August 5, 2014
A difficult year for China's swine sector
Sagging hog prices, high feed costs, steep losses darken the first half of the year. Beyond late 2014's cyclical upturn, serious challenges loom.
by Eric J. BROOKS
An eFeedLink Hot Topic
In a year of disease decimated hog inventories and record pork prices, China's self-contained swine sector is the odd exception. Single-handedly accounting for over half the world's hog population, in a year defined by inflation, supply shortages and record returns in exporting countries, China's swine sector finds itself oversupplied, deflated and unprofitable.
2013's 6.6% increase in hog numbers collided with decelerating economic growth and cost-pushed high pork prices, made worse by a succession of disease outbreaks that hit both the swine and poultry sectors over the past eighteen months. The troubles have their roots in late 2013, when, instead of rising sharply as they traditionally do before Chinese New Year, a combination of disappointing consumer demand, livestock disease outbreaks and government pork sell-offs kept live hog prices nearly flat.
Low prices, high feed costs, big losses
In late January, after peaking at RMB15.81/kg just before Lunar New Year, hog prices steadily sank by over 30%, bottoming out to RMB10.99/kg by early May. They briefly responded to festive demand, jumping 27% from late April's RMB11.00/kg to just under RMB14.00/kg by early May
The prices stayed at that level for a few weeks, just long enough to stock up pork for early June's Dragon Boat Festival. By late May, with festive celebrations complete and slack summer time demand ahead, deflation once more set, with live hogs falling 7% to barely RMB13/kg by early July.
Compared to 2013, when prices stayed in the RMB15/kg to RMB19/kg range for eight months and never went below RMB12.40/kg, this year's swine market is a very weak one. It leaves hog prices at the same depressed level they were in the second quarter of 2013, when an epidemic that caused 50,000 hogs to wash up dead in Chinese rivers caused consumption to fall off a cliff -except that it costs more to raise a hog in China today than it did back then.In fact, it is the exact opposite of situation enjoyed by western pork exporters, where the last year has seen high pork prices complimented by a 30% drop in feed costs. In China by comparison, feed costs have gone from 2013's high level to increase another 5%. For example, even as CBOT corn trade's below US$3.70/bushel, Dalian futures remained stubbornly high, near US$10.00/bushel.
Hence, unlike the west where profitability rebounded sharply, with this year's average hog price falling nearly 25% from last year's level and feed costs increasing, producers have been running deep net losses. Whereas a 6:1 hog:corn price ratio is Chinese swine rearing's break-even point, Rabobank estimates that in mid year, it was 5.1, and had touched lows of 4.9 during the second quarter.
Losses melt away inventories
This had a devastating impact on profitability: eFeedLink reports that from April to early July, large scale Chinese hog farms ran net losses ranging from RMB0.48/kg (US$0.07/kg) to RMB2.58/kg (US$0.41/kg) while backyard operators suffered losses ranging from RMB1.37/kg (US$0.22/kg) to 2.34/kg (US$0.38/kg). Rabobank estimates that some Chinese hog growing regions, losses bottomed out near US$50/hog.
With producers running net losses for five to six consecutive months, there was no incentive to expand inventories. Rabobank estimates that at mid-year's 429 million head, inventories were down 4.4% from the middle of 2013 –and 9.7% from their late 2012 highs. With the industry in a net loss position for an extended period of time, farmers have also sold off their sows. It estimates that as of mid-2014, at 46 million head sow numbers are down 7.5% from a year earlier and have fallen 10.7% from their all-time high of 51.5 million head in 2011, when hog prices hit all-time highs.
Imports do well
Interestingly, despite slack demand, supplies were further bolstered by a rise in import volumes. According to Rabobank's Q3 Pork Quarterly, "In the first five months of 2014, they increased 13.3% over a year earlier. The report concluded that given the past year's food safety scandals and disease outbreaks, this reflects, "strong demand for imported products due to food safety concerns over local products."
But there is also a medium-term business trend powering the increase in pork imports: With Shuanghui taking advantage of its acquisition of American pork integrator Smithfield, US pork imports led the upswing, up 78.2% from the first five months of 2013, and accounting for 27.4% of shipments. Danish and Spanish pork imports also increased by a strong 10% and 45% during this time.It is in China's interest to boost imports of pork from countries it has commercial ties to at the expense of those it does not. This explains that while American pork imports skyrocketed, they did more than just meet rising demand for higher quality imported pork: Importers used Shuanghui's easy access to US supplies to substitute American pork in place of those from other countries, which saw their imports to China drop by 10%.
Better times, bigger challenges ahead
Despite the terrible first half endured by China's swine sector, things are already looking up for it. With hog inventories down sharply, September's Mid-Autumn Festival and subsequent National Holiday week should stimulate demand far more strongly than the Dragon Boat Festival did in May. But with hog numbers deflated by half a year of falling inventories, that should provide strong price support.
This means that from their early July bottoms, hog prices could rise up to 20% to above RMB15.00/kg before flattening out when Mid-Autumn Festival preparations are completed in early September. However, with sow numbers having been cut back, even if a higher price level is sustained, it will not result in a sizable supply increase before the second quarter of next year.
Thereafter, prices should flatten out further before running into another market stimulant: By mid November, preparations for mid-February's Chinese New Year celebrations should commence. Amid relatively low hog inventories and depleted sow numbers, barring an unexpectedly strong government pork dumping exercise, prices should rise just as the Autumn harvest pushes down corn costs. The hog sector, which will have returned to profitability by late summer, should thereafter enjoy average to above average fourth quarter profits.
Over the long-term, once world pork prices fall back from their PEDv-induced highs, China's swine sector needs to tackle an emerging competitiveness issue: Due to their higher animal productivity, better farm management and much lower feed costs, US live hogs can afford to be 30% to 50% less expensive than their Chinese counterparts. With world feed costs plunging and China's government controlled, import-restricted corn costs staying stubbornly high, the cost gap between foreign and Chinese pork is growing.
In that way, pork, like poultry risks going the way of China's dairy sector, where near 10% annual increases in production wilted under a combination of domestic food safety issues and rising foreign imports. That protein line suffered a worst-case nightmare, with years of flat output followed and consumers who could afford foreign dairy products opting to consume them rather than domestic supplies.
On one hand, China's swine sector is not nearly in the same danger as its dairy producers. The country accounts for 50% of the world's pork production and imports have always accounted for less than 4% of supplies. In fact, total global pork exports amount to a little over two months of domestic Chinese consumption. Hence, the world is in a far weaker position to overwhelm China's pork production than it is to topple its dairy sector.
On the other hand, with China's pork staying less safe, more expensive and kept relatively costly by government policies, it has, over time, become far more difficult for domestic producers to boost production than it is for leading western exporters to do so.
That could create a situation where China's pork consumption keeps rising strongly, but a large proportion of each year's domestic production is met by imports, particularly among educated consumers who can afford to do so. With a structurally uncompetitive feed cost base and scope for food safety scandals, Beijing's policymakers should tread carefully, lest they suffer a repeat of what happened to the nation's dairy industry.
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