The issue of packer livestock ownership again looms large. Leading the charge is legislation re-introduced in Congress, and Smithfield winning a challenge of the law that prevents packers from owning livestock in Iowa.
A ban on packer livestock ownership was first proposed last year as part of the 2002 Farm Bill, but the measure fell out in final negotiations. Now it’s back, although the new version may eliminate some confusion.
“The biggest problem with the last proposal was the wording, which had the potential to eliminate marketing contracts,” says Steve Meyer, Paragon Economics.
Now, with the wording remedied, a packer livestock ownership ban may have little direct impact on the industry. “A packer ban would likely cause more complex legal structures, but possibly not much else,” says Ron Plain, University of Missouri agricultural economist.
The Iowa law has resulted in legal relationships such as the one between Smithfield Foods and Stoecker Farms – essentially a matter of ownership on paper and in name only. When the state tried to close this loophole, the court struck down the law, which the state is now appealing.
“If packers were banned from owning hogs it wouldn’t change much,” says Meyer. “Packer-owned hogs would move to someone else’s hands, but likely remain under contract to the same packer. It won’t do what some proponents say it will – put more hogs on the spot market, nor will it raise the price of live hogs.”
A ban on packer livestock ownership could negatively impact future industry investments, says Meyer. Such a ban would illustrate a willingness to change major industry rules, which could scare off potential investors.
“Profitability of raising hogs and slaughtering hogs are inversely related, so combining the two reduces some risk,” says Plain. “There’s a strong economic incentive to coordinate packing and production. A packer ban looks to limit that.”
Five of the nine largest U.S. pork producers today also are packers. If they’re forced to liquidate, someone may be able to purchase a lot of hogs at a reasonable price.
“You have to discern between two different markets,” says Meyer. “The market for hogs won’t change, but the market for production assets could become very depressed.”
That’s assuming the vertically integrated companies would choose to keep their packing plants and sell production units. If the companies keep the production assets and dump their packing interests, slaughter capacity could decline, which would have negative price ramifications.
The National Pork Producers Council’s official position on packer livestock ownership remains “neutral.” “NPPC must represent member state associations, which are very divided on the issue,” notes Roy Henry, NPPC board member and producer from Longford, Kan. In truth, packer ownership is one of the more divisive industry issues today.
“Many small producers see packer ownership of hogs as one of the many industry changes that they don’t like,” says Plain. “Others feel that the economies of scale give large producers an advantage. Still others are convinced the packing industry is very profitable despite all evidence to the contrary.”
In most proposed packer livestock ownership bans, producer-owned cooperatives are exempt, which seems to be a double standard.
“If packers can’t own hogs, why should producers be allowed to own packing plants?” asks Henry. “Everyone needs to work together to identify where they fit in this protein-production chain.”
What the Economics Say
Last year when a ban on packer livestock ownership was proposed as part of 2002 Farm Bill, the National Pork Producers Council had the Sparks Company study the economic impact on the livestock sector.
The study determined the impact would fall into two main categories, those that change the industry’s cost structure and those that affect demand. Here’s a quick look at the results.
Cost changes – production and packing.
Plant operations and efficiencies. Rough estimates suggest that even if packing plants were only slightly underutilized, it would be a major cost to the industry. The study estimated loss of operational efficiencies could range from 50 cents per hog to $2, with the impact varying greatly by firm.
Risk management. To sustain investment in packing facilities, packers must maintain reasonably steady margins or risk collapse. One way to manage margin risk is to invest in pork production. The value of this natural hedge to the industry, in terms of more stable margins, is around $4 per hog.
For example: if 60 percent of the costs that packers incur in this case were passed on to producers, farrow-to-finish margins would be about $3.82 per head less than if packers were able to use livestock ownership to manage risk.
Cost of capital. A key impact of a packer livestock ownership ban might be for agricultural lenders to raise interest rates to reflect the increased risk of investing in a more volatile sector. Assuming a starting point of 8 percent interest rates, the cost of a 1 percent interest-rate increase could cost you $22.25 per sow, or $133.5 million for the industry.
Availability of additional equity. A ban would require some packers to divest direct ownership of 1.4 million sows (likely more.) Those sows are worth about $2.8 billion. Developing capital sources to replace those assets would be difficult and would likely lead to capital problems for the sector.
If packer-owned sows were devalued by 10 percent, $280 million of equity would be lost and all pork production assets would be affected. For example, the impact of a 5 percent erosion in sow asset values for the non-packer base could exceed $500 million.
Demand impacts – for both live hogs and pork.
Loss of export markets. A major impact of the ban would be less U.S. pork exports. Competitor nations would become more cost competitive as the U.S. industry restricts packers’ cost-management tools. Market-share losses could be dramatic, especially in Japan.
A 10 percent cut in export volumes would result in a 0.8 percent increase in domestic supplies, deducting about $2 a hundredweight from the national lean-hog value.