Before the Committee on Agriculture, U.S. House of
February 10, 1999
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Mr. Chairman and members of the Committee, I appreciate the opportunity to appear at this hearing to discuss livestock prices. My comments examine the recent performance of livestock markets, concentrating on the key factors affecting recent farm-level prices as well as price prospects in 1999. My statement also examines the relationships between farm, wholesale and retail prices. Lastly, I will describe structural trends in the livestock industry, including production, processing and marketing arrangements, and their relationships with prices.
Livestock is a major part of U.S. agriculture. In 1998, 1.116 million farms raised cattle and calves, including 116,000 operations with milk cows, and 114,000 farms raised hogs. In 1998, farmers and ranchers received an estimated $93 billion for their livestock and livestock products, 47 percent of total farm market receipts. In some regions, the importance of livestock is much greater; for example livestock and livestock products generally account for over 60 percent of total receipts in many states in the Northeast; Southeast; Upper Mid-West; Southern Plains, including Texas; and the Mountain states, such as Colorado, New Mexico, Wyoming, and Utah. With the exception of dairy, wool and mohair, and limited disaster assistance, government programs, such as price and income support, have not existed for livestock, making the prosperity of livestock producers entirely dependent on their success in the market place.
Current Livestock Price Situation and Prospects
The market was rough for most livestock producers during 1998; record-large per capita meat and poultry supplies and weaker export markets reduced livestock prices–see data in the appendix. The index of prices received by producers for meat animals during 1998 was nearly 15 percent below the average of the 1990's, and for the month of December 1998, it was 30 percent below the average of the 1990's. The drop in hog prices was especially severe, as average slaughter hog prices fell nearly 40 percent in 1998 below their 1997 level. Prices received for cattle fell 6 percent, averaging the second lowest level in the 1990's. In contrast, broiler prices rose 7 percent in 1998, as the rate of growth of broiler production was slowed because of low profitability and hatchery flock problems.
For 1999, the Department of Agriculture (USDA) predicts that red meat and poultry production will remain at record levels again, with declines in red meat production offset by increased poultry production. Lower cattle slaughter will support recovery in cattle prices in 1999. USDA expects hog prices to show modest improvement, but USDA forecasts that broiler prices will fall in 1999. Pork production will remain high, poultry production will recover but poultry exports will remain weak.
Cattle. Fed cattle prices (Nebraska direct) averaged
$61.50 per hundredweight (cwt) in 1998, down from $66.30 in 1997, and the
lowest in the 1990's. Feeder cattle prices (Oklahoma City) averaged
$71.80 per cwt in 1998, down from $76.19 during 1997, but above 1995 and
1996. USDA had expected cattle prices to strengthen during the second
half of 1998 and early 1999 following herd liquidation since late 1995;
however, despite declining U.S. cattle numbers, now at 98.5 million head,
the lowest since 1992, cattle prices fell again in 1998 and remain weak.
Why the drop and continuing weakness in cattle prices?
New production, use, and price forecasts for 1999 were released this morning at 8:30 a.m. in USDA’s World Agricultural Supply and Demand Estimates report.
Hogs. For all of 1998, slaughter hog prices (Iowa-Southern
Minnesota) averaged $31.74 per cwt., down from over $51 in 1997 and $53
in 1996 and the lowest since 1972. In December, hog supplies strained
processing capacity causing hog prices to drop to the $10 per cwt. range
but have bounced back to the $25-30 range since then.
What caused the unprecedented drop in hog prices?
Despite the weak world economy, exports continued to be a bright spot for the hog industry. In 1998, U.S. pork exports increased by 18 percent, while U.S. pork imports increased by 10 percent. Through November 1998, pork exports were about 1 billion pounds. Major U.S. export markets in 1998 were Japan, Russia, Mexico and Canada. At the same time, the strength of the U.S. dollar and large production in Canada and Denmark provided an incentive for increased pork imports. Pork imports totaled 635 million pounds through November.
What are the prospects for 1999? USDA expects continued large pork supplies will pressure hog prices during the first half of 1999. Because of biological production lags, the market hog inventory on December 1, 1998, was 2 percent above a year earlier. USDA expects pork production to be up about 5 percent during the first half of 1999, keeping prices in the $25-$35 per cwt range. As hog slaughter begins to decline in the second half of 1999, prices are expected to rise above last year, particularly in the fourth quarter.
Producers have already responded to the exceptionally low prices
in the last half of 1998 by reducing the breeding herd. On December
1, the breeding herd was 4 percent below a year earlier, the first reduction
in the quarterly year-over-year hog breeding inventory since March 1997.
In addition, December 1 farrowing intentions for March-May were 7 percent
lower than last year. This implies a fractional decline in third
quarter pork production but a 10 percent drop for the fourth quarter.
For all of 1999, USDA expects hog prices to average $33-35 per cwt., about
7 percent higher than 1998.
USDA expects pork exports to increase about 10 percent in 1999, while imports remain steady. The Russian economic crisis will limit their pork imports mainly to donations under food aid programs. Exports to Canada may also trend downward as restructuring and expansion of the Canadian pork industry reduces the demand for U.S. pork products. However, increased pork exports to Mexico, Japan, and other markets are projected to more than offset the decline in exports to Canada and Russia. U.S. pork imports may remain at about the 1998 level in 1999.
Poultry and other livestock. The rate of growth in broiler production slowed in 1998, as production was negatively affected by below normal egg hatching rates. The 2-percent growth in production in 1998 helped strengthen broiler prices, which for all of 1998 averaged 7 percent above 1997, although weakening during the fourth quarter with loss of the Russian market and increasing production. In response to higher prices overall for the year, USDA projects broiler production will be up about 5 percent in 1999, causing prices to fall from the average wholesale price (12 city) of over $0.63 per pound last year to $0.57-$0.61 per pound in 1999.
USDA forecasts broiler meat exports to remain weak through much of 1999. The loss of the Russian market is not expected to be offset by gains to other markets, and first-half exports could be 20-25 percent lower than 1998. However, exports in the second-half of 1999 may increase relative to 1998. The recent inclusion of poultry in the Russian assistance package will help boost sales opportunities.
Farm-level milk prices were record-high in 1998, averaging $15.39 per cwt., compared with $13.34 last year. Producer milk receipts totaled a record-high $24 billion, up 16 percent from 1997. The sharp increase in milk prices reflected modest growth in milk production and strong demand for milk products. In 1998, milk production was adversely affected by weather in California, Texas and the Southeast. In addition to high milk prices, lower feed prices boosted dairy producers’ incomes in 1998.
Dairy farmers appear to be reacting to the record-high milk prices and low feed costs over the past year by expanding milk production, which USDA projects to average about 2 percent higher in 1999. After being up only fractionally for most of the year, milk production increased by nearly 3 percent during the last 2 months of 1998. In response to the increase in milk production, which supported higher cheese production, wholesale cheese prices fell sharply in January dropping by about $0.65 per pound. The sharp decline in wholesale cheese prices in January will lead to a substantial drop in farm-level milk prices over the next few months. For all of 1999, USDA projects farm-level milk prices will average about $1 per cwt. lower than last year--putting them halfway between 1997 and 1998--but the decline could be even steeper if recent increases in milk production are maintained through much of the year.
The U.S. sheep and wool industry continues to contract. On January 1, 1999, there were 7.24 million head of sheep on farms, down 8 percent from 1998 and the ninth straight year of decline. Lamb prices were weak in the early 1990's, but shot up in 1996 and 1997 as U.S. lamb production fell. USDA estimated that lamb farm prices during 1998 were $73 per cwt, down from $90.49 in 1997. Wool markets have also been weak as U.S. wool consumption is declining and both raw wool and wool textile and apparel imports are estimated up for 1998. For 1999, lamb prices may strengthen a little as U.S. lamb production declines. However, declining lamb consumption, weak textile markets and continuing lamb imports will limit price recovery.
Relationships Between Farm, Wholesale and Retail Cattle and Hog Prices
Low livestock prices, particularly hogs, have increased attention to the transmission of farm prices to retail, with focus on the farm-to-retail price spreads. For example, the farm value of a hog was only 10 percent of its equivalent retail value during December, the latest month for which USDA has data. That was the lowest on record and compares with 30-35 percent typical during 1996 and much of 1997. The drop in farm value is raising concerns that rigidity in wholesale and retail prices is limiting demand growth for pork, aggravating the hog price decline.
Two points are important when examining price spreads. First, their definition. Price spreads are the differences in imputed values for a consistent equivalent quantity and quality of product as it is successively measured at the farm, wholesale, and retail levels. Price spreads are not measures of profitability, and they are not perfectly accurate. In fact, data used in estimating the spreads may understate farm value, due to a failure to fully account for contract prices and spot prices that do not reflect average quality traded, and may overstate retail prices due to lack of information on volumes of pork moving on sale at retail outlets. Second, nominal price spreads may increase over time simply because of inflation. Therefore, when assessing their long run trends, it is important to adjust spreads for inflation.
Long-term trends for the nominal, farm-to-wholesale spread for choice beef have been fairly stable, with the spread in the range of 18-25 cents a pound since 1980. On a deflated basis, this spread has trended down over time, indicating that costs for slaughtering, cutting the carcass to wholesale or primal cuts, and transporting the beef to wholesale markets have fallen on a real basis. The nominal spread from wholesale to retail has grown significantly since 1980, standing at $1.23 for 1998 compared to 62.5 cents in 1980. However, if adjusted for inflation, this spread appears fairly stable over time.
Turning to pork, the nominal, farm-to-wholesale spread has been fairly stable since 1980, running 28-35 cents per pound. However, as for choice beef, the inflation-adjusted farm-to-wholesale spread has decreased over time. The trend of the wholesale-to-retail pork spread is similar to that for beef, where the nominal spread has grown but, adjusted for inflation, the spread is stable. The long-term trends in pork and beef spreads do not suggest any specific biases in pricing at the packer or retail level. Efficiencies gained in meat packing over the past two decades appear to more than offset inflation in packer input and other wholesale costs, and efficiencies appear to be passed on to buyers over time. However, the stable wholesale-to-retail spread suggests production efficiencies in that sector are being offset by the general inflation of input costs and by the costs of adding value to products.
The farmers’ share of the retail price indicates the percentage of the retail price that goes to the producer. For Choice beef, this share has slipped from 63 percent in 1980 to 47 percent in 1998. The decline observed for Choice beef may be in line with the increased value added in marketing from farm to retail. The monthly farm value for Choice beef ranged from 44-49 percent during 1998, compared with 48-50 percent during 1997. For pork, however, the farmers’ share fell from 45 percent in 1980 to 22 percent in 1998 and was only 10 percent during December. The very low farmers’ share for 1998 reflects an unusually rapid drop in live hog prices in 1998 that out paced downward adjustments in retail prices. The 1997 share was 35 percent and more reflective of price relationships in the late 1990's.
A low farm share of retail value with a lengthy adjustment lag is typical when livestock prices drop sharply. When hog prices plunged in November 1994, the farm value fell to 23 percent from about 34 percent three months earlier. Three months after the drop, the farm value rebounded to about 33 percent. While the 1998 pattern is similar to what happened in 1994, the drop to 10 percent is unusually steep. Retailers argue that the retail prices used in the spreads, which include CPI data, do not accurately reflect large volumes of pork moving at sale prices. They argue the CPI for pork in December 1998, which was down 5.8 percent from a year earlier, would have been down even more if it was volume weighted.
What retail price would be expected if there were no lags at retail,
supplier contracts, and so on? A 10-percent increase in pork production,
using established price-quantity demand relationships, would be associated
with a 14-percent decline in retail pork price, which would still imply
a sharp decline in the farm share of retail value, since hog prices fell
about 40 percent.
USDA’s Economic Research Service is in the process of revising procedures for calculating pork price spreads to account for changes in hog genetics, such as larger and leaner animals; hog processing; pork merchandising; and data availability. New series are expected to be published in several months. Effects of Consolidation and Concentration in the Meat Industry
Overview of Change. Consolidation of farms into very
large production units is sometimes called industrialization, raising concerns
over the level of economic opportunity for smaller farms. Similarly,
as meat packing became more concentrated with few firms dominating the
market, concerns have been raised over the degree of competition in markets.
Major causes of consolidation in U.S. agriculture include economies of scale from technical change, which increases labor productivity and reduces production costs over larger volumes of production; pecuniary economies related to size, such as volume-based input price reductions; the exit of operators to retirement or more attractive income opportunities in off-farm occupations; knowledge and skills of entrepreneurs and what is needed to stay competitive; and various government programs.
The desire for increased coordination or production control in the farm-to-consumer chain has also led to increased contractual arrangements, alliances and vertical integration. Consumers increasingly demand higher quality products offering nutritional benefits, convenience and taste, rather than simply homogenous commodities purchased for home meal preparation.
Increased consolidation and coordination is accompanied by potential benefits and costs. Benefits include uniform, higher quality products being available at lower consumer prices and more efficient use of production resources enabling resources to move to production of other products thus increasing national living standards. Costs include issues related to environmental quality, economic viability of small farm and firm operations, and effects on rural communities dependent on agriculture. If consolidation results in highly concentrated markets, costs include the potential exercise of market power in unduly discriminatory or predatory ways.
Finally, when assessing the costs of consolidation or coordination, economists usually consider several factors. Consolidation does not necessarily mean concentration. For example, while farms have become larger, and some very large, there are still sufficient operations to ensure competition in the supply of farm production. However, if high concentration does occur, the potential for adverse effects on competition depends importantly on the level of barriers to entry of new firms, the ability of consumers to switch to substitute products, and the speed with which competitors react to one another’s price changes.
Cattle. The number of farms with cattle and calves
totaled 1.116 million during 1998, down 3 percent from 1997 and 5 percent
from 1996. The pace of concentration for cow-calf operations has
remained well below that of other livestock sectors, as production has
remained spread throughout much of the country and is tied to the land.
On the other hand, fed cattle has become one of the more concentrated livestock
sectors, although the location of the industry has remained relatively
stable in recent decades. There were about 110,000 feedlots in 1997,
but the largest 2 percent market 85 percent of the fed cattle.
Cattle slaughter is highly concentrated. The four largest steer and heifer slaughter firms accounted for 80 percent of commercial steer and heifer slaughter in 1997. Although the four-firm concentration ratio is high, it has not increased since 1993. The rapid concentration took place in the 1980s and early 1990s with the four-firm ratio growing from 36 percent in 1980 to 81 percent in 1993. One measure of concentration used by the Department of Justice and the Federal Trade Commission in evaluating mergers is the Herfindahl-Hirschman Index (HHI). The HHI value for steer and heifer slaughter in 1996 indicated a highly concentrated industry.
Consequently, USDA is paying close attention to the methods packers use to procure slaughter cattle, including purchasing cattle on the spot market, procuring from their own inventories, forward contracting, or other marketing agreements. Transactions outside the spot market have become important in cattle producers’ marketing strategies and in slaughter firms’ procurement plans. Arrangements include using forward contracts, with either a fixed basis or price, and trades through marketing agreements with price established through a negotiated formula, which typically includes a base price with premiums or discounts for quality differences.
Data from the Grain Inspection, Packers and Stockyards Administration (GIPSA) for the four largest firms slaughtering steers and heifers, show that in 1997, 3.8 percent of supplies were acquired from packer-fed cattle and 16.0 percent from forward contracts or marketing agreements. These figures have varied by only a few percentage points since 1988 with no evidence of an upward trend in the use of these procurement arrangements.
Hogs. In 1967, there were 1.047 million hog operations. This figure fell to 667,000 in 1980 and to 114,000 in 1998, declining by over one-third every five years. Large operations account for the majority of the hog inventory. Operations with more than 2,000 hogs accounted for only 5.9 percent of the operations in 1998 but 63.5 percent of total inventory. In just the past 6 years, the percent of total inventory accounted for by these operations has grown from 28 percent to 63.5 percent. In 1998, there were 1,915 operations with over 5,000 head in inventory, accounting for 42 percent of total U.S. hog inventory. Over 62,000 small operations have less than 100 head and account for 62 percent of all operations. These small producers account for only 2 percent of the U.S. hog inventory and are usually operated in conjunction with other farm enterprises, such as grain production and with off-farm employment.
Hog production continues to be concentrated in the north central states–Iowa, Illinois, Minnesota, Indiana, Missouri, and Nebraska. Production has spread to other areas, notably North Carolina, now the second largest hog producer, and Oklahoma, and Colorado. Growth in these and other states has been characterized by a relatively few but very large operations.
U.S. hog production has been becoming more efficient in general
with larger operations tending to have higher litter rates and more litters
per year than smaller operations. For example, operations with more
than 5,000 hogs in 1998 had 24 percent more pigs per litter than operations
with less than 100 head. Feed conversion to useable meat has been
improving and the quality of hogs marketed has improved. Producers
are using improved genetic stock to produce more standardized hogs with
carcass characteristics desired by meat packers and consumers. It
is this ability to produce and deliver large lots of desirable quality
hogs which explains in large part the trend seen in increased marketing
and production contracting.
The four largest hog slaughter firms accounted for 54 percent of total commercial hog slaughter in 1997, up from 40 percent in 1990 and 34 percent in 1980. The eight largest firms accounted for 73 percent of total slaughter in 1996–the latest year of available estimates–up from 58 percent in 1990 and 51 percent in 1980. The HHI for hog slaughter in 1996 indicated a relatively unconcentrated industry.
On a regional basis, there are fewer packers in the Southeast (NC, SC, VA), Southwest (TX, OK, NM), and West (CA, UT) than in the Midwest. The four largest firms in these regions slaughtered more than 90 percent of the total federally-inspected hog slaughter in the region in 1997. However, a large share of the hogs produced in these regions is produced by packers or through contracts with growers. USDA’s 1996 study, Concentration in the Red Meat Packing Industry, found no correlation between regional concentration and price; rather, geographic hog pricing patterns were consistent with a single national market for slaughter hogs.
A large and growing proportion of hogs is produced and marketed under some form of contractual arrangement, with the volume of spot market trades declining. Production contracts often specify production practices and genetics that help assure that hogs will conform to a packer’s product requirements. Contract producers provide packers a steady supply of uniform quality hogs, which leads to efficiencies in plant utilization. Contract arrangements have enabled producers to enter or expand in the hog industry and to reduce some price risks for hogs and feed.
Contact terms vary. A few pay on the basis of cost of production but most pay on a formula with hog prices based on the spot or futures market prices at time of delivery. Many hogs are sold through long-term contractual arrangements that provide price risk sharing if market prices fall outside a specified range. Producers who enter into these contracts give up some opportunity for high prices for protection against very low prices. Packers in turn provide the enhanced price when prices fall to protect themselves against very high prices and assure a steady supply of hogs when the market tightens. With some marketing contracts, called ledger contracts, some or all of the difference between the market price and the guaranteed price is recorded as a loan. Producers incur a debt to the packer when the guaranteed minimum price is above actual market prices. Packers incur a debt to the producer when the guaranteed maximum price is below actual market prices.
While there is consensus that the share of hogs sold through spot markets has declined in recent years, estimates of the current size of the spot market vary from a low of 10 percent of trades to 50 percent. USDA data indicate larger producers market a larger proportion of their hogs under marketing contracts than smaller producers.
Pricing issues. A number of pricing issues relate
to methods used to sell and buy animals. For example, attention has
been directed at the procurement of cattle by packers through forward contracts
and marketing agreements and with cattle that are packer-owned or fed.
These methods of procurement, often collectively referred to as captive
supplies, accounted for about 20 percent of steer and heifer procurement
in 1997, about the same as in 1988.
A concern of producers about captive supplies is that as more animals are procured through captive supply arrangements, the thinner cash or spot markets may make it more difficult for a producer to find a spot buyer, diminishing access to competitive markets. Similar concerns have been raised for hogs as marketing and production contracting has grown. Some small, independent producers worry that they may not have access to contracts and be left with a thin, potentially less competitive and more volatile spot market. Some cattle producers have alleged that the spot price may be influenced by the supply of cattle being delivered under contract, which may be under the control of packers. On the other hand, captive supply arrangements are voluntary agreements common to other industries to manage risk on the part of both the buyer and the seller. These methods ensure a market for the seller and provide the buyer more control over delivery of animals to use packing capacity to maximize production efficiency.
The concern over the potential effects on competition in concentrated markets led Secretary Glickman to appoint a USDA Advisory Committee on Agricultural Concentration. In response to the Committee’s report, the Report of the National Commission on Small Farms, and USDA’s ongoing programs to ensure competition prevails in livestock slaughter markets, USDA has taken a series of actions to help ensure more transparent markets.
For example, since 1996, we have expanded coverage of boxed beef sale commitments; initiated a weekly report of premiums and discounts being offered by packers; started reporting beef grading results on a regional basis; started reporting the number of hogs produced under contract; started reporting weekly the number of cattle produced under contract for future delivery and reporting the basis difference from a futures price, if part of the contract; started reporting daily live cattle, hog and sheep crossings from Canada and Mexico; expanded the Missouri hog price reporting project to other states; started a new weekly report on meat imports; announced the intention to propose a rule to require mandatory reporting of export sales of meat by volume and destination; and in January 1999 started reporting a range of hog spot prices based on quality. Last year, Secretary Glickman indicated his desire to have discretionary authority to require that livestock price information be reported to USDA. In addition, the Economic Research Service has expanded its reporting of commodity-specific market supply and demand outlook and situation reports from six times a year to twelve times.
To deal with issues related to the potential exercise of market
power, USDA has restructured the Grain Inspection, Packers and Stockyards
Administration to strengthen enforcement against anticompetitive practices
and improve the ability of the agency to enforce other provisions of the
Packers and Stockyards Act. The agency has added economic, statistical
and legal expertise to its field investigative staffs and recently completed
an assessment of hog procurement practices. The agency is also The
agency has asked for increased funding in its year 2000 budget to continue
to expand its enforcement capacity.
That completes my testimony. I will be happy to respond to questions.