March 27, 2017
China's swine sector: Recovery and market liberalization, with new spanners in the works
By ERIC J. BROOKS
An eFeedLink Hot Topic
- A decade of artificially high corn costs and suppressed hog prices is ending but not before poor returns resulted in a mass slaughter of 25% of all sows
- While corn protectionism has ended and live hogs are priced well relative to feed, new environmental regulations, a mass exit of backyard farms is keeping inventories at very low levels
- New environmental regulations favor the relocation of hog farming to northern China and closer to feed crop growing regions
- With supply falling faster than demand and production costs high compared to world levels, China has become the world's largest pork importer
The good news is that while it is not an easy time to be a hog farmer in China, unlike its broiler sector, there is a light at the end of the tunnel. If anything, this sector, like China's red meat demand, held up better than was expected. The bad news is that several years of challenges remain and the country while it remains 95% self-sufficient, ten previous years of swine hostile government policies have turned the world's biggest hog producer into its largest pork importer.
Ever since the government introduced a protectionist corn policy back in the late 2000s and assuage urban demand for cheap pork, the industry has been in a lose-lose situation. On one hand, several years of economic recession and pork prices that are very high by historical standards have decimated hog demand. At the same time, despite falling from a peak of 40kg in 2014 to 37kg, per capita pork consumption remains 16% higher than it was ten years ago, which is not the case with chicken.
On the other hand, China's pork supply side fundamentals and trade are also unusually weak. From 2013 through 2015, high government controlled corn prices inflated corn production costs and with them, prices to record levels.
At the same, government manipulation politically popular state pork sell-offs, especially during peak demand periods when most profits should have been made, kept prices lower than they should have been. Even though old pork price records were repeatedly shattered in 2007, 2011 and 2014-15, the high cost base meant that returns were often at best marginal.
Needless to say, a combination of artificially high feed costs and artificially low selling prices is lethal to any agribusiness line, and it devastated hog rearing returns. From a large portion of the time from late 2012 through mid-2015, China's hog: corn price ratio fluctuated between 4.5 and 6.0, with the break-even point at 5.5. Large farms used their in-house piglet production to maintain nominal profitability. Saddled with the extra burden of piglet replenishment costs, backyard farms ran huge losses over this time.
In 2015 the government announced plans to gradually deregulate corn prices. Unfortunately, after suffering years of low profits or losses, farmers had lost their patience and began a mass sow slaughter. From a peak of slightly over 50 million head in 2013 and 2014, the sow population plunged 24% over three years, bottoming out at a USDA estimated 38 million head. This is the smallest sow herd since 2004, when pork production was 22% lower than it was last year.
Live hog inventories fell accordingly too. After peaking near 475 million head throughout 2013 and 2014, USDA figures show an 11.5%, 55 million reduction to 420 million head by the start of 2017. With hog numbers dropping, so did pork production, from its all-time peak of 56.71 million tonnes in 2014 to 51.85 million tonnes in 2016, with another large production drop expected this year.
Curiously, piglet supplies fell even faster than inventory rebuilding, boosting their cost to record levels.
From their RMB20/kg to RMB30/kg levels of the previous decade, piglet prices skyrocketed into the RMB50/kg to RMB60/kg range for much of 2015 and 2016. While this did not impact large farms that raised their own piglets, it made backyard farms exit the industry faster than large producers could expand, making for an even sharper downturn in hog and pork output than would have otherwise been the case.
Going forward, while there is good news ahead, even that is tempered by austere new realities. On one hand, H2 2015 saw the hog: corn price ratio rise into the 7.5 to 8.0 range. Throughout 2016, its stayed in the highly profitable 8.5 to 10.5 range. After bottoming out near the still profitable 8.8 level in the last two months of 2016, the hog: corn price ratio recovered back to above 9.0 in Q1 2017 and is fluctuating near 9.4 at the time of this article's publication.
Under its five-year plan for agriculture introduced in 2016 seeks to control pollution by relocating hog farms away from waterways and crowded urban areas. Towards this end, over 20 provinces and municipal governments have established, official Development Control Areas (DCAs), which forbid swine farming within their boundaries. This primarily impacts provinces in China's populous northeast and southeastern Chinese provinces near the Pearl River delta.
At the same time, it encourages the relocation of hog farming to regions like Szechuan, Henan, Hebei and China's northwest. All of these are located closer to feed crop growing areas and are expected to reduced transport costs and improve industry logistics over the longterm.
For now, it is having a devastating impact on inventories already minimized by low pork prices and artificially high feed costs. Hog farms located within DCA boundaries must be relocated or shut down. This is having a devastating impact on backyard farms, which lack the capital or returns to relocate their operation.
According to reports in the Chinese press, the removal of hog farms from DCAs has reduced hog inventories by at least 3.6 million head. In urbanized regions or provinces with fresh water resources such as Jiangsu and Zhejiang, the number of hogs has fallen by up to 50%. Provinces with large swine populations including Guangdong, Shandong and Jiangsu have committed to removing all their swine farms out of DCAs by the end of this year.
Alongside the creation of DCAs, China's government has also added new environment-based swine farming regulations. According to the USDA, these tougher regulations are forcing many swine farms to dedicate 40% of this year's capital investments to the introduction of new environmental control systems or upgrading existing ones
By forcing many remaining backyard farms out of business, these industry stresses have accelerated a longterm consolidation trend. According to Rabobank's analysis, hog farms with 50 or fewer pigs made up 74% of China's swine population in 2001. This fell to 37% by 2010, approximately 15% this year and they will only supply 10% of China's hogs by 2020.
On the other hand, commercial farms containing from 50 to 3,000 live hogs jumped from 21% of inventories in 2001 to 58% in 2015 and are expected to make up 60% of the total by 2020. However, even the share of output provided by commercial integrators will decline after 2020. This is because the proportion of Chinese hogs raised by integrators who house more than 3,000 per farm has risen from 5% in 2001 to 12% in 2010.
However, the unit cost advantage of integrators truly came into its own in the last few years of thin returns. As a result, they jumped to holding 22% of China's hog population by 2015. Integrators are expected to grow 30% of China's live hogs by 2020 and over 50% by 2030.
All this is creating a strangely paradoxical situation: One where the hog population of integrators, while expanding rapidly, cannot make up for inventory losses at backyard farms. As mentioned earlier, hog farming returns have been consistently strong for nearly two years running, beginning in mid-2015 –but thanks to these new regulations, a much-anticipated upturn in hog numbers and pork production never materialized.
After the 2014-5 mass slaughter reduced the sow population, it was expected to bottom out at 41 million head in 2016. After the new regulations were introduced, the USDA had to downwardly revise its sow estimate to 40 million for 2016. Entering 2017, China has 38 million sows instead of the 42 million it expected a year earlier.
This is due to the exit of small backyard farms from the industry, which in turn is driven by the fact that profitability now rises exponentially with production scale. For example, eFeedLink's Livestock Tracker reports that in January and February, large-scale Chinese farms made profit margins of RMB6.13/kg (US$0.89.kg) and 5.63/kg (US$0.82/kg) respectively. By comparison backyard farms lost RMB0.77/kg (-US$0.11/kg) and RMB0.22/kg (-US$0.03/kg) over these same two months –and this at a time when the hog: corn price ratio was 1.72 times above its break-even level.
The low sow numbers did not materially impact large scale producers, as they produce their piglets in-house. On the other hand, with backyard farms paying three times more for a piglet than they did ten years ago, their bottom lines have been decimated. For this reason more than any other, eFeedLink reports that in February, large scale hog farms faced unit production costs of RMB11.99/kg (US$1.74/kg) Bloated by historically ultra-high piglet costs, backyard farm hog raising unit expenses amounted to RMB17.57/kg (US$2.55/kg).
This huge, near 50% difference in unit costs between large and small scale farms is causing the latter to exit the industry in a manner that reduces overall inventories. For large scale producers, over the next year or two, the need to comply with new environmental regulations and in some cases, relocated entire integrated facilities will take precedence over expanding hog herds.
For this reason, production is defying two years of high prices and good returns. At a revised 50.9 million tonnes, pork production is at its lowest level since 2011. It is also 10.3% below its peak production level of 56.71 million tonnes set back in 2014.
While high pork prices have constrained consumption, they have not done so by nearly anything close enough to match the drop in demand. To this can be added the fact that at US$2.00/kg, China's pork production costs are more than twice that of exporters. In fact, at US$1.75/kg, the most efficient Chinese pork integrators still have production costs far higher than the US$0.70/kg of their American rivals.
All this has caused the post-2007 import rise (which was due to artificially high corn prices) to turn into a flood. Until ten years ago, China was net pork exporter and a tier two player in the world swine meat market. In 2007, it exported 350,000 tonnes of meat, nearly two times the 180,000 tonnes it imported.
By 2013, just before the industry's mix of current troubles, corn market liberalization and new environmental laws began to take hold, imports had risen to 740,000 tonnes, triple that of that of the 240,000 tonnes exported that year. By 2016, with supply falling much faster than demand, imports had tripled to 2.4 million tonnes while exports shrunk to 190,000 tonnes. Ten years of misguided policies may have avoided China becoming a mass corn importer, but it did turn the country into the world's biggest corn importer, buying nearly twice as much as next ranked Japan.
On one hand, it will take almost half a decade for the current mix of feed crop market liberalization and costly compliance to new environmental policies to work their way through China's swine sector.
Over the next few years, we can expect China's economy to recover faster than its swine sector.
Indeed, we can see the new market liberalization starting to work in one statistic: After staying in the 75kg to 77kg range from 1997, through 2014, the amount of pork harvested per finished live hog is jumping up to 81.4kg this year.
On the other hand, while pork output will bottom out this year and resume growing in 2018, the appetites of Chinese consumers will not wait that long. They will continue to eat pork en masse, probably pushing imports close to the 3 million tonne level before rising production stabilizes the demand for foreign swine meat.
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