March 26, 2008 — Pork over a Barrel

Hog producers are squeezed by rising ethanol production and higher grain prices
By Matthew Martin

Virginia-based Smithfield Foods, the nation's largest producer of hogs, recently announced plans to reduce its sow herd by up to
5 percent. A similar announcement by Pilgrim's Pride, a major chicken producer, said the company will close its chicken processing center in Siler City, N.C.

Both announcements suggest that this will be a difficult year for many livestock farmers, especially hog producers in North Carolina — the state has the second-highest pig population after Iowa. While record prices for many crops have benefited farmers concentrating in grain production, a combination of rising feed costs and falling prices for pork has created a very challenging economic environment. One of the factors driving up feed prices is the growing use of ethanol in the nation's fuel supply.

Ethanol has been used as an automotive fuel for many years in the United States, mostly in the Midwest. However, only in the past several years has ethanol use become widespread, due in large part to federal legislation that has both subsidized the production of this renewable fuel and mandated its use in much of our gasoline supply.

The use of ethanol was initially seen as a way to improve air quality. As crude oil prices have soared in recent years, however, ethanol has become part of the nation's drive toward energy independence.

The Energy Independence and Security Act of 2007 set a goal of selling 36 billion gallons of renewable fuel for transportation by 2022. (U.S. production of fuel ethanol and biodiesel reached an estimated 5 billion gallons in 2006, the most recent year for which data is available.) Ethanol is expected to account for 16 billion gallons of that goal, more than twice the industry's productive capacity of 7.8 billion gallons in 2007.

Most of the ethanol produced in this country comes from corn. Between 2001 and 2007, the amount of corn devoted to ethanol production has more than tripled to about 2.3 billion bushels. That amounts to nearly 18 percent of all corn produced in the country last year.

As would be expected, the greater demand for corn has pushed its price higher, providing a strong incentive for farmers to devote more land to corn production. The price of a bushel of corn has increased from $2.42 in 2003 to $5.34 on March 11 — a new record. As a result, the number of acres planted in corn has increased from less than
80 million acres in 2006 to more than 90 million acres last year. The U.S. Department of Agriculture (USDA) expects corn acreage levels to remain elevated over the next 10 years.

Devoting additional acres to corn reduces the available land for other crops, causing their production to decline and their prices to rise. Currently, nominal prices for soybeans and wheat are much higher than in the recent past, with wheat prices recently surpassing previous records. This has also affected the prices of various grocery items, with cereal and bakery products costing 6.6 percent more in February than a year earlier, according to the Consumer Price Index.

It's not just households that have to deal with higher grain prices. Most of the corn crop is used as feed for pigs and other livestock. But while beef and dairy producers can switch to lower-cost options like hay or grass, pig producers rely solely on corn and soybean feed because of their starch and protein content.

At the same time, farmers have had to contend with lower hog prices. According to the Producer Price Index, prices are down 20 percent over the past year through January, due in large part to expanding supply. The USDA reported that the total dressed weight of pork produced rose 9.9 percent in 2007, easily outpacing demand.

Expensive feed costs are taking their toll. At current prices, farmers can expect to lose about $34 per pig. Even if pork prices improve, farmers are likely to lose money raising pigs this year. The underlying economics put the Smithfield announcement in perspective — from a producer's standpoint, raising fewer pigs limits losses in the near term.

Other pig producers will almost certainly follow Smithfield's lead, making it likely that pork prices will rise over the next year or two, no matter what happens to feed prices. In the meantime, farmers will try to devote even more acres to corn and other grains that are generating record-setting prices.

Thus, through the incentives provided by market prices, policies promoting the use of ethanol have contributed to higher grain and food prices. This has redistributed farm income from livestock farmers to grain farmers, and sparked a future increase in meat prices.

Put another way, this represents the opportunity cost of not having more corn available for the food supply. With high energy prices also stretching consumer resources, this cost may be especially burdensome in the short term, even if the long-term environmental benefits of ethanol use arrive as advertised.

Matthew Martin is a regional economist in the Charlotte office of the Richmond Fed.