August 2, 2018
China and America, Brazil and Mexico: Red meat's perfect storm?
Pork import substitution, Russia's banning of Brazilian red meat, heavy Chinese and Mexcian pork tariffs create a 900,000 tonne US pork oversupply. Beef will not be spared.
By Eric J. Brooks
An eFeedLink Hot Topic
For the first time since the Great Depression, agricultural commodity markets have been thrown into chaos by trade wars. Soy may dominate US-China agribusiness trade flows, but tight bean markets mean that this will mostly play out in a redirection of trade flows and bean origin price spreads. This however, is not the case with red meat. Beef and pork not only have a much greater tendency towards oversupply than soy but are often substituted in place of each other.
-Moreover, for red meat domestic friction between Russia and Brazil, Mexican trade retaliation and the domestic production of importers matter as much as China's widely publicized tariffs on US meats.
These circumstances make red meat significantly more complex to analyze and far more at risk of deflation than soybeans. -All this matters because unless Chinese, Russian and Mexican trade barriers are soon removed, they could transmit Brazil and America's swine market deflation into the world markets for both beef and pork.
Going into this trade war, beef and pork production are both rising strongly. This makes the substitution of one in place of the other more awkward than if only the supply of one red meat was increasing.
World pork production is rising by 2.3%, from 110.929 million tonnes last year to a USDA projected 113.463 tonnes in 2018. While this is the first time in five years that world pork production has risen by more than 1%, it coincides with the strongest sustained expansion in US cattle numbers seen in decades and several years of steady increases in world beef production. It will rise by over a million tonnes for a second consecutive year, up 2.3%, from 61.58 million tonnes in 2017 to a USDA estimated 63.025 million tonnes this year.
Moreover, 1.25 million tonnes or nearly half the USDA projected 2.54 million world's increase in global pork production is happening in China, the world's biggest swine meat importer. This means that China's tariff against US pork is happening just as it starting to undertake massive import substitution.
In 2016 when China imported 2.18 million tonnes of pork, there was a 1.99 million tonne gap between its pork consumption and production. Last year, a 1.41 million tonne gap between China's pork consumption and output caused imports to fall 25.8%, to 1.61 million tonnes.
While the USDA's most recent production forecast shows a 1.3 million tonne gap between Chinese pork consumption and production, recent eFeedLink reports have noted excess supplies, slack pork demand, soft hog prices and large farming losses. With average Chinese pork prices having fallen approximately 50% from RMB22/kg in mid-2016 to RMB11/kg by June of this year, the price incentive to export pork to China is also greatly reduced.
These indicate that the gap between Chinese pork supply and demand is significantly more narrow than official estimates. This implies that China's pork imports may fall nearly 20% from 2017 levels and 40% in two years to 1.3 million tonnes -less than those of Japan.
China's raising of its import tax on US pork from 25% to 78% coincided with Mexico imposing a 20% tariff on US pork. As if Canadian pork's duty-free access to Mexico was not enough, it also provided duty-free entry for up to 350,000 tonnes of pork imported from Brazil and EU nations such as Germany, Poland and Spain.
Buying 1.08 million tonnes of pork in 2017 (of which 0.808 million tonnes was sourced from the US) and a USDA estimated 1.2 million tonnes this year, Mexico is the world's third largest pork importer -and it's going to start buying significantly less US pork.
Under these circumstances, Canada's market share of Mexican pork imports should reach 15% or 180,000 tonnes, with Brazil and the EU taking around 10%. It implies that over 250,000 tonnes of US pork that was destined for Mexico will now contribute to a domestic oversupply. To this must be added at least 250,000 tonnes of lost 2018 US pork exports to China and over 150,000 tonnes of canceled Brazilian pork exports.
While China's trade tariff's deflationary influence on US pork prices is thought to have cost producers over US$2 billion in lower hog prices, the fact that number three exporter Brazil is also in a trade-induced deflationary funk is less well known. Buying over 30% of the number three pork exporter's shipments, Russia discovered banned ractopamine in Brazilian meat, and promptly banned imports of its beef and pork in December 2017. From a record 830,000 tonnes of pork exports in 2016 and an expected 900,000 tonnes in 2018, Brazil will be lucky to export 625,000 tonnes of pork this year, the same volume it did in 2008.
Moreover, Russia's ban on Brazilian pork imports coincided with protectionist political pressure on the part of Russian hog farmers. As is the case in China, rising domestic Russian pork production is resulting in massive import substitution. Russian pork imports are falling 46.7%, from 375,000 tonnes in 2017 to a USDA estimated 200,000 tonnes this year.
Even though China, Hong Kong, Uruguay, Argentina and Chile are on track to collectively buy an additional 125,000 tonnes of Brazilian pork over 2017 levels, this was achieved by a heavy discounting, denting revenues and profitability. This has left Brazilian processors with far more pigs for slaughter than they know what to do with.
Thus, long before China imposed its tariff on US pork, Brazilian live hogs sank into deflation, selling for less than feed costs since the first quarter of this year. As of late July, Brazilian pork sold at BR3.10/kg. That's the lowest pork price since the late 2000s and approximately 50% less than that in July 2017, resulting in wide net loss margins.
While Brazil's pork production is responding to the deflation and will fall by 1.3% this year (to 3.68 million tonnes), from a world market perspective, a 50,000 tonne drop in Brazilian production cannot make up for the strong expansionary momentum built into US hog production, which exceeds Brazil's by a factor of three.
Even though Iowa State University economist Dermot Hayes estimates that US hog farmers US$2.2 billion in revenues from China tariff-induced price deflation, America's hog herd entered 2018 at its highest level since the early 1940s.
While it normally takes 10 months for US hog producers to respond to steep price deflation, it will take much longer this time. On one hand, with farmers eager to rid themselves of large, rapidly depreciating herds, the resulting increase in slaughter rates will defy the above deflation, causing 2018 pork production to rise by 556,000 tonnes or 4.8%, to 12.166 million tonnes.
With the USDA expecting 2018 American pork consumption to rise by only 7,000 tonnes, that leaves 550,000 tonnes of excess 2018 US pork production looking for an export valve -just as China and Mexico reduce their imports.
When one adds to that 550,000 tonnes of overproduction an additional 220,000 to 240,000 of canceled exports to both China and Mexico, America is faced with a whopping 900,000 tonne excess of US pork supply over domestic consumption and exports. The US Meat Exporters Federation (USMEF) projects that China's tariffs alone could result in a net loss margin of US$9/head per hog slaughtered.
On the other hand, with the USDA reporting that significant new pork processing plant capacity coming online this year; and these new slaughtering facilities can only keep themselves economically viable by slaughtering hogs even when there is a pork oversupply.
-This implies that despite mounting (and rapidly depreciating) swine meat surpluses, US pork production is on track to keep rising until at least the last quarter of 2019, or even into early 2020. In all, the oversupply of unexportable pork in America and Brazil adds up to a million tonnes. That's a heavy inventory burden for a world market with an estimated 8.3 million tonnes of pork exports to carry.
--It implies that while Brazil's 50% pig price deflation has run its course, US and world swine deflation has a long way to go: US lean hogs are still trading around US$48/head and down only 25% from the time China first imposed pork tariffs.
The projected gross oversupply implies that we can expect US pork prices to fall by at least 25% over the next 1.5 years. with most of this drop occurring by Q2 2019. Given that US December hog futures sold at a 40% discount to late July cash hog prices, this is probably a conservative estimate. With top pork importer China already deep in swine deflation and now the top pork exporter is also on the cusp of a deep market downturn. With number three supplier Brazil already running losses, the world market for pork is in for severe price deflation over the next eighteen months.
Of course, crashing US swine prices do not happen in a vacuum. US markets exert a huge influence over world prices of beef, cattle, pork and swine. Within the US market, beef and pork are readily substituted and their prices correlate closely.
With US beef production rising by a steep 6%, the pork supply glut can be expected to have a knock-down impact on US beef and cattle prices. More specifically, US beef and pork prices correlate most strongly in mid-year. That implies that US beef prices could be 15% to 20% lower by mid-2019, with more deflation to come in the second half of the year.
With Australian and US beef competing in the same foreign markets 93% of the time, that would entail large decreases in domestic US pork prices first crashing world pork prices by the end of this year, with beef and cattle prices to follow in the first half of 2019.
Conclusion? All this can go away if America resolves its trade disputes with China and Mexico. Otherwise, beef and cattle prices will crash 25% within 18 months. Those of pork by up 30% or more. With world inventories of these two feed-hungry animals in recession by that time, the current bottom in feed crop prices could also last beyond 2020.
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