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DAVID KRUSE

By Staff | May 27, 2016

(This is the first of a two-part series.)

Back in the middle ages when Iowa Sen. Chuck Grassley first proposed legislating a ban on packer ownership of livestock, I was all for it. The state of Iowa had such a ban and the only way that it was going to be effective is if the ban were implemented federally through all states.

Iowa eventually relented on its ban on packer ownership of livestock which had been circumvented, rather than isolate itself from the industry. The ill effects of integration on price discovery are obvious.

When packers own cattle or hogs the captive supply insulates them from true price discovery and becomes leverage that they can use to negatively impact the cash markets in their favor. The vast number of producers now schedule delivery of hogs rather than negotiate their sale.

Industry integration circumvents price discovery. My prediction then was that the industry would eventually integrate to the level of having either fully integrated producers within a supply chain or niche producers who raise hogs for what are essentially small closed-supply chains ending the traditional commodity hog market.

Being a little integrated was about the same as being a little pregnant … no such thing. It would eventually be all or nothing.

Independent producers were becoming an endangered species that is now virtually extinct outside of the realm of supply chains, be they large producers or niches. Packers are granting permission for producers to participate in production, but are not in charge of everything.

The rules and restrictions on entry are extending down from the top as retail interests consult with their HSUS advisory boards as to permissible production practices and supply chains adopt them to gain access to consumers.

One of the tenants that historically determined a monopoly in Theodore Roosevelt’s trust busting day was “freedom of entry.”

For example, if you wanted to own and produce hogs can you find market access? I think the answer would be “not without some serious concessions and accommodations” that would dictate limited entry.

You would need to find a buyer before you produced the hogs. It is not a free commodity market like producing corn and soybeans where you can grow the crops first and easily find buyers for them.

When packers have a vested interest in lower live costs, captive supply became the lever that they could use to say no to higher asking prices and still have supply when needed.

When they have most of their supply needs met, the rest are easier to acquire. If told no on price, they draw from a captive supplier until seller resolve softens.

Independent producers could no longer trust either market access or price discovery so were essentially squeezed from production or required to rejoin the industry as part of the integrated structure in modified roles.

Many of the hogs being fed today are owned by packers who pay for the hotel spaces and production services turning hog barns into commercial real estate investments with manure as a dividend. Many producers are comfortable with that as they do not have the risk capacity to own hogs.

Neither do their lenders. Captive supply can be acquired through ownership or through contracts. Control, even more than ownership, is the primary lever.

Bob Peterson, the late IBP chief executive officer, once said he thought feedlots were nuts to submit to surrendering captive supply to packers undermining their leverage in the market, but IBP had to go there too in order to compete with other packers acquiring captive supply.

When price discovery became untenable and risk too great, industries restructured with vertical integration. The poultry industry has fully integrated with most chickens owned by the integrators and are now produced under contract.

The hog industry interpreted poultry industry integration as a competitive advantage for the chicken industry. It is continuing to evolve where the integration is being extended further up the food chain as in Tyson buying Hillshire.

No commercial market for hogs technically exists today as the cash trade has shrunk to only a minute portion of daily livestock transactions with values now determined by the pork trade which to what degree is truly price discovered we can only guess.

I knew that the hog industry was going to leave independent production and the cash livestock markets would become anachronisms if packers were allowed to own livestock.

Hog prices received by the Maschoffs, for example, are likely quite different than was paid to a smaller operation producing on a Tyson contract. They took the “public market” out of the commodity hog market.

The integrators wanted control, not only of the supply, but of the quality, determining what kind of livestock and meat was produced. That could have been accomplished by market incentives paid to producers but they took the more direct approach and just built their own facilities, implemented new technology and streamlined the efficiency of the industry without using the market.

The playing field is multi-dimensional. In the beef industry, scale led to risk and risk led to captive supply. Feedlots market cattle today like a herd of sheep lurching in different directions away from whatever noise packers make when they bang on the drum once each Friday afternoon.

Commercial feedlots have avoided negotiated sales, marketing with formula contracts based on the little price discovery remaining that they are trying to avoid.

(To be continued next week.)

David Kruse is president of CommStock Investments Inc., author and producer of The CommStock Report, an ag commentary and market analysis available daily by radio and by subscription on DTN/FarmDayta and the Internet.

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