October 19, 2018
Trade wars, beans and Chinese pork
China's import tax on US soybeans inflated soymeal costs and made their availability a bigger concern than high domestic corn prices. This is causing pork import volumes to increase at a time when they were expected to fall.
By Eric J. Brooks
An eFeedLink Hot Topic
Despite having a vast hog population estimated by eFeedLink to be approximately 490 million head, China's prolific pork production is having increasing difficulty keeping up with demand. This situation began when Beijing introduced a protectionist corn market policy over 10 years ago. Although the corn market is being gradually liberalized, China's swine sector might turn into a casualty of the country's trade war with America.
Over much of the past two years, eFeedLink's monthly October Livestock Tracker frequently reported a situation where relatively low inventories and hog releases to markets is matched by low demand from slaughterhouses, keeping prices low -but the slack state of China's domestic swine sector does not reflect the reality of high, steadily growing hog demand.
Live hogs are currently making a full, circular return on their yearly cycle: From selling near RMB19/kg (US$3.06/kg) in February's Lunar New Year market, they bottomed out near RMB10.50/kg (US$1.69/kg) in Q2. After a Mid-Autumn Festival induced price spike to RMB14.5/kg (US$2.10/kg), hogs will trade near RMB14/kg (US$2.01/kg) to RMB15/kg (US$2.15/kg) for a month or two before climbing back into the RMB18/kg (SU$2.57/kg) to RMB20/kg (US$2.86/kg) in Q1 2019's run up to Chinese New Year. [currency conversions reflect the exchange rate during a given time period]
The good news is that even with post-harvest domestic corn prices increasing, the hog:corn price ratio is on course to stay between 6.5:1 and 8.5:1, well above its 6:1 break-even ratio. The bad news is that while domestic corn remains abnormally expensive, it's not the biggest headache on Chinese hog farmers' minds.
Massive hog rearing losses in mid-decade caused a mass sow slaughter, resulting in nearly two years of record high piglet prices, which traded at double normal price levels. Cornered between high feed costs and record piglet prices, small-scale farmers incapable of breeding their own herds have exited the industry in droves. This finally caused demand for piglets to fall precipitously, resulting in a price crash. From near RMB50/kg at the start of Q2 2017, piglets fell below RMB30/kg by the start of Q2 2018 and are now trading near RMB28/kg.
Low piglet demand is counterbalanced by sow inventories, which total 44 to 45 million head, some 12% below their 50.5 million head peak in 2013. While China's 2018 pork production is 98.5% of 2013's level from 10% fewer hogs, China's pork consumption is higher this year than it was in 2013. Over the longterm, the profitability of large-scale farms has been not been enough to justify the replacement of small-scale farmers going broke.
Needless to say, with piglet prices having fallen 40% in eighteen months and swine disease rates rising, breeder farms were reluctant to replace aging sows. Moreover, due to China's tariffs on US soybeans, surging soymeal costs and tight supplies threatens earnings even when piglet prices are low. With small-scale farms still supplying nearly half of China's hogs, their inability to expand herds is another factor keeping China's hog production lower than it should be.
The rationale for backyard farmers exiting the industry is clear: For the past two years, large-scale integrators have made marginal or average profits on hog rearing while backyard farms have suffered large losses. In September for example, large-scale farms made an estimated profit of RMB1.54/kg (US$0.22/kg), compared to RMB0.18/kg (US$0.03/kg). At Chinese New Year (when profits usually peak), large farms made a return of RMB1.10/kg (US$0.18/kg) while backyard farms suffered a loss of RMB2.10/kg (US$0.34/kg).
All this is extending imported pork's longterm price advantage. Ever since China put a floor on domestic corn prices in the late 2000s (while capping peak pork prices via state sell reserve offs), production costs have been too high and returns too low for domestic pork production to keep up with consumption growth.
For the past ten years, the tendency has been for pork imports to peak with every market cycle, then fall to a level higher than their previous low. That would then be followed by a new record pork import volume during the next market peak. By letting corn prices slowly drop to world levels, it was hoped that the gradual liberalization of China's corn market announced in 2015 would put an end to rising import dependence.
At first, this seemed to be working: After peaking at a record 2.18 million tonnes in 2016, imports fell to 1.62 million tonnes in 2017, with some analysts expecting them to fall to 1.2 million tonnes in 2018 –but the trade war between America and China has scuttled these early projections. By buying soybeans exclusively from Brazil and Argentina, China has made its imports cost up to 23% more than US soybeans at the time of publication.
- The resulting price spread between Chinese and international soy costs is made worse by the fact that soybeans are priced in US dollars, and China's currency has fallen by nearly 11% against it over the past six months. With farmers in other pork exporting countries are paying up to 15% less for their soymeal this October (US$377/tonne) than they did in April (US$466/tonne), China's hog farms have seen their soymeal costs rise from RMB3,100/tonne (US$494/tonne) in March to RMB3,500/tonne (US$503/tonne).
The resulting 33% price spread between Chinese soymeal and CBOT prices is made worse by China's corn prices. The slow pace of corn market deregulation means that Chinese farmers pay US$7.00/bushel for corn, nearly twice more than hog farmers in most pork exporting countries. eFeedLink's October Livestock tracker reports that, "Hog farms will be cautious in expanding inventories as the costs of soymeal, a key hog feed ingredient, are set to soar in Q4 amid scarce availability resulting from the trade war." Hence, while pork consumption is projected to rise by 1.7% and nearly a million tonnes (to 55.725 million tonnes), production is only rising 1.4% to 54.15 million tonnes).
As a result, instead of falling to 1.2 million tonnes from 2017's 1.62 million tonnes, the USDA now expects Chinese pork imports to rise 8%, to 1.75 million tonnes –and their projected 1.875 million tonnes estimate for 2019 is probably too conservative. Unless the trade war between America and China is resolved and domestic hog production costs fall, it is more likely that 2019 imports will rise to 2 million tonnes or higher.
Over the long run, China needs to face up to some painful realities: Its trade war with the United States is endangering the long-term health of its swine sector. Up to now, artificially high corn prices were partly offset by ample soybean availability and relatively stable soymeal costs. Now, high soymeal prices and incomplete corn market liberalization is resulting in extremely high feed costs.
Beijing's policymakers are aware that high soymeal costs are damaging China's swine sector. To lessen the pain of high feed costs, they intend to reduce the legislated protein level (and therefore soymeal content) required in hog feed. This strategy may have a nominally positive impact over the short term.
Over the longterm, low protein feed's lower carcass yields may make the gap between domestic pork supplies and demand worse. Moreover, if the quality of pork suffers due to low feed protein content, it may encourage the growth of higher quality pork imports. That would be a big, value-added price to pay for reducing one's import requirement for lower value beans.
In the long run, China's soy import tax will merely cause American farmers to grow more corn and less soy, while Brazilian farmers do the opposite. The new USMCA trade agreement between Canada and Mexico means that pork once destined for China will now find a home in Mexican supermarkets. Owning half the world's hogs and eating up approximately half the world's soybean exports, China's swine sector does not enjoy such flexibility.
In 2019, China may import 1 million tonnes more pork than it would have had there been no import tax on US soybeans. Assuming an average yearly live hog price of RMB15/kg and a carcass yield of 70%, the imports represent a revenue loss of approximately RMB18 billion (US$2.6 billion) to Chinese hog farmers at current exchange rates.
--And there is one other wild card all these projections must take into account: For the past two months, China has suffered serious outbreaks of African Swine Fever. While ASF outbreaks may cause demand to drop by putting fears into consumers, it may require mass cullings that will reduce pork production by more than its consumption falls, thereby boosting imports even further.
Such disease outbreaks notwithstanding, for as long as the trade war persists, imports may increase by 500,000 tonnes/year and hog farming revenues lost to foreign pork may increase by US$1.3 billion/year. Without a doubt, China's swine sector could become one of the biggest casualties of its trade war with America.
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