John Nalivka: The Economics of Capacity & Utilization
Well, packing plants are back on track with fed beef plants averaging 91% capacity and pork plants running at 96%. No – capacity utilization is back at 91% for fed beef plants and 96% for pork plants. This is an important distinction – capacity versus capacity utilization.
Capacity became a much-discussed issue in 2020 as packing plants either shut down or production was severely cutback with COVID during the second quarter. Capacity and capacity utilization became loosely interchanged. Capacity is a business’ maximum productive capability while capacity utilization is a key metric indicating the how much a business is employing of their total capacity at any given time. Capacity has been a significant measurement in my analysis and consequently, I have calculated and tracked slaughter capacity for both the beef and pork packing industries since 1988. Based on plants operating on a 6-day work week, the beef industry currently has the capacity to slaughter 29,438,000 fed cattle and 7,350,000 cows annually or a total of 36,788,000 cattle. On a weekly basis, the total cattle slaughter capacity equates to 707,462 head per week. In 2019, average weekly slaughter for the year indicated plants utilized on average 89.7% of the total cattle slaughter capacity. This is the key metric – utilization and should not be confused with capacity. Capacity increases as plants increase their operational capability to slaughter more cattle, not utilize more existing capacity.
When a plant increases operational capacity, there is an increase in total industry capacity which in turn has economic ramifications through the cattle cycle as the inventory is expanded or liquidated. Markets are affected as capacity and / or capacity utilization change. As cattle numbers decline following herd liquidation, packing plant capacity utilization declines and competition for cattle increases leading to higher prices. This was not the case when beef plant capacity utilization fell to 60% during April. The supply of cattle did not change. What changed was the number of cattle that packers were able to slaughter and process in the face of operational restrictions due to COVID. Consequently, packer demand for cattle was reduced against an unchanged supply. For the year, I expect plant capacity utilization for all cattle to average 87.7%. In general, utilization in the low-to-mid 90% range is considered optimal. In comparison, during 2015 following major drought-driven herd liquidation leaving the cattle inventory at a 60-year low, fed cattle slaughter fell to 23 million against a slaughter capacity of 29 million head and left average plant utilization at 80.5%. Fed cattle prices during 2014-2015 averaged $151.55 / cwt., and record high. Though plant capacity is generally calculated against slaughter; fabrication, further-processing, and cooler space are also important.
I estimate current pork industry market hog slaughter capacity at just over 142,256,000 hogs and utilization of that capacity will average about 90% for 2020 compared to the 2015-2019 average utilization of 97.7%. New pork slaughter and processing capacity has increased 22% since 2016 and as with beef industry, the operational utilization metric is key. Utilization fell to 55% with plant shutdowns during April and May upsetting the very important – markets hogs out – feeder pigs in – balance and totally disrupting the economics of the industry. Again, the issue was capacity utilization NOT capacity.
For ranchers, think capacity on your ranch the next time the topic of packer capacity comes up. Your ranches operational capacity is measured by total forage production resources – grazing and hay. The economics of your ranch are largely determined by your utilization of those resources at an optimal level. I would submit that if the carrying capacity of your ranch, based on forage production, is 1,000 cow-calf pairs and you are only utilizing 60% of that carrying capacity, the economics are not the most favorable. Whether applied to packing plant, feedlot, or ranch, the economic impact of under-utilized capacity is important and the key metric is utilization rate.