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Ethanol Margins Thinning
This week's announcement that VeraSun is suspending work
on an Indiana ethanol plant underscores the economic impact of
"irrational exuberance" in any market. Pork producers could have told
ethanol investors all about that. If you doubt that statement look back
at the price graphs in last week's edition of North American
Preview and study that deep "V" shape in 1998! Furthermore, pig
production was not encouraged by a tax credit.
Iowa State University's Center for Agricultural and Rural Development
(CARD) has been taking what appears to me to be a brutally objective
look at the ethanol business for the past couple of years. Bruce
Babcock and Dermot Hayes and their colleagues have probably not been on
the ethanol industry's dinner party invitation list after the
publication of their work.
Their findings have suggested larger impacts on corn prices than had
previously been predicted, and pointed to eventually negative margins in
ethanol production at a time when promoters were claiming that little
could derail the ethanol train.
Figure 1 shows the most recent estimates from CARD regarding the
financial performance of ethanol producers. The graph breaks the total
price of ethanol into the amounts spent for natural gas, corn and margin
above gas and corn costs. This graph is based on $1.55/gal. of
ethanol, $3.69/bu. for corn and $7.05/mm/BTU in natural gas costs.
Note that this ethanol price (represented by the top of the buff-colored
area) is the lowest it has been since mid-2005, when the market really
started to respond to higher oil prices. In addition, corn now accounts
for much more of the cost of producing ethanol, while natural gas costs,
which surged in late 2005, are near what appears to be a normal level.
The shocking part of this graph is the decline of the blue area, which
represents gross margin over corn and energy costs. It is not a net
margin. Ethanol producers must still pay labor, transportation,
overhead and fixed costs out of these funds before arriving at a net
profit. That gross margin hit a new low for the time period covered
here three weeks ago -- and it has improved little since then.
What may be more important is that it doesn't appear that things are
going to get better for ethanol producers any time soon. Figure 2 shows
the same CARD calculations based on ethanol, corn and natural gas
futures. The blue area representing gross margin becomes just a sliver
at the end of 2008, even with a stable ethanol price.
Does all of this mean the demise of the ethanol business? No. There is
a lot of momentum here, just as we see during an expansion phase in the
pork industry. Investors are not going to leave plants half-built. The
Indiana plant apparently had site work done but, to my knowledge, no
work had commenced on structures. They will complete the plants that
are under construction and that will roughly double our current ethanol
capacity by late 2008 or early 2009.
In addition, plants will continue to operate as long as they can cover
variable costs. Corn and energy (whether natural gas or coal) are the
primary components of those variable costs, so it appears to me that as
long as there is any blue area in these graphs, corn will still go into
Finally, few if any of these plants will close. Just as the new hog
farm failed financially for its original owner never had the pigs taken
out of it resold for 50 cents on the dollar, some of these plants will
change hands at relatively bargain prices. The second owners will be
able to withstand these kinds of margins because the items that will
have to be deducted from the blue slivers of Figures 1 and 2 to arrive
at net profit will be much smaller. Rest assured, there are large funds
of money just waiting to fill that role.
Corn demand is still going to be higher than in the past. The question
is whether anyone -- ethanol makers included -- will make any money.
Click to view graph.
Steve R. Meyer, Ph.D.
Paragon Economics, Inc.
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Variation in Sow
Most production systems now have a discreet requirement
for a consistent output from their sow herds. Within these systems, sow
herds have a downstream capacity for weaned piglets that is not very
flexible, particularly with the emphasis on all-in, all-out production.
This lack of flexibility should lead to a discipline of creating
consistent output from sow units, and a probable conflict between the
ideal of maximizing productivity and the need to make that productivity
as consistent as possible.
Figure 1 is an attempt to benchmark the level of consistency within U.S.
and Canadian sow herds. We chose herds above 600 sows that had
consistent sow inventory and were not batch farrowing. We also chose to
benchmark the number of pigs born alive/week rather than the number of
Although it can be argued that the target parameter is number of pigs
weaned/week, the problem is that weaning ages are manipulated to lower
the variation of pigs weaned/week. Lowering the number of pigs
weaned/week through such a method has its own costs, because it can
increase variation and reduce the quality of pigs weaned.
When we look at the coefficient of variation (CV) of weekly sow unit
output, we see that the mean CV is 19%. In other words, the range of
output on average is plus or minus 38%. If we look at the distribution
of CVs, we see a wide range, with very few having a CV below 12%.
With benchmarking, there are three main questions to address. First, is
there adequate range to allow improvement? As the figure shows, there
is a wide range of performance in the industry on this parameter.
Second, is there adequate reason to improve? This seems to have an
obvious answer, based on the structure of pig farms, because we need to
ensure that downstream facilities are utilized efficiently.
The last question of concern is this: How do we reduce variability of
output? This area has had relatively little study, as most of our
techniques have focused on average performance.
We have looked at sources of variation from week to week and the first
and foremost problem is with the number of sows bred into that farrowing
group. Control seems self-evident, particularly with groups that are
greater than the breeding target. The second problem is with variation
in farrowing rates. The control here seems to be simply to increase
average farrowing rates. Low farrowing rates are not only a problem,
but they also contribute to variation. Finally, there is some variation
in litter size that should be understood in more detail.
Benchmarking variation is a new exercise. As with any new parameter,
there are real opportunities for new methods of analysis and discussion.
John Deen, DVM, PhD
Editor's Note: For all your agricultural news, markets and
commentaries, go to www.farms.com.
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Swine Health Preview
New PRRS Virus
A novel PRRS (porcine reproductive and respiratory
syndrome) virus has caused significant clinical losses since May in
swine herds throughout southwest Minnesota and northwest Iowa. This
particular strain has fully lived up to the moniker of the virus,
causing severe reproductive and respiratory disease, even in herds
considered "stable" to other highly virulent strains such as the MN184.
Reproductive losses are reminiscent of when the MN184 first emerged in
Minnesota in the spring of 2001 and "atypical-PRRS" hit southeast Iowa
in late 1996. Losses have been substantial despite herd immunity against
PRRS virus developed through endemic infection, gilt acclimation
programs and ongoing vaccination. Sow mortality has also been a factor
in some herds.
Clinical signs in growing pigs have been somewhat variable, but often
quite severe. Respiratory disease and marked lethargy have been the main
clinical signs, featuring a primary viral pneumonia that is unresponsive
Unique Strain Spreads in Summer
This strain is somewhat unusual in that the virus has spread throughout
the area during the summer months, commonly the season with less PRRS
virus transmission and disease outbreaks in most years. The virus has
also caused outbreaks in sites with high-level biosecurity practices.
This raises concern that more extensive transmission might occur as we
enter the season with higher risk of PRRS transmission.
Characterization Proves New Virus Strain
Based on analysis of viral sequencing, this strain is new to the region.
Our molecular diagnostics group at the Minnesota Veterinary Diagnostic
Laboratory is reporting the predicted RFLP cut pattern as "1?2" based on
the virus sequence. The question mark indicates an undefined cut
pattern. There are other 1?2 viruses that are genetically distinct from
the cluster or group of viruses, reinforcing the value of virus
sequencing and indicating the novel status of this strain. The viral
sequence of the new strain is substantially (>10%) different from the
MN184 virus, and, based on recently published sequence information,
different than the PRRS virus strain from China that has been in the
Maintain Strong Biosecurity
Although this virus has been able to make its way into herds with strong
biosecurity programs, diligence in preventing virus entry is still
warranted. At the Leman Swine Conference last month, University of
Minnesota swine veterinarian Scott Dee reported his group has conducted
field research under controlled conditions that demonstrated significant
reductions in the incidence of PRRS virus transmission using established
biosecurity practices. Air filtration was the step that ultimately
completed the virus blockade. However, many other commonly practiced
procedures were also necessary and clearly reduced transmission.
Round 3 for PRRS Emergence?
It's still early, but this appears to be Round 3 for emergence of a
highly virulent PRRS strain in a hog-dense area at five- or six-year
intervals. Steps taken with each occurrence have more or less limited
the long-term impact to the health and performance of farms in the area.
Looking longer term, this potential PRRS virus cycle, and the recent
experiences with porcine circovirus type 2 (PCV2), are an incentive for
us to evaluate what changes would be prudent at the farm and regional
level to reduce the frequency and severity of the next "big ones" we
anticipate in the future.
Jerry Torrison, DVM
University of Minnesota Veterinary Diagnostic Laboratory
Contact Torrison at Torri001@umn.edu
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Legislation to Add
Processed Product to COOL
Senator Sherrod Brown (D-OH), a member of the Senate
Agriculture Committee, has introduced legislation that would require
that processed products be covered by mandatory country-of-origin
labeling (COOL). The bill would give the Secretary of Agriculture one
year from enactment to implement regulations to apply the provision to
processed foods. This would be an expansion of provisions in the 2002
Farm Bill that established country-of-origin labeling for fruits,
vegetables, meat and seafood. Senator Brown indicated during
introduction of the bill that food imports constitute a growing share of
what is sold on grocery shelves across the country. The U.S.
agricultural trade surplus shrank from $27 billion in 1996 to $8 billion
in 2006. Individual shipments of food from China increased from 82,000
shipments in 2002 to 199,000 in 2006, he explained. COOL will be a
major issue during the House-Senate farm bill conference.
No Early Out for CRP -- USDA announced that it will not offer
penalty-free early releases from Conservation Reserve Program (CRP)
contracts at this time. In a statement, Acting Secretary of Agriculture
Chuck Conner said, "While this year's global wheat market remains very
tight, corn production is expected to be record-high, and today's grain
stocks report indicated higher than expected stocks for corn and
soybeans at the start of the 2007/08 crop year. In addition, more than 2
million CRP acres expire under existing contracts this weekend, on Sept.
30, 2007." Conner added, "I would not anticipate offering a general
signup while grain stock levels remain historically low and prices
continue at unprecedented levels. Acres under continuous CRP signup,
such as filter strips and riparian buffers, are not affected by general
signup decisions. Enrollment of acres that qualify for continuous signup
Livestock Enforcement Issues & Farm Bill -- Twelve Senators
have written the Senate Agriculture Committee urging them to include
provisions in the farm bill that improve enforcement of the Packers and
Stockyards Act to protect livestock producers from "unfair, deceptive
and discriminatory practices." The Senators wrote, "Court decisions
have watered down the Packers and Stockyards Act, contracts have become
increasingly used by producers without the tools needed to protect them
from abusive practices, not to mention these contracts are being priced
off a tremendously thin and volatile spot market." Senators signing the
letter included: Claire McCaskill (D-MO), Mike Enzi (R-WY), John
Barrasso (R-WY), Sherrod Brown (D-OH), Hillary Clinton (D-NY), Byron
Dorgan (D-ND), Russell Feingold (D-WI), Chuck Grassley (R-IA), Herb Kohl
(D-WI), Tim Johnson (D-SD), Barack Obama (D-IL) and John Tester (D-MT).
Interstate Shipment Runs into Trouble -- The House farm bill
provision that would allow for the interstate shipment of
state-inspected meat has met objections in the Senate. Senator Barbara
Boxer (D-CA) indicated she would try and block the farm bill if this
provision is included in the Senate version. Boxer said, "If the House
provision becomes law, meat and poultry plants could choose to forego
federal inspection in favor of more lax and uneven state-run inspections
-- putting the health and safety of millions of Americans at risk."
Senator Tom Harkin (D-IA), chairman of the Senate Agriculture Committee,
said this is a serious issue and any changes need to be carefully
evaluated. He said, "If states are equal to the federal system now, why
not just switch to federal inspection?" Those opposing interstate
shipmen of state inspected meat include the Consumer Federation of
America and the union that represents federal meat inspectors.
Presidential Commission on Food Safety -- Senator Tom Harkin
(D-IA), chairman of the Senate Agriculture Committee, plans to mandate a
Presidential Commission on Food Safety in the farm bill. Harkin said,
"The recent spike in recalls involving meat products should serve as a
warning about our meat and poultry food safety system and the oversight
of domestic processing. We all want USDA and FDA -- the two primary
agencies charged with regulating food -- to have stronger authority to
do a more effective job at keeping our food safe. But we must examine
where gaps and weaknesses exist in addition to strengthening other
policies that improve our food safety regulations." The panel announced
earlier this year by the White House is focusing on imported food.
Harkin wants the commission to examine the entire food safety system.
Food Import Proposal -- Congressman John Dingell (D-MI),
chairman of the House Energy and Commerce Committee, has introduced H.R.
3610, "The Food and Drug Import Safety Act of 2007." This legislation
would mandate new user fees for imported food, require labels for meat
and poultry packaging utilizing reduced oxygen formats, and limit ports
where food can be imported to 13 locales in close proximity to Food and
Drug Administration (FDA) labs. Also, H.R. 3610 would include an
interstate shipment record and tracking provision, require
country-of-origin labeling for all foods, and provide mandatory recall
authority. Chairman Dingell plans hearings on this bill yet this year.
Farm Bill Mark Up Postponed -- The Senate Agriculture Committee
postponed this week's mark up of the farm bill. There are still major
differences among members regarding commodities, payment limitations,
conservation, etc. Members are frustrated with the lack of progress and
details of proposed provisions.
P. Scott Shearer
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