November 22, 2016
China's swine sector: Closing a dark chapter, embarking on a new era
By ERIC J. BROOKS
An eFeedLink Hot Topic
- Even though integrators boosted their output 30% in 2016, a mass exit of backyard farms, PEDv and flooding resulted in falling hog inventories, declining pork production
- Record piglet prices and falling feed costs resulted in record healthy integrator profits, large losses at backyard farms
- Coming after a decade of protectionist corn policies and artificially high feed costs, the production shortfalls have made China the world's largest pork importer
- After 10 years of artificially high production costs, lagging output and low returns, an era of healthy profits, normal growth will commence in 2017
China single-handily may own half the world's hogs and produce 50% of the world pork supply, but it has been a very difficult decade for the world's largest swine sector. More recently, the past two years have seen many producers suffer severe losses despite record high hog prices, falling feed costs and skyrocketing import volumes –even as large integrators prospered. But having said that, the hellish post-2007 decade is winding down and within a year, a new chapter will dawn.
It could not come too soon, as the past year has seen an unusual combination of record pork prices, declining inventories and moribund sow numbers. This however, is because backyard farms, which accounted for 80% of China's hog inventory back in 2005 are literally disappearing.
Low sow prices from 2014 through 2016 had already encouraged their mass slaughter and reduced the scope for herd expansion. February 2016's PEDv epidemic then made things worse by killing many piglets born in the first quarter. This delayed any inventory recovery into the second half of the year.
With hog prices reaching record levels, the resulting piglet shortage motivated large producers to keep the piglets for themselves. The cost of piglets more than doubled, causing farms that purchased them to run deep losses. The situation was made worse by new, strict environmental regulations. Many small farms could not afford to comply with the new regulations, which forced them to go out of business.
Then, just when a nascent turnaround in piglet numbers promised a recovery in hog numbers, southern China's summer time floods delayed further delayed the herd restocking cycle. PEDv had already pushed the hog inventory recovery time into H2 2016. With floods devastating southern Chinese hog populations and reducing sow numbers, the expected inventory was again postponed, this time to the second quarter of 2017.
With piglets (which previously fluctuated in the RMB20/kg – RMB30/kg (US$3.00/kg to US$4.40/kg) range) setting all time price records in the RMB55/kg to RMB63/kg (US$8.00/kg to US9.15/kg) range, a huge industry disparity resulted: On one hand, those who could breed their own piglets (and had no piglet procurement expenses) enjoyed handsome profits. On the other hand, small farmers who replenish their herds by buying their piglets on the open market tipped massively into the red.
Depending on the month and hog prices, integrators mostly saw profits of RMB2/kg to RMB7/kg (US$0.29/kg to US$1.01/kg) during 2016, while backyard farms suffered losses of RMB1/kg to RMB5/kg (US$0.15/ to US$0.73/kg) over the same time –with almost all the difference due to record high piglet prices. With piglets still trading above RMB45/kg (US$6.53/kg) at the time of publication, this wide, persistent disparity in profitability between large and small producers will result in the latter's near extinction within a year –and a return to normal industry conditions
Furthermore, due to this rapid exit of small producers, we are seeing a one-off, paradoxical combination of record swine prices and declining hog numbers. On one hand, from over 80% of hogs in 2005, traditional backyard hog farms will hold no more than a tenth of China's swine herd in 2017. On the other hand, while hog inventories declined by nearly 7% this year and 12% over the last 20 months, the volume of pork produced by China's ten largest integrators will have increased by approximately 30% in 2016.
Live hogs are currently selling near RMB16.10, nearly 25% below May's all-time high of RBM21.20/kg, though they remain at historically high levels. This is because while supplies are tight, demand is also slack: Recessionary economic conditions mean that at 54.07 million tonnes, 2016's pork consumption is down 5.5% from its 2014 peak of 57.20 million tonnes.
With rising carcass yields turning this year's 6.9% fall in swine inventories into a 5.5% drop in actual pork output, the fall in supply exceeds the projected 2.9% lower demand (from a USDA estimated 55.67 tonnes in 2015 to 54.07 tonnes this year). With supply falling faster than demand, prices stay high and import volumes are soaring.
The irony is that over the last ten years, even though pork price records were repeatedly broken in 2007, 2011, 2013, 2015 and 2016, production has not been able to keep up with demand. This long run inability to keep up with consumption was due to China's protectionist corn market policy, which boosted domestic supplies at the cost of keeping corn prices –and pig production costs– approximately two times higher than what it costs to raise a kilogram of pork in North America.
The output depressing impact of artificially high corn prices was made worse by politically popular sell-offs of pork reserves. This kept pork's price artificially low on occasions like Chinese New Year and the Mid-Autumn Festival, which account for a large portion of yearly pork sales. The resulting low returns have made output trail demand for nearly ten years.
Although late 2015 saw China's corn market take gradual steps towards liberalization (and lower corn prices), the damage has been done: Since 2007, China has gone from being a top five pork exporter to becoming the world's leading pork importer. From 53,000 tonnes and 0.01% of consumption in 2006, imports rose by 4,428% over ten years.
The 2.4 million tonnes of pork China imported this year is just 4.4% of the pork it consumed in 2016. Even so, it is still 81% more than the volume imported by number two pork buyer Japan, and exceeds the total combined pork imports of South Korea, Mexico and Russia.
Going forward, the next year should see ongoing corn price deflation offset much of an expected decline in hog prices. At this time, with inventories having gone below sustainability levels, the highest profits are in piglet production.
With integrator margins staying healthy and so few backyard farms left to go out of business, China's swine sector should see a USDA projected 1.2%, 4 to 5 million head recovery in hog numbers, from 420 million at the end of 2016 to near 425 million in late 2017.
Having established all-time highs in RMB20/kg to 21/kg range this year, hog prices are expected to decline gradually through most of 2017. A hog price fall into the RMB12.50/kg to RMB15.00/range is expected to occur in tandem with falling feed costs. This should gradually move the centre of profit growth from pig production to slaughtering, which has seen below average returns in 2016, when hog prices rose faster than the cost of pork.
After several years of high prices and recession, next year's projected coincidence of lower prices, better economic growth and rising pork supplies is expected to see consumption grow at its fastest rate since the boom year of 2012. Moreover, high quality breed stock imports are expected to keep boosting swine productivity, such that the 1.2%+ increase in hog numbers is expected to make pork production rise 3.7%, from 51.85 million tonnes this year to 53.75 million tonnes in 2017.
This is slightly better than the 3.3% projected consumption increase to 55.87 million tonnes. That will keep the gap between supply and demand from widening, causing 2017 imports to level out at a very high level of 2.3 million tonnes, 100,000 tonnes or 4.2% less than in 2016.
Going forward, provided corn market liberalisation keeps feed costs on a downtrend, higher production and the yuan's 13% drop in value could cause pork import volumes to decline to around 2 million tonnes near the end of the decade –but that would still leave China far and away the world's largest pork importer.
Moreover, it is doubtful that China's hog production can ever completely catch up to demand. With per capita consumption of approximately 40kg, four times as many people as America but with roughly the same quantity of arable land, there is a lack of frontier regions for swine farming. Production can keep pace with long-term growth but not overtake it to the extent of completely eliminating imports.
With China's hog market entering a secular two-year upturn, hog imports will bottom out near 2 million tonnes. Thereafter, the cost-effectiveness of boosting more feed efficient protein lines will make imports (which are currently 4.4% of consumption) end the next decade somewhere between 6% and 10% of China's pork demand. By the late 2020s, imports will exceed 3 million tonnes, such that the world's swine grower and pork consumer will achieve considerable market power as its top importer.
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