March 02, 2022
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.