The Spot Market Continues its Slide

Hogs sold on the spot market continue to decline at a rapid rate, according to a study by the University of Missouri.

Total spot market sales have dropped from 25.7 percent of U.S. slaughter hogs in January 2000 to 17.3 percent this past January. That pattern continues to follow the trend line, which shows declines from 62 percent in 1994 and 43 percent in 1997.

“Unless something happens, the spot market will disappear within the next five years,” says Glenn Grimes, University of Missouri agricultural economist.

Grimes does point out, however, that the trend away from the spot market may start to level off. Some packers have expressed interest in maintaining the number of hogs sold on the spot market near current levels. Keeping some semblance of a spot market gives packers more flexibility, because they don’t have to secure their entire hog supply.

In early February, Grimes surveyed the following packers: Smithfield/Morrell, IBP, Swift, Cargill/Excel, Hormel/Rochelle, Farmland, Seaboard, Premium Standard Farms/Lundy, Indiana Packers, Hatfield and Clougherty. These packers represent 86.9 percent of the U.S. federally inspected hog slaughter.

“Everyone in the pork industry should be concerned, because in five years we may need a substitute way of determining the price of hogs,” says Grimes.
Breaking Down the Contracts

As more hogs are being sold by some kind of contract, the formula contract has become the most popular pricing method, according to Grimes.

Formula pricing contracts – defined as a reported price plus some bonus amount – have increased about 10 percent since 1999, now covering 54 percent of the hogs sold in the United States today. No other form of contract makes up even 10 percent of the hogs sold in the United States.

However, risk-shifting contracts with either a fixed price tied to a futures market contract, a fixed price tied to a feed price with no ledger maintained, or a window contract with no ledger maintained are also gaining popularity in some circles.

“That’s the direction that producers and bankers would like to go,” says Grimes. “If you look at the last three or four years, producers with risk-shifting contracts have been better off than those without them, but it’s impossible to tell if this will be the case in the future.”

Grimes goes on to say that packers are having mixed reactions on risk-shifting contracts. Some have worked hard to expand these contracts, while others are beginning to pull back.

Grimes also says there is no one contract that is better for particular producers or particular situations. He does recommend that you look for an opportunity that gives you a solid price compared to your cost of production.
Vertical Integration Continues to Grow

It should comes as no surprise that the percentage of hogs owned by a packer or company with packing plants continues to grow.

In 1994, hogs owned by a packer equaled 6.4 percent of the total; in 2001 that number was 27 percent, according to Grimes.

Despite increases in hogs owned by a vertically integrated company, the number of packer-owned hogs reported by internal transfer has declined. Grimes says that’s because nearly all vertically integrated companies are reporting their hog transactions on a formula contract, because that allows them track how each unit of the business is performing.

Grimes says the rise in vertical integration has more impact on annual production than the price of live hogs or the amount or types of contracts offered. In addition, Grimes speculates that the success or struggles of Smithfield Foods over the next couple of years will determine the future growth of vertically integrated companies.
What Does the Future Hold?

If the current trend continues and the spot market disappears in five years, a new system for determining the price of hogs will become necessary.

Grimes says the most talked about method to replace the spot market would be some form of product pricing, using prices on the wholesale level.

“The biggest problem with using product pricing is confidence in a new system because of the thinness of the market,” says Grimes. “Packers know what price they sell the product for, but producers don’t have that information, so that gives packers an advantage.”

Grimes says it is conceivable that in the future, packers could become required to report this information, if it became the basis for pricing hogs.