Hog margins have steadily improved since the beginning of the year. Futures markets are projecting the highest forward-looking hog margins for a model operation since 2014. Taking Q2 as an example, current margin projections are about $25/cwt., one of the highest projections for this quarter over the previous 10 years, and the highest for this point in the calendar year since 2014 when margins peaked at about $50/cwt. during the first week of March.
The opportunity to protect historically rare margin levels comes on the heels of a red-hot hog market, despite corn and soybean complex futures notching multi-year highs. The strength in feed markets has been quite remarkable, and it is important to realize the impact this has on profitability. Since the beginning of October, the nearly $1.00/bushel rise in corn and $100/ton increase in soybean meal have combined to reduce margins by about $8/cwt. for Q2, even though projected margins have improved almost $9/cwt. overall since then. The increase in projected hog prices has more than offset the increase in feed costs.
While you may believe the opportunity to the upside for hogs outweighs the risk to the downside, it may be prudent to protect forward profitability, particularly in deferred periods where margins could end up being weaker than current projections. Q3 2022 hog margins are currently just below $20/cwt., and like Q2, are in the top decile of the previous decade at the 93rd percentile of the past 10 years. While both Q4 and Q1 2023 margins are comparatively weaker from a historical perspective, they are nonetheless above average and close to the 80th percentile of the previous decade. Moreover, we are moving into a seasonal period where it has historically been beneficial to protect winter margins as they tend to peak during the spring.
While feed costs are already quite high, a further rise in prices could pressure forward profitability during a period when it may be more difficult for hog and pork prices to keep pace. The recent Russian invasion of Ukraine adds a whole new risk dimension to the global supply/demand outlook. The slowing of Ukrainian corn flow is a major potential issue in a tightening global balance sheet situation. Tension in the Black Sea region introduced new volatility to the market over the past several weeks.
While there are a multitude of knock-on effects from the escalation, the corn market has been particularly impacted. According to the latest WASDE report, USDA projects Ukraine to account for 17 percent of global corn exports. Ukraine on February 24 suspended commercial shipping at its ports after Russian forces invaded the country. While it is unclear the impact this will have long term on the Eastern European country’s ability to supply grain to the world, futures markets were limit up in the immediate aftermath of the invasion.
Moreover, the major corn and soybean exporter stocks to use ratios are historically low, and this magnifies the risk from uncertainty in the aftermath of Ukraine’s situation. Major corn exporter stock-to-use for the 21/22 crop year of 8.4 percent in the latest WASDE is well-below the average over the past decade. It is important to note this figure accounts for record corn production in both Argentina and Brazil, where La Nina has significantly impacted crop planting and conditions. Most analysts expect the South American crop to continue shrinking, putting further pressure on an already tighter-than-average global balance sheet.
Likewise, the global soybean balance sheet is also historically tight. USDA last projected the major soybean exporter stock-to-use ratio at 16.8 percent. If realized, this would be the lowest level since 1996. Similar to corn, USDA has been shrinking South American soybean production in each of the last two WASDE reports. Crop conditions in both Brazil and Argentina continue to struggle, opening the door for a continued tightening of the global balance sheet.
The fertilizer market is another risk factor for corn which could significantly impact the domestic supply/demand balance sheet for the upcoming crop year, particularly if the weather is unfavorable during the planting and growing season. Russia is the second largest nitrogenous fertilizer exporter to the US and nitrogenous is the second most imported type of fertilizer. Corn typically requires applications of all three nutrients (Nitrogenous, Phosphatic, Potassic), while soybeans typically only need Phosphatic and Potassic. If the Russia/Ukraine conflict leads to lower supply/higher priced Nitrogenous fertilizer, there could be more incentive to either plant soybeans over corn or use less fertilizer on the corn which would decrease yields and production.
The US imports approximately 27% of the domestic nitrogen supply, with imports sourced from Canada (19%), Russia (18%), Qatar (14%), and Trinidad and Tobago (10%). Russia recently set 6-month quotas on phosphate fertilizers, further stressing the global market. Russia accounted for 10% of global processed phosphate exports in 2020. Potassium is also important for corn growth as it aids in disease resistance and water stress tolerance. The US imports the vast majority of its potash consumption annually with imports sourced from Canada (85%), Belarus (6%) and Russia (6%).
The USDA’s Outlook Forum recently estimated 2022/23 US corn ending stocks at 1.965 billion bushels, up 425 million from this year with a stocks/use ratio at 13.2% which if realized would be the highest since the 2019/20 crop year. The projected season-ending corn price received by producers was forecast down 45 cents from the current year to $5.00/bushel. Obviously, there are a lot of assumptions in this forecast including trendline yields and normal growing conditions. The good news is that despite currently high feed prices there are margin opportunities, and it may be prudent to take advantage of these opportunities including the protection of feed input costs.
To take advantage of opportunities, it is important to know where your margins are. By taking account of your various input costs and expenses and projecting hog sales revenue against those, you can begin tracking forward profitability and put that into a historical context. This will allow you to objectively determine favorable opportunities to initiate margin protection and shield your operation from either rising feed costs or declining hog prices. While no one can know for certain what the markets will do as we move forward in time, it is probably safe to say that we can expect more volatility given increased uncertainties.
Trading futures and options carries a risk of loss. Past performance is not indicative of future results. Insurance coverage cannot be bound or changed via phone or email. CIH is an equal opportunity employer and provider. © CIH. All rights reserved.
The outlook for forward hog margins is less optimistic than it was even a month ago following the release of the USDA’s September Hogs & Pigs report. The surprising data indicating there were fewer pigs than what the market anticipated produced a bullish response in the futures market, although that soon faded as the calendar turned over to October. Spot December Lean Hog futures subsequently dropped about $13/cwt., and despite a recent bounce remain below the level we were trading prior to that quarterly report. Factors including a concern over labor shortages that could impact processor capacity in the winter months when it is needed the most as well as a significant slowdown in pork export sales to China recently have in part been attributed to the recent slump.
Meanwhile, feed costs have crept higher despite what generally have been better than expected yield results for both corn and soybeans as harvest winds down. Strong corn demand from the ethanol sector as margins swell to multi-year highs have supported the spot market, while concerns over South American weather and high fertilizer prices potentially reducing corn acreage in the U.S. next spring are adding premium further out on the curve. As a result of pressure from both lower hog prices and higher projected feed costs recently, forward margins have deteriorated over the past month and are only about average from a historical perspective looking back over the past 10 years. (Figure 1)
Figure 1 – Hog Margins (Q4 2021 – Q3 2022)
Focusing on either the spot Q4 or upcoming Q1 marketing periods, where margins are currently negative, there have been ample opportunities over the past several months to protect historically strong profitability and well above average margins. In fact, Q4 margins briefly breeched the 90th percentile of the past decade following the September Hogs and Pigs report, with projected profitability at $7.89/cwt. on September 30th (Figure 2). This followed a series of opportunities to protect at least 80th percentile margins going back to the middle of May. While it is obviously too late to do anything about protecting Q4 margins now that the marketing period is almost half over, there may be upcoming opportunities to address risk further out in 2022 if the margin landscape improves.
Figure 2 – Q4 2021 Hog Margin
In order to take advantage of these opportunities however, it is important to know where your margins are at. By taking account of your various input costs and expenses, and projecting hog sales revenue against those, you can begin tracking forward profitability and put that into a historical context. This will allow you to objectively determine favorable opportunities to initiate margin protection and shield your operation from either rising feed costs or declining hog prices.
While no one can know for certain what the markets will do as we move forward in time, it is probably safe to say that we can expect more volatility given increased uncertainties. Will China begin to see sow liquidation due to depressed prices and negative margins? Are there going to be less corn acres next spring because of high input costs? Is South America going to have a drought during their growing season? If strong demand continues from the ethanol sector, is it possible that the balance sheet may end up being much tighter than what the market expects?
Looking again at the graph of Q4 hog margins in Figure 2, you will notice that there has been quite a bit of volatility over the past six months. Margins have ranged from over $7.50/cwt. positive to about $5/cwt. negative since the middle of April. Swings in both hog prices and feed input costs have led to these changes in projected profitability, and this volatility creates opportunities. In addition to signaling beneficial times to initiate margin coverage, these price swings also allow for opportunities to improve existing margin protection. Examples of this include reducing cost in hedging strategies, creating more price flexibility in hedge positions, cutting exposure to performance bonds, and taking equity out of positions.
Moreover, with recent improvements to the LRP program and new alternatives like the CME’s pork cutout contract, there are now a variety of ways that margin protection can be established and more opportunities to create complimentary or supplemental positions once this protection is put in place. Regardless of the tools used, the main point is to have a plan and be disciplined with following through on that plan. Does your operation have triggers in place to establish coverage in forward time periods? Do you anticipate what types of supplemental strategies might allow you to improve on that coverage over time?
Figure 3 – Q4 Hog Margin 10-Year Seasonal
Figure 3 displays the seasonal tendency for Q4 margins over the past 10 years. The recent spike in margins to above the 90th percentile corresponds to a typical period of strength where margins seasonally peak at the 85th percentile by the first week of October. A secondary period of strength typically occurs from mid-January to mid-April (highlighted by the green bars), suggesting that producers be ready to execute on possible opportunities that may show up into that period. Similar approaches could be taken for other periods such as Q2 and Q3 2022.
Inventorying your costs and revenues to project forward margins and putting a plan together that will allow your operation to take advantage of opportunities once they arise can put your operation in a better position to be competitive. Now more than ever, it is important to be proactive in managing forward profitability. Please feel free to contact us with questions on how to create a margin management plan and take change of your bottom line.
Trading futures and options carries a risk of loss. Past performance is not indicative of future results. Insurance coverage cannot be bound or changed via phone or email. CIH is an equal opportunity employer. © CIH. All rights reserved.
In today’s fast-paced world where everyone is connected to the 24-hour news cycle, it can be difficult to tune out noise and opinions. The constant influx of COVID-19 headlines, weather maps for crop production regions, estimates of yield potential, and animal health issues have dominated agricultural news outlets. While it is natural to focus on how each of these factors could impact lean hog, corn, and soybean meal prices, it is also important to put those factors into greater context. Using futures markets to project forward margin curves for hog producers, the market is offering favorable pricing opportunities throughout the rest of the year and the first half of 2022. These margins are offered despite a tremendous amount of uncertainty heading into the same timeframe.
Leaning on lessons learned when favorable margin opportunities eroded after the initial reaction to PED and ASF, solid margin opportunities are not static and can be fleeting. For that reason, it often makes sense to begin thinking about layering into coverage when profitability can be secured, as it can be today. Despite the rapid rise in corn and soybean meal prices since the beginning of the year and the quicker-than-expected rebound in Chinese pork production, open market margins in Q4 2021 are at their highest level for this point in the year since 2014. Notwithstanding the unknowns in the marketplace, some of which are outlined below, securing historically strong profit opportunities may be an attractive option for producers today and should be considered.
No Shortage of Unknowns
As we head into the end of summer, market participants’ focus continues to zero in on new crop corn and soybean supplies. While volatility in the corn and soybean markets has tapered in recent weeks, crop condition ratings remain toward the lower end of the historical range because of widespread hot and dry weather throughout the upper Midwest. Even though we are already in August, industry opinions on final yield projections still vary greatly, placing additional emphasis on the upcoming August 12th WASDE report. In light of the continued importance of domestic weather and recent global production challenges, market volatility seems likely to persist. Uncertainties within feed markets can be managed in conjunction lean hogs to protect solid margin opportunities.
Figure 1. Corn Crop Progress
Figure 2. Soybean Crop Progress
Robust domestic demand and strong export shipments throughout the first half of this year have continued to support hog prices. Lower production, strong grocery sales, and lower weights have underpinned a hog market that made a remarkable rebound from the lows seen in the first half of 2020. While high feed prices will likely curtail expansion in the near term, there are also some uncertainties which could derail an otherwise optimistic outlook. Global swine health is always an important variable in margin outlooks and has dominated headlines in recent weeks. A common theme at recent industry events has been the impact PRRS continues to have on the domestic hog herd. On July 19, Germany confirmed its first case of African swine fever (ASF) in a domestic swine herd after more than 1,200 cases in wild boars in the eastern region of the country. On July 28, the USDA confirmed ASF in samples from pigs in the Dominican Republic, marking the first detection of the disease in the Western Hemisphere in about 40 years offering another reminder that ASF continues its march around the globe and the pork industry remains a single event away from a market-altering headline.
China was a major driver of pork export growth over the last two years but shipments and sales of pork exports to China have slowed in recent weeks. Widespread floods across China’s Henan province present another hurdle in its herd rebuilding efforts. After the province’s worst flash floods in centuries, reports of widespread crop and infrastructure losses were prevalent. More than a million livestock are reported to have died across nearly 1,700 farms, causing concern about the potential for disease to spread. Henan was the country’s second largest grain producer and the third largest pig producer in 2020.
Figure 3. Pork Export Commitments to China
Supply chain issues throughout the economy have been well-documented since the beginning of the pandemic and the hog sector has not been immune. The recent federal court ruling to repeal the provision of the New Swine Slaughter Inspection System (NSIS) that enabled pork processors to safely increase maximum line speeds adds to the uncertainty for this coming fall and winter. Combined with questions surrounding California’s Proposition 12 and its potential impact on demand as well as the recent resurgence of COVID, there are many factors that could impact future margins – both good and bad. When you consider that August 2020 hog futures traded as low as $47 and August 2021 futures traded as high as $120, protecting strong margins seems to be a prudent idea.
Current Opportunities and Structuring Your Coverage
Open market margins for Q4 2021 are at the 87th percentile of profitability over the past 10 years, offering producers a chance to protect historically strong profitability. Likewise, open market margin levels in Q1 and Q2 2022 are at the 83rd and 74th percentiles, respectively. Projected Q4 2021 margins for a demonstration operation can be seen below.
Figure 4. Q4 Open Market Margin
There are many different strategies that one may consider to protect the opportunities the market is offering today. Each strategy differs in its level of margin protection to the downside, opportunity to the upside, and cash flow considerations. A producers’ position should also reflect his or her individual bias. Given the risk and uncertainty on both the input and revenue side of the margin equation, it likely makes sense to protect both components in some way, shape, or form. Futures, options, and the recently-revamped Livestock Risk Protection (LRP) program may by viable tools to fit into your margin management approach.
Protecting favorable margin levels does not necessarily mean one must “lock in” each component with futures. For example, if a farmer is bullish on hogs, a flexible strategy could be developed to allow for an improvement in lean hog futures between today and the Q4 2021. Allowing for $10 of upside would increase the open market margin to the 95th percentile. Likewise, a producer may be bearish corn and believe there is a chance December corn futures could be trading down at $5.00 per bushel by the end of the year. Allowing for 50 cents to the downside from today’s price level would increase the open market margin to the 90th percentile of historical profitability.
With all the risks inherent in the management of forward hog margins, it is important to remain disciplined. With positive margins that are historically strong, it may make sense to examine a mix of futures, options, physical, and/or LRP to protect these margin levels. Opportunities and risks abound heading into the end of the year, from crop size to unknown exports and domestic demand. Whether focusing on margins through Q4 2021 or beginning to scale into coverage throughout the first half of 2022, a variety of different strategies can address the tradeoff between trying to preserve forward opportunity and protect existing profitability. For more help on evaluating specific strategy alternatives or to review your operation’s risk profile, please feel free to contact us.
Trading futures and options carries a risk of loss. Past performance is not indicative of future results. Insurance coverage cannot be bound or changed via phone or email. CIH is an equal opportunity employer and provider. © CIH 2021. All rights reserved.