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Rivers of red ink are threatening to drown hog producers all across the Midwest. Prices are the lowest they've been in more than 25 years. It's a variation on the oldest of economic formulas: too many hogs despite healthy demand. U.S. meat packers can't process the animals fast enough to keep ahead of the glut. Some farmers wonder if the rise of a new form of hog marketing, the contract, is causing the industry's current problems.THESE ARE GLOOMY DAYS for hog producers. Everyone expected a price drop, but no one thought it would get this bad. Joe Malecek is used to downturns, but this one doesn't seem to have a bottom.
Malecek: I've been in this business all my life, and been through many high and low hog cycles. But today's situation, the low cycle we're in now, is the worse one that I've seen in my career as a hog farmer.The price meat packers pay for live hogs has dipped below 15 cents a pound. Farmers figure they need more than twice that, between 35 and 40 cents, just to break even.
Malecek: It's questionable when this thing is going to turn around and that's the scary part of it, and I think everybody that produces hogs is in that position, when is this thing going to turn around ... we don't know.The hog industry is changing rapidly and Malecek says that's part of the problem. Perhaps no segment of agriculture has attracted as much public attention this decade as hog farmers. The growth of large scale hog production has been criticized as an environmental risk, an assault on the family farm, and just plain smelly. Malecek says the downturn raises another issue: the financing of these large operations.
Malecek: There's a need to secure financing for them. And lenders worked with packers to insure the cash flow to keep these big units going.That insurance is known as a "packer contract." A farmer agrees to sell a certain number of hogs to a slaughter house for a fixed price. Malecek sells about 30,000 hogs a year but he refuses to sign a packer contract. He says he doesn't see enough profit in them. Hogs have been a good way to make money for most of the decade. Those profits encouraged farmers to expand, and many used the packer contracts as a way to finance expansion. Malecek says the availability of contracts encouraged farmers to produce more and more hogs. In some cases, they just grew too large too fast.
Malecek: The packer would not issue contracts in the first place unless it was definitely to his advantage to offer them. And I firmly believe that packer contracts issued in excess of what the market can use is causing these very, very low prices.Did meat packers accidentally or deliberately create an oversupply of hogs, more than they can slaughter? So far the largest hog processors in Minnesota, Hormel and Swift, have refused comment. The price slump appears driven by a huge hog supply which has overwhelmed a robust demand for pork. Even with the Asian financial crisis hurting demand there, worldwide U.S. pork exports are up 32 percent over last year. Consumers are also buying more pork at the nation's grocery stores, up seven percent over last year. Paul Fitzsimmons and three brothers run a large hog farm near Good Thunder in southern Minnesota. He says its tough keeping emotions in check during what he calls a "brutal" hog-market crash.
Fitzsimmons: I think the biggest thing is an attitude problem that we face every day when you see the hog-market drop. You got to tell yourself every day that you're getting up with a purpose. That's the toughest thing I think to battle, during the dips in markets, is the belief that it's going to come out of it.Fitzsimmons sells his hogs to Hormel under a contract which guarantees him a fixed price. But there's a catch. The open market price almost always will be higher or lower than the price Hormel pays Fitzsimmons. The contract has an accounting mechanism designed to balance out those price swings. When the market is down like now, the meat packer could buy hogs for much less than it's paying Fitzsimmons. Hormel keeps track of that difference per hog and, in effect, Fitzsimmons runs up a debt with the company.
Fitzsimmons: That debit balance is actually cash that I wouldn't have received had I been on the open market. You know, it's like taking out a no-interest loan.In theory, the debt Fitzsimmons is building now will disappear when the hog market improves. That's because in good times Fitzsimmons could get much more on the open market than he receives under the Hormel contract. That difference is also tracked and figured into his balance. Fitzsimmons says without the Hormel contract he'd have to borrow money from his banker to keep things going, so it's a wash. Redwood Falls hog producer Joe Malecek worries the current downturn is so severe that some farmers will not be able to pay off their packer debt, no matter how good the next "up" cycle is. If that happens producers could accumulate more debt than their hog farms are worth.