June 6, 2018
America's swine sector under fire! First China, now Mexico taxes US pork
Trade wars have not yet impacted export volumes but they are already costing US hog farms billions of dollars in lower hog prices. Without a negotiated political solution, things could get a lot worse.
By Eric J. Brooks
An eFeedLink Hot Topic
After a succession of prosperous years and good returns, politics is giving America's swine sector its worst nightmare in decades. Caught in the crossfire of the Trump administration's trade war with China, March saw the latter impose a 25% tariff on imports of US pork. Before US pork producers could even recover from this blow, Mexico added insult to injury.
Furious at the imposition of new US trade tariffs, Mexico imposed a 10% tariff on US pork with immediate effect, which will rise to 20% come July 1st. Excluding variety meats, unprocessed pork cuts including boneless pork, legs, shoulders, hams, and pieces of ham will all be subject to the new import duty.
Make no mistake: US pork producers have a lot to lose Mexico, where their pork previously entered duty-free. The third largest pork importer after China and Japan, Mexico bought a USDA estimated 1.083 million tonnes of foreign pork last year -and 80% of this volume came from the United States. It is by far the largest single importer of US pork, buying 60% more than China did.
Collectively amounting to 1.3 million tonnes, Mexican and Chinese tariffs impact or slightly over half the pork America exported last year. This means that with 22% of US pork production exported in 2017, about 11% of the swine sector's annual meat output ends up in Mexico or China.
Moreover, America is more dependent than ever on the goodwill of Mexico and China. On one hand, from 2007 through 2017 inclusive, its combined pork exports to Mexico and China have risen 213%. On the other hand, US pork exports to all other countries were 14.6% lower in 2017 (1.258 million tonnes) than they were in 2012 (1.437 million tonnes), with the USDA forecasting them to fall another 3.7% this year, to 1.211 million tonnes. Hence, from the perspective of US hog farmers, America could not have picked two worse countries to pick a trade dispute with.
In particular, 2017 saw US pork exports to Mexico jumped 8.8%, to nearly 802,000 tonnes, from a USDA estimated 737,000 tonnes the previous year. 2017 Pork exports to China had amounted to 495,000 tonnes and US$1.09 billion in 2017 (309,000 tonnes shipped directly to China, with rest smuggled in from Hong Kong). Rabobank had projected 2017 exports to China (including re-exports from Hong Kong) to rise to 615,000 tonnes this year -before a 25% tariff was imposed.
According to Ohio pork farmer and National Pork Producers Council (NPPC) president Jim Heimerl, "Mexico is US pork's largest export market, representing nearly 25% of all US pork shipments last year. A 20% tariff eliminates our ability to compete effectively in Mexico. This is devastating to my family and pork producing families across the United States." The NPPC estimates that 500,000 people are employed in America's swine sector and 110,000 of these jobs depend on exports.
To make matters worse, Mexico's import tariff coincides with a new 350,000-tonne quota for duty-free imports of pork legs and shoulders from other countries. Consequently, US pork is suddenly at a 20% price disadvantage to Canadian pork and (due to the 350,000-tonne duty-free quota) and at a 25% to 30% disadvantage to pork from nations such as Brazil, Australia, Spain or Denmark.
How much damage could be done? In all, Mexico bought 31% of the 2.556 million tonnes of pork that America exported in 2017. Of the US$1.51 billion and 801,887 tonnes exported to Mexico approximately 650,000 tonnes and US$1.07 billion were accounted for by pork legs and shoulders -the same cuts that Mexico will now let up to 350,000 tonnes/yr from other countries duty-free.
On an annual basis, about half the pork legs and shoulders Mexico currently imports from America could be replaced by imports from other countries. -That would amount to roughly US$500 million less revenue and 350,000 tonnes in lost exports -and that doesn't even include legs, shoulders, hams and other cuts which Mexico already buys duty-free from NAFTA partner Canada.
To all this must be added a reduction in pork exports to China and the lower hog price deflation caused by these import duties. Mexico's tariff comes three months after China's retaliatory 25% import duty. That made US pork in China's market go from being 15% cheaper than European pork to being 10% more expensive.
Iowa State University Economist Dermot Hayes notes that in the three months since China announced its 25% tariff, "Hog futures have dropped by US$18 per animal, translating to a US$2.2 billion loss on an annualized basis. While not all of this lost value can be attributed to trade friction with China, it is certainly the main factor."
--Interestingly, despite hog farms enduring large net operating losses, up to this time, US pork appeared to have been maintaining its international market share. It seems to be replacing lost pork exports to China with higher shipments to other countries: In his June 4 podcast, Perdue University economist Chris Hurt stated that "Exports have remained favorable in the data that is available so far this year which shows pork exports growing by almost 6%. This is on-track with current USDA estimates for pork exports to grow by 5% (to 2.68 million tonnes) for the entire year."
--One possibility is that for political negotiating reasons, China is allowing a higher volume of US pork exported to Hong Kong to be smuggled tariff-free into the mainland. With both Mexico and China deliberately obstructing half of US pork shipments from H2 2018 onwards, it is highly unlikely that the 5% year-on-year expansion in US pork exports can be sustained. A more conservative projection would be the same export volume as last year or nominally higher (2.50 to 2.60 million tonnes)
Up to now, most of the losses have been due to lower hog prices rather than reduced exports -but this could quickly change. On top of this estimated US$2.2 billion lost to lower hog prices, the reduction in collective Chinese and Mexican export earnings could amount to somewhere between US$600 million and US$900 reduction in industry revenues.
Needless to say, even more deflation in live hog prices will follow Mexico's imposition of trade tariffs. In a note to investors, Farha Aslam, an analyst with Stephens Inc stated that if the trade dispute which led to these tariffs is not resolved by July, "The market impact on prices and profits could become more pronounced."
Nevertheless, even before Mexico's announcement, Hurt warned that "Losses are expected for the rest of 2018 and 2019. Those losses will be small this summer, but then the bottom falls out. Losses of more than US$25 per head are estimated for the last quarter of 2018 and the first quarter of 2019."
Lean hog prices peaked in mid-February near US$0.75/lb At that time they started falling in anticipation of China's import tariff. Thereafter, they fell approximately 30% in six weeks, declining steeply in anticipation of China's impending import duty.
By the time China slapped its 25% tax on US pork, hogs had already been discounted in anticipation of this action. Hence, live hogs bottomed out around US$0.52/head in mid-April, around the time China imposed its import duty.
Thereafter, surprisingly strong export volumes and domestic consumption sparked a partial price recovery that was held back by bad news related to the possible imposition of trade tariffs. Late May saw lean hogs finally rise above the US$0.70/lb level where they had previously peaked. They had just exceeded their February top and traded at US$0.775/lb when Mexico announced it devastating tariffs.
Going forward, Aslam predicted that, "US packers such as Hormel and Tyson will seek to offset the tariff costs by reducing their bids for hogs. Given hog supplies are relatively ample and given the slow start of the new hog slaughter plants, packers should be relatively successful in protecting profits." -In other words, US hog farmers will bear a much greater share of the revenue losses arising from Mexico's tariff than downstream meat processors and packers.
Alongside these immediate net loss margins due to lower hog prices, lower revenues from lost export market shares will inevitably follow: Canada, Spain, Germany, and Denmark will gladly occupy any market vacuum created by more expensive US pork in China. Expect Brazil, Canada, and several EU pork exporters to do the same in Mexico.
Several months ago we commented that America's swine sector was "prosperous but with a few dark clouds on the horizon." America's share of the world pork trade has not changed but prosperity has given way to a perfect storm of dark political and economic circumstances: Unless a political solution to these trade impasses is negotiated soon, heavy operating losses and the bankruptcy of main US farmers will follow.
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