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A Few Thoughts – key beef industry economics – not just farmers and packers

As I have been thinking about the Biden Administration’s plan to “fix” the meat packing / processing industry so that “farmers” can receive a “fair” price and be profitable, I have come to the conclusion that I must have missed something in my graduate economics classes. Or perhaps, USDA’s conclusion with regard to the economics of market structure and pricing across the meat industry supply chain is just wrong. I support the latter.

First, let’s define the beef (yes, beef not cattle) industry supply chain. This is important in any discussion as each link in the chain plays a critical role for the success of the entire supply chain from producing a calf to marketing finished beef products to the consumer and is far more complex than farmers and packers. It involves 1) cow-calf operations that raise calves, 2) stocker operations that hold those calves for added gain on grass and sell feeder cattle, 3) feedlots that buy and finish those feeder cattle to market weight, 4) packers who buy the finished cattle and convert those live cattle to finished marketable quality beef products through fabrication and further-processing and market those beef products directly or through 5) distributors to 6) restaurants and supermarkets.

Emphasizing the structure of the beef industry to stress the importance of the distinct segments, I say without reservation, it takes every segment of this supply chain working for the industry to be successful and the supply chain is more than family farmers and big packers.

One key economic principal of this beef supply chain is economies of scale. This is true for the ranches raising cows and calves, feedlots finishing cattle, packers and processors converting those cattle to beef products, and even supermarkets and restaurants. Simply put, as a firm expands production and achieves greater production efficiencies, per unit costs decline. This is a driving force in any business and has been particularly true in production agriculture as well as the packing / processing industry. Much of my graduate research on economies of scale and the minimum efficient scale of cattle ranches in Nevada in 1983 would still hold true today.

The drive toward economies of scale and the resulting increased production efficiency has a notable impact on the beef industry. This is true whether it be ranches raising cows, feedlots, and packers. Economies of scale have led to consolidation in all segments of the industry as agriculture businesses strive for the point on the long run average cost curve where economies of scale are exhausted.

So, getting back to the Administration’s $1 billion plan to make the market fair – yes, it’s a bad idea, particularly as the supply of cattle declines in the face of herd liquidation over the past 2 years. Prices may rise in the short term simply because cattle numbers are declining against the current capacity, but those higher prices for cattle will be paid by all packers – large plants, small plants, new plants, and old plants. And yes, more plants may mean increased competition but for how long, until herds are rebuilt and cattle numbers increase and the capacity gap is narrowed again? I go back to my recommendation over the past 5 years or more – instead of building packing plants, the cattle segment of the supply chain needs to be more focused on becoming more involved with the beef’s segment’s branded programs with premiums or marketing direct to consumers through locker beef plants.

A Few Thoughts by John Nalivka – the long view

As the saying goes, your business has to survive the short run to be successful over the long run. While that is certainly true, I think there is often a tendency to get so concerned over the short run that a longer-term vision for the business is lost. Consequently, I think that in conjunction with managing for the short term, it is also appropriate to combine the short-intermediate view of your beef business with the long view.

In economics, the long term is a time period long enough that a producer has flexibility to change all of the factors of production and significantly impact costs and potentially market prices received. In other words, he can adapt to a changing business environment with significant production decisions that will permanently affect his business. Adjustments made in response to a short-term drought typically are not permanent.

With 2022 nearly upon us and bringing with it the prospect of a solid cattle market and profits to cow-calf producers not realized since 2015 (Sterling estimate), this would be a great time for ranchers to rethink their business in terms of time frame. This is particularly important as the industry and consumers are changing. Rather going through 2022 with the goal of just “making it through another year,” think longer term (10 years) and profitability on your terms. Ask questions and think about the changes you can begin making in order to make your ranching business profitable every year with or without a market rally. Take a deep dive into your financials and your current ranch resources as well as the potential to expand those resources. Think production capacity on your ranch and the potential for economies of scale to lower your per unit costs.

This may be a significant change in mindset and I don’t say that to be critical. Change can be difficult and I understand the constraints faced in ranching. However, by simply expanding your planning horizon from short-to-intermediate view to one that includes the long view, the possibilities may suddenly look quite different.

A few thoughts by John Nalivka: Looking ahead into 2022 – Stronger markets and increased opportunity for cattlemen

The last two years may be the most interesting and challenging that I have observed over a time span approaching 40 years of market analysis as well as many years on large cattle ranches before that. And, I will admit from the perspective of the market outlook and this year’s drought it is nice to be at the end of 2021 and closing in on the beginning 2022.

So, let’s take a look at prospects for 2022 and I will begin with saying that markets are a function of the dynamics of supply and demand – period. While this may seem like one of those overused statements made by economists, both have played an important role in markets over the past 6 months as well as the outlook going forward.

Beginning with the supply aspect, I don’t think anyone would argue that cattle numbers will be declining as low prices and drought have both led to herd liquidation over the past two years. Through the end of October, beef cow slaughter was 10% higher than a year earlier. In fact, the industry slaughtered the largest number of beef cows since 2011, a year when herd liquidation driven by drought beginning in the Southwest and moving into the Midwest, pushed U.S. cattle numbers to a 50-year low by the beginning of 2014. Dairy cow slaughter is up 3% year-to-date while total cow slaughter through October posted a 6% increase from year-earlier and the highest since 1996. Furthermore, we started with nearly the same U.S. cattle inventory at the beginning of 2011 as we did at the beginning of 2020.

How about the other part of the breeding herd – heifers? Heifer slaughter through the end of October was the highest since 2011. I am forecasting 2022 heifer slaughter to be down 4% from this year and just marginally higher than during 2012. Reduced cattle numbers for 2022 and likely through 2024 are evident. My forecast or estimate for the January 1 total cattle inventory is 91.25 million, down 2% from the beginning of 2021, the lowest since 2015, and 475,000 more than the beginning 2012 cattle herd. That’s a lot of numbers, but important as we look ahead.

I am forecasting 2022 cattle slaughter to be down just over 2% from this year’s 3% increase with fed cattle numbers also down 2% and cow slaughter down 4% from a year earlier. While there is always uncertainty with carcass weights, I would expect weights to fall as fed cattle numbers decline and feedlots are increasingly current with showlists marketing into a strong market. Also feed costs and cost of gain will continue to be relatively high. So, assuming a 1% year-over-year drop in carcass weights, beef production in 2022 will be down 3% from my estimate for 2021.

Moving onto the next critical piece of the puzzle – beef demand – I have consistently said in speaking with clients this year that while beef production will be down in 2022, the outlook for prices next year will be highly dependent upon demand following this year’s surge as consumers satisfied pent-up demand with restaurants openings during the second-half of this year. In addition, buying at the supermarket meat case was driven by consumer preference in the face of rising prices. If only we had to think about the supply, but that is not the case as it takes a consumer willing and able to buy your beef. Demand was definitely increasing and I would submit that consistent quality has been the key. The $64 question was still whether demand will hold steady into 2022. Other costs in the household budget, particularly gas at the pump, are rising sharply with inflation posting a 6% annualized increase and the highest in 30 years.

I do believe and I am assuming in my forecasts that even if demand weakens somewhat, prices across the beef complex, including fed cattle, feeders, and calves, will post notable gains during 2022. This is further supported by global beef demand. U.S. beef exports through September are up 21% from a year earlier with the value of fresh and frozen beef exports and variety meats posting a 40% increase over the same period a year earlier. That value of those U.S. beef export categories is over $7 billion! Japan accounted for 24% of those exports while China’s share grew from 2% for all of 2020 to 15% for January-September 2021. That is solid support to U.S. beef markets and will continue as a significant contributor to demand going forward.

The outlook for the industry is looking quite optimistic going into 2022 and beyond both from the perspective of the current cattle cycle and solid consumer demand. However, I believe that the impact of the last 18 months will lead to many changes in the entire beef industry through production and processing and last but not least, retailers and foodservice who put that product in front of the consumer.

 

A Few Thoughts by John Nalivka – Assessing risk

Risk management has become somewhat of a “household” term. Building packing plants has become somewhat of a household term – at least at the ranch. But I firmly believe cattlemen might want to think seriously about how your risk profile changes as you go down the road from being the owner of a ranch to the owner of a packing plant.

Every year as a rancher you face the risks posed by the market, the weather, government policies and regulation, the political environment, and family health just to name a few. These risks are generally common to all ranchers and managed not necessarily in any priority but managed in order to hold on to the ranch and remain in business. The impact of any of these risks mostly only concern the ranch and raising cattle on that ranch with no need to expand the risk roadmap beyond the road turning into the ranch.

So, now a group of ranchers decides to take greater control of their destiny and build a packing plant. This has become a fairly common conversation over the past 12 months as in light of volatile and often what seemed to be “unfair” markets to many. While I am sure these conversations have all included many aspects of risk in owning a packing plant, I think it is important to really think about how the exposure to risk changes significantly going down that road from owning the ranch to now owning both the ranch and a packing plant.

Once your cattle enter the knock box in that packing plant, the risk and liabilities change significantly. Managing that risk on the ranch to stay in business and raise the “right cattle for the right market” has now shifted to the number one priority – food safety. And food safety concerns consumers. One critical issue can shut a plant down or in the very least result in a massive lawsuit. Just this week, we are reading about just that.

Also, we all know the devastation and cost of range fires. That doesn’t change with packing plants. Packing plant fires pose the same risk. We have seen that in the last couple of years.

Cost management is critical to managing risk in a packing plant. Operating costs driven by working capital to purchase cattle, labor, trucking, and the cost of building and retaining markets are all significant. Thus, the drive to large, multi-plant companies and this is risk management. A client many years ago said to me, “if you own only one plant, your risk is increased several-fold.” Food for thought.

 

A Few Thoughts – Supply chain issues are impacting capacity utilization in the meat industry

Since the plant shutdowns and ultimate production slowdowns resulting from COVID last March, available capacity as measured by daily slaughter, has become a focus of the beef industry with government seemingly designated as the chief problem solver. However, as I have stated many times, capacity is not the critical issue, but rather capacity utilization and that issue largely centers on plants with processing and further-processing. In fact, labor constraints are not just noted in the slaughter and processing, but coupled with other critical issues are creating bottlenecks across the supply chain, from packaging to trucking.

Let’s take a look at beef industry slaughter capacity and utilization. I have calculated and tracked these figures since 1988 and I do think that slaughter, while not in-compassing all aspects and potential bottlenecks of a plant, it is probably the best metric to estimate and track capacity in the red meat industry. However, one cannot lose sight of that other plant components can have an impact, i.e., further-processing and cooler space. My estimated annual figure for fed cattle slaughter capacity is 29,796,000 head and 7,602,000 for cow slaughter. On a weekly basis, fed slaughter is 574,974 or 104,541 per day on a 5½ day week. Cow slaughter capacity is 146,190 per week or 26,580 on a 5½ day week.

Is there enough capacity? As I said earlier, to answer that question, the analysis must shift to utilization. This is true of any aspect of the industry whether it be packers, feedlots, or grass when talking about cow-calf capacity. It’s not total feedlot pen or bunk space but rather the utilization of that space and with grazing capacity, the unencumbered utilization of existing forage.

I look at weekly and annual capacity utilization. So, utilization of fed plant capacity has averaged 87.3% YTD through September 11. This compares to 84.3% last year for the same time period and 88.3% in 2019. This comparison illustrates the impact of plant closures and line slowdowns due to COVID in 2020. In fact, during April and May 2020, utilization of capacity in fed beef plants averaged 67.2%. That was not only significant to the industry, it posed a major challenge to every plant in the country and that’s an average for the industry and does not show the significance of the problem for some plants. A target is to consistently week in and week out operate at 90% or higher.

Improvement for capacity utilization in cow plants YTD through September 11 has been substantially better than fed plants and has averaged 89.7% compared to 84.3% for the same period a year ago. It’s no wonder. Beef cow slaughter is up 10% YTD from a year earlier while dairy cow slaughter is up 2%, and total cow slaughter is 6% higher YTD than a year ago. In 2019, for the same period, utilization of cow slaughter capacity was 85.3% and averaged 80.1% for April and May 2020.

Reduced cattle numbers in 2022 through at least 2024 coupled with a continued tight labor supply for packing plants will further aggravate this issue of capacity utilization holding capacity unchanged. My estimate of average fed plant capacity utilization for 2022 is 85.3%. So, the question is – if capacity is increased against a declining cattle supply and reduced capacity utilization, how could a new plant carrying large debt coupled with working capital compete?

 

A Few Thoughts by John Nalivka – beyond the numbers

This week, I intended to write about the ill-conceived decision issued by the Ninth Circuit Court against the Hanley family in Jordan Valley, Oregon regarding their Federal grazing permit in Idaho. I will follow-up on that important topic next week, but this week – upon reading the White House’s briefing paper entitled “Addressing Concentration in the Meat-Processing Industry to Lower Food Prices for American Families” dated September 8, I was somewhat stumped, to say the least, and consequently decided to present a few thoughts.

My reaction after reading the article and listening the press briefing was that there is more to this brief talking about “lower food prices for American families” particularly since we have all expressed how U.S. and global consumer demand has been a key driver, if not the key driver, to the strength of U.S beef, pork, and poultry prices this year. And of course, the impact of COVID and the tight labor situation on the packing/processing industry and capacity utilization in the plants. So, now I am told that high prices are because of packer concentration!

I recently commented to a client that, as analysts, we have become so accustomed to discussing demand in terms of total meat supplies and prefacing our outlook with the reservation that “large total meat supplies will be the limiting factor to higher prices.” We have had to change gears on that assumption as there has definitely been a positive shift in demand.

So, what’s up? Perhaps, in the haste to go after packers in order to gain producer trust, the government may be using consumer price inflation as a means for greater leverage against packers and get their foot in the door to a greater presence in the meat industry. I think we have now approached the point where the government will increasingly play an increasingly greater role – beyond enforcing the Packers and Stockyards Act – in U.S. meat and food production. I believe they were invited to the party. Again, I reference the title of that briefing – “lowering food prices for American families.” A little trip along memory lane – remember the price controls put in place by the Nixon Administration? The beef industry paid for that little bit of government involvement for years! In all honesty, there are few people who would disagree that we pay a relatively small price for a more than ample supply of safe, quality food in this country (my emphasis).

The briefing paper presented on September 8th presents far too many opportunities for the government to increase their presence in the meat industry. It should be required reading for cattlemen. As a cattle producer, you might ask whether more government really generate higher prices. Will more packing plants financed by taxpayer dollars create higher prices when the cattle cycle turns and herd numbers grow? There are many new plants financed by taxpayer dollars that didn’t make it 2 years. An invitation to “fix” the packing industry is only the beginning and reading between the lines of this paper may be a pretty clear roadmap to the future for the beef industry and cattlemen beyond just markets.

 

A Few Thoughts by John Nalivka: Backward planning

As cattlemen set their sights on 2022, there is quite a bit of optimism. Looking at markets, I have been optimistic, but let’s presume for a minute that all of this optimism turns out to be wrong and market performance is not as we are forecasting? How will this affect your business going forward? At this point, you may be thinking, where is Nalivka going with this? No, I am not changing my market outlook, but rather asking the question to bring attention to budgeting and planning for “worst case” scenario.

Market outlook is built on assumptions. Those assumptions concern supply and demand and I would submit, the demand side of the equation is more critical to market direction as 2022 approaches. The supply side of the equation at this point is probably more certain as cattle numbers will be down as the result of drought and poor market conditions over the past 2 years.

To say that volatility and uncertainty have defined markets over the past 18 months as producers and consumers have acted or responded to the events of those 18 months would be an understatement. Obviously, this has affected the assumptions underlying our forecasts and market outlook more than once since the beginning of 2021.

Beef cow slaughter remains well over a year ago. In fact, since the beginning of the year, it has been the highest since 2011. While this may lead to the conclusion that we are going back to the record prices of 2014 and 2015, I believe that is not likely. The herd was liquidated to 88 million and a 60-year low as a result of drought in the Midwest and a severe economic recession.

Coming back to my question – how will your business of raising cattle be affected if demand does not support higher prices? Worst case scenario may be the better starting point in times of uncertainty where circumstances are quickly changed by legislative action, government decisions, and nature all which are leading to sharply higher inflation.

 

A Few Thoughts by John Nalivka – optimistic 2022 outlook for the beef industry

The outlook for cattle prices and substantially higher returns to cattlemen is looking positive for 2022. Low prices and significant cost inflation have had a significant impact on cow-calf producer decisions toward herd numbers over the past 2 years. In addition, this year’s severe drought across the West and North Dakota have only added to an already bad situation. Consequently, beef cow slaughter was up 10% through the end of July and the highest since 2011. Dairy cow slaughter year-to-date through the end of July was up 1/2% leaving total cow slaughter through the end of July 5% higher than a year earlier. Total cow slaughter during 2021 will likely be 4% higher than prior year.

The other part of the herd building equation of course is heifers. With heifer slaughter 8% higher than a year earlier through July, there’s no question that heifers have not been retained and bred. In fact, I am not even sure if the 1% increase in the number of heifers that were intended to calve this year as indicated on the January 1 inventory report even happened. For 2021, I expect heifer slaughter to be up 4% from a year earlier.

Herd liquidation during 2021 will result in a 1% smaller calf crop this year. This calf crop is next year’s cattle supply. Furthermore, indications are that heifer retained from this year’s calf crop will also be limited so reduced cattle numbers are likely to be realized for at least the next 3 years.

So, the supply side of the equation is positive, but the other half of the equation is demand and right now, demand is looking quite positive as well, both from the U.S. consumer perspective as well as global customers. Of course, I still believe caution is the watchword as prices in restaurants and retail are rising substantially.

U.S. beef exports during 2021, through the end of June were up 22% from a year ago with sales to China up 1,076%. Export sales will end the year record high and up 15% from a year ago and though expected to slow and post a minor decline during 2022, will still remain strong.

Declining cattle numbers coupled with lighter carcass weights will lead to 2% less beef production in 2022 than this year’s record production. As with all forecasts, uncertainty is always present and that spells risk, but the outlook for sharply higher prices and returns to cow-calf production and feedlots is greatly improved for 2022. Given the current situation, I expect calf prices to end 2021 8% higher than a year ago followed by a 5% increase in 2022, with 400 – 500 lb. calves averaging $191/cwt and the highest since 2015. 750-800 lb. steers will be up 9% for this year followed by an 8% increase in 2022 and an average of $159/cwt, also the highest since 2015. Slaughter cows will remain strong into 2022 with 12% higher prices against this year’s projected 10% increase over prior year as demand for lean cow beef remains strong.

How will my price projections for 2022 impact cow-calf returns? Even against increasing costs of production, I expect returns against cash costs to show the most improvement since 2015 and an opportunity for industry optimism!

 

A Few Thoughts by John Nalivka – Be careful what you wish for!

Cattlemen – be careful what you wish for! This was my response to the administration’s July 9th Executive Order on Promoting Competition in the American Economy. As someone who is very suspicious of legislative and regulatory activity that interferes with markets under the guise of improving them, I characterized the order as “the camel getting his nose under the tent.” Writing legislation and regulations is easy – containing them is not. And, therein lies the problem. Before long, the entire camel is “in the tent.”

Six days later, Sen. Cory Booker reintroduced his Farm System Reform Act which amongst other measures, the proposed legislation lists maximum sizes for livestock and poultry operations. By the way, Booker is a vegan. The “camel is “in the tent.” Did any cattlemen ask for Booker’s 1,000 head limit on the size of feedlots? I would guess that the vast majority of cattlemen had the same response as me – how’s that going to work? With a follow-up statement – he obviously doesn’t understand the industry.

The Executive Order was applauded by cattle industry groups as a path or THE path to fair and competitive markets. Beyond my suspicion of government tampering with markets, there are a couple of other important issues with the legislation and the first is that economies of scale are a significant driver to structure. Consolidation across all of U.S. agriculture is not a ploy to control the market. Consolidation is driven by economies of scale or increasing the scale of the operation reduces long run average fixed costs. It is true with packing plants, feedlots, and cow-calf operations.

Yes – in many respects, size and scale of operation can give an advantage in the market. And, yes, those advantages can have the potential of creating non-competitive market activity. This is why the Packers and Stockyards Act was passed in 1921. But, going further and asking politicians to interfere with and or constrain an industry that efficiently and sustainably produces the most secure and affordable food supply in the world because packers are perceived as the roadblock to free markets is not the answer. I see the end result as a multitude of regulatory measures to redesign the industry toward some preconceived notion of “fairness.” Free markets will become legislation driven by bureaucratic mandates and cattlemen won’t like it any more than packers.

Lastly, in written comments to a USDA Solicitation for Bids to address the topic of Packer Concentration in January 1992, Sterling Marketing, Inc. wrote, “on the surface, one would assume that it would be a fairly straight-forward task to isolate the various components, track their respective margins and contribution to value, and in short order, determine if any one sector or sectors have been placed at a distinct economic disadvantage because of non-competitive activities by the other components. These actions could then be scrutinized to determine if they, under “normal” market conditions constitute unfair practice. Unfortunately, the study may not be afforded the luxury of drawing a definitive conclusion because of the myriad of other factors at work as well as the vast number of interested parties.”

 

A Few Thoughts by John Nalivka on drought, the cattle inventory, and risk management

We were at the Idaho Cattlemen’s Summer Roundup in Salmon, Idaho on Monday and Tuesday to discuss with members about structuring a risk management program on their ranch including developing and using budgets and using USDA’s risk management insurance programs. The program was well received by Idaho cattlemen attending and as ICA marketing committee chairman, I felt it was definitely a success.

With severity of the drought, risk management is definitely the major topic as ranchers scramble to sustain their herd and develop a sound marketing plan for their calf crop. There has already been a substantial number of pairs sold as available forage dwindles. To say this has not been a good situation in many areas of the West would be an understatement which definitely confirms the importance of risk management on your ranch. And, I don’t make that statement lightly. As we all know, in a severe drought, costs increase and revenue declines as calves are lighter and sales of cows and calves often do not follow a marketing plan other than “there isn’t enough feed.”

So, as I said at the meeting on Tuesday, we are liquidating cattle this year at a more rapid pace than probably would have occurred had there not been a drought. Beef cow slaughter through mid-June was 10% higher than a year ago and on a weekly basis above, the levels realized during the 2011-2013 drought which sent U.S. cattle numbers to a 60-year low. In fact, year-to-date beef cow slaughter is the highest since 2011, but furthermore, the two figures are nearly equal. Beef cow slaughter picked up following the severe winter storms in February and has remained above a year earlier since that then as ranchers sold cows that lost calves or needed to manage tight forage supplies.

We started the year with just over 31 million beef cows and just slightly more than at the beginning of 2011. At the same time, heifer slaughter year-to-date is up 9% from a year earlier, partly as the result of comparing to 2020 with plant shutdowns and slowdowns during the second quarter. But still, there were substantially fewer heifers from the 2020 calf crop held as replacements and instead, went to the feedlot. Dairy cow slaughter year-to-date this year is down 2% from a year ago and has accounted for the smallest share of cow slaughter since 2011.

I expect cow slaughter to remain higher through August which could somewhat temper the 4th quarter seasonal increase. This would leave cow slaughter for the year up 4% and when coupled with increased heifer slaughter and a 1% smaller calf crop, the January 1, 2022 U.S. cattle inventory would be down nearly 2% from the beginning of 2021 and nearly the same as at the beginning of 2012. In my analysis, depending upon demand and weather in 2022, that portends higher prices. But again, think budgets, break-evens, marketing, and risk management.