, medicines, micro-nutrients and macro-minerals.
Based on the 2019 Alberta Pork Cost of Production Study, wheat and barley alone accounted for more than half of total feed costs, and 65 cents of every dollar earned in revenue was used to cover the total cost of feed. Extrapolating the 2019 relationship between grain feed cost and total feed costs, total feed costs could consume up to about 70 cents of every dollar earned in revenue, with the current surge in feed prices. That does not leave much for everything else.
Producers and packers share the risk
Vertical relationships, like the ones between producers and packers, require some element of risk sharing.
For instance, when the hog price is high, there is increased risk that packer margins will decrease. Alternatively, a low hog price increases the risk that producer margins will decline. Current contracts with some packers are designed to minimize these risks; however, with such volatility in feed prices as seen in the past few months, should there also be consideration of feed costs in the risk sharing equation? Would packers be willing to share a bit of producer feed cost risk? Is there any precedent for this?
In the U.S. market, on which Canadian hogs are priced, there are contracts offered that consider price movements of primary feed ingredients, such as corn and soybean meal. These tend to be lumped in with other contracts under the swine of pork market formula (SPMF) classification subcomponent of the U.S. Department of Agriculture’s (USDA) LM_HG201 report. It is unknown the extent to which these contracts, or any other contract under the SPMF classification, are used in the industry.
Nevertheless, for illustrative purposes, below are two examples of how feed prices are used in U.S. contracts.
In the first example, producers are offered six options and can choose up to two. The options include three cash price options, a cut-out option, a mix of cash price and cut-out price option, and a feed ingredient option.
In the second example, monthly cost of production is computed based on the feed ingredients, and this cost of production figure becomes the floor price for the month. A price ceiling is also computed as USD $8 above the floor price. The cash hog market price can move freely between the floor and the ceiling, but if the market price falls below the floor price, then the floor price becomes the market price, or if the cash price exceeds the ceiling price, then the producer receives 93 per cent of the cash price.
Viewing U.S. contracts through a Canadian lens
Following on these examples, in the coming weeks, Alberta Pork will illustrate how these U.S. contracts compare, and how they would look if adopted in Canada. Alberta Pork will also explore how similar types of contracts could be adopted when pricing off western Canadian feed ingredients such as wheat, barely and canola meal. And finally, Alberta Pork will look at how feed pricing is secured into the future. Stay tuned.