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January 19, 2007

Table of Contents
Smaller Crop Fuels Higher Corn Prices
Changing the Culture
Packer Ban

Market Preview
Smaller Crop Fuels Higher Corn Prices
Readers are probably tired of hearing about the impact of ethanol on the livestock industry and I'm certainly tired of writing about it. I would rather write about a.) something good that is happening and b.) something that I think we have a fighting chance of changing. Ethanol-induced corn prices certainly do not fulfill the first of those, and I fear that they do not fulfill the second either. So I will not linger on the subject this week.

Last Friday's Crop Production Report and World Agricultural Supply and Demand Estimates from USDA, however, deserve some attention, especially in light of the new rocket they have lit under corn prices. USDA's final and smaller estimate of the 2006 crop (10.535 billion bushels vs. the December estimate of 10.745 billion bushels and a crop of 11.114 billion bushels last year), and a 50-million bushel increase in exports (to 2.25 billion), resulted in projected year-end stocks falling to 752 million bushels. That is the second-lowest carryover on record and nearly 200 million bushels lower than last year. USDA increased its estimate of the season average farm price of corn by 10 cents/bushel to $3.00 to $3.40/bushel.

What was the market response? The Chicago Board of Trade futures for 2006 crop corn all went above $4.00/bushel with July trading near $4.30. Even new-crop 2007 corn futures are now approaching $4/bushel. That's about all I can handle for now.

Analyzing Price Spreads
Farm-to-wholesale and farm-to-retail price spreads don't get much attention when hog prices are high. There's never a need for anyone to blame when things are going well, so we tend to leave well enough alone. That probably makes such times when heads are cool and finances are good the proper time to study spreads and what they may mean for our business.

Figure 1 shows price spreads from pork for 1986 through November 2006. USDA's Economic Research Service publishes these estimates monthly. They are useful from a descriptive standpoint but, in my opinion, are limited from an analytical standpoint by the way in which the retail price series is computed. The USDA retail price series is based on a rather small sampling of pork cutout prices gathered each month by the Bureau of Labor Statistics. Each cut's prices are averaged and are not weighted, thus, meaning that a low price that may move large quantities of product counts the same as a high price at which very little quantity may be sold. This tends to smooth out the price data and makes it very unresponsive to times of low hog and wholesale prices.

Another less serious shortcoming is that the conversion factors that USDA uses to adjust 1 pound of retail pork to some equivalent amount of wholesale pork and, eventually, an equivalent amount of live pig, are very old. This problem should be solved soon as USDA is nearing the completion of a project to update its conversion factors for many agricultural products.

Even with those shortcomings, these price spreads are interesting to study. A few features of the spreads should be noted.
  • They are not profits. These are gross margins from which all costs of transformation, transportation, packaging, marketing, etc. must be paid. There may or may not be a profit left after all of those are deducted.

  • They tend to make discreet shifts and then remain relatively constant. It happened in the late '70s and again in the late '90s. I attribute the shift in the '90s to the Hazard Analysis and Critical Control Point programs and much higher food safety scrutiny. Some would attribute it to consolidation at the packing and retail levels. I don't think that was the major factor but would agree it had an effect, especially over short periods of time.

  • Their trend has been flat since 2001. These spreads have been moving sideways during this past period of higher hog prices. The variability of the farm-to-wholesale margin is apparently smaller than in the past, while the variability of the wholesale-to-retail margins appears to be larger. I would attribute the former to more coordination in the producer-packer relationship and the tendency for wholesale and producer level prices to move together better than in the past. The latter is likely due to more competition from other species and higher volatility of those species' prices than in the past.

Click to view graphs.

Steve R. Meyer, Ph.D.
Paragon Economics, Inc.

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Production Preview
Changing the Culture
"The only thing that doesn't change is change." We've all heard the phrase, yet, accomplishing change in a pork production facility is not an easy task.

In recent columns, we've discussed Six Sigma, the highly structured program used in some industries to achieve improvement. Improvement inherently requires change. And we would be remiss if we did not discuss the one element key to achieving it.

For change to be successful, the culture has to be willing. And for a change to be sustained over time, it has to have the full support of top leadership.

When we refer to "culture," we are referring to an organization's value system and collection of guiding principles. There are three levels of culture:
  1. The artifacts are the tangible aspects of culture -- the things we see, but they can be difficult to interpret;

  2. The espoused values are the stated aspects of culture. Mission and vision statements are two examples; and

  3. The stated values. The underlying assumptions are the reasons behind the stated values. For example, a security guard at a school may be a cultural artifact because it is readily visible. The stated value of the school is that security is important, while the underlying assumption of the school may be that the students aren't trustworthy.
Culture is inherently resistant to change and any changes that are made take time. For those of us with some experience under our belts, these are statements of the obvious. More than once, I visited a farm with tremendous potential, only to return and find that they were unwilling to adopt a new practice. And I've watched a new employee's enthusiasm fade over time as he or she adjusted to the company's culture.

Culture is described as "frozen." That is, it is difficult to change. When it does change, those changes generally take place from the top down. Have we not witnessed the "shake up" that occurs when a new manager is brought into a unit or a new leader is brought into an organization?

The process of changing culture is defined as a three-step process. In the first step, the existing culture is unfrozen. To do this, leadership must create a "controlled crisis" in which the organization cannot continue in its current state. Once the culture is unfrozen, a plan is presented to solve the crisis. After the plan is presented, freezing of the new culture is achieved by rewarding desired behaviors.

During my first job out of school, the company I worked for underwent a culture change. At the time, I was working for a small production company that had experienced a number of injuries on their farms and Workmen's Compensation premiums had become a substantial burden.

The vice president of production (top leadership) came out to the farms and presented the grim statistics to the employees: The current rate of accidents/injuries was making the company unsustainable (the controlled crisis). To address the problem, the company would implement a safety program (the plan). All employees would be responsible for their own safety as well as that of their co-workers. Farms began tracking the number of days worked since an injury, and monetary rewards were provided to employees of farms that completed the quarter without any injuries (the freezing).

The role of culture in the ability to achieve improvement must not be underestimated. To quote another, "Culture eats strategy for lunch over and over again." In an unaccepting culture, even the best plan cannot succeed.

Stephanie Rutten, DVM
University of Minnesota
Editor's Note: For all your agricultural news, markets and commentaries, go to


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Legislative Preview
Packer Ban
Senators Chuck Grassley (R-IA), Tom Harkin (D-IA), Byron Dorgan (D-ND), and Mike Enzi (R-WY) have introduced legislation that would ban packer ownership of livestock. The legislation would make it unlawful for a "packer to own, feed or control livestock, either through a subsidiary or an arrangement that gives the packer operational, managerial or supervisory control prior to seven days before slaughter." Senator Grassley said, "Outlawing packer ownership of livestock would make sure the forces of the marketplace would work for the benefit of the farmer just as much as it does for the slaughterhouse." According to Harkin, "The livestock marketing system will become dysfunctional if the industry becomes overly vertically integrated. We need some federal limits as to how far packing and processing firms can go in controlling all phases of the livestock production and processing industry." The bill exempts packers who have one facility or cooperatives where the members own, feed or control the livestock themselves. This legislation passed the Senate in 2002.

End Mandatory Arbitration Livestock Contracts - Senator Tom Harkin (D-IA) introduced legislation that would end the use of mandatory arbitration in livestock and poultry contracts. Harkin said, "Producers or growers who feel they have been subject to breach of contract, fraud or illegal activity should be allowed to pursue their rights and remedies in our courts and not be forced into arbitration." This issue will be addressed during the 2007 farm bill.

Ethanol - U.S. Department of Agriculture (USDA) Chief Economist Keith Collins made some observations regarding renewable energy in relation to U.S. agriculture before the Senate Agriculture Committee's hearing on renewable energy. According to Collins:
  • In 2000, about 1.6 billion gallons of ethanol were produced in the United States, with ethanol utilizing about 6% of the 2000 corn harvest. In 2006, an estimated 5 billion gallons of ethanol were produced, and ethanol accounted for 20% of the 2006 corn harvest. With the current 110 ethanol plants, another 73 plants under construction and eight more facilities expanding, ethanol capacity will reach 11.4 billion gallons/year during 2008-2009.

  • For 2006/2007, USDA forecasts the total use of U.S. corn will be equivalent to the production of 85.6 million acres. Yet only 78.6 million acres were planted in 2006. Corn supplies are expected to meet demand because of large carryover stocks of corn, which are projected to be reduced by more than half.

  • Looking ahead to the 2007 corn crop, it is quite likely, based on current ethanol plant construction, that corn used in ethanol production will increase by more than 1 billion bushels from the 2.15 billion bushels of the 2006 corn crop expected to be used for ethanol. Use of 1 billion bushels, at a trend yield of 152 bushels/acre, would require an additional 6.5 million acres of corn, if corn consumed in other uses remains unchanged from this year's projected levels.

  • A $1/bushel increase in the price of corn would raise the cost of producing hogs by about $6/cwt. With live hogs selling for a U.S. average price of $43/cwt in December 2006, the cost of production increase would be about 10% of the market price.
House Agriculture Committee Membership - The House leadership has named the 46 members of the House Agriculture Committee for the 110th Congress. Seventy percent of the members of the committee have never been through a farm bill debate. Congressman Collin Peterson (D-MN) will serve as chairman and Congressman Bob Goodlatte (R-VA) will serve as the ranking member. Democrats serving on the committee are Peterson, Tim Holden (PA), Mike McIntyre (NC), Bob Etheridge (NC), Leonard Boswell (IA), Joe Baca (CA), Dennis Cardoza (CA), David Scott (GA), Jim Marshall (GA), Stephanie Herseth (SD), Henry Cuellar (TX), Jim Costa (CA), John Salazar (CO), Brad Ellsworth (IN), Nancy Boyda (KS), Zack Space (OH), Tim Walz (MN), Kristen Gillibrand (NY), Steve Kagen (WI), Earl Pomeroy (ND), Lincoln Davis (TN), John Barrow (GA), Nick Lampson (TX), Joe Donnelly (IN) and Tim Mahoney (FL). Republicans serving on the committee are Goodlatte, Terry Everett (AL), Frank Lucas (OK), Jerry Moran (KS), Robin Hayes (NC), Tim Johnson (IL), Sam Graves (MO), Jo Bonner (AL), Mike Rogers (AL), Steve King (IA), Marilyn Musgrave (CO), Randy Neugebauer (TX), Charles Boustany (LA), Randy Kuhl (NY), Virginia Foxx (NC), Michael Conaway (TX), Jeff Fortenberry (NE), Jean Schmidt (OH), Adrian Smith (NE), Kevin McCarthy (CA) and Tim Wahlberg (MI).

Senators Discuss Beef with Korean Ambassador - A number of U.S. senators met with the South Korean ambassador this week to reiterate that the beef issue needs to be resolved before the U.S.-Korea Free Trade Agreement moves forward.

Mexico Removes HFCS Tax - Mexico has removed the 20% tax on soft drinks sweetened with high fructose corn syrup (HFCS). The tax had been ruled illegal by the World Trade Organization (WTO). The Corn Refiners Association (RFA) said the tax had "closed the door" on U.S.-owned sales of HFCS to Mexico for more than four years. RFA estimated losses of $944 million in HFCS sales, equivalent to 168 million bushels of corn when the tax was in affect.

P. Scott Shearer
Vice President
Bockorny Group
Washington, D.C.

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