Sellers have lost leverage throughout the supply chain as larger protein supplies in North America are pressuring prices down. Lower cattle prices have resulted in serious red ink for feedlots and disappointing calf prices this fall. Cow-calf returns have dropped but remain above the 10-year average. For producers who have made major infrastructure investments over the last two years, that add to their depreciation costs, they may be looking for innovative ways to reduce their per-unit cost of production.
Larger protein supplies in North America
A perfect storm of events led to the price rally in 2014. Protein production in North America was reduced by porcine epidemic diarrhea virus (PEDv), limited access to egg sets for the broiler industry due to trade restrictions, and beef expansion was not available yet. Chinese imports started mid-2013 and really hit the market in 2014 adding 300,000 tonnes of new global demand to the beef market — equal to the annual volume of Canadian beef exports.
A complete reversal occurred in 2015 as PEDv was mostly dealt with (pork production +7.0 per cent), highly pathogenic avian influenza (HPAI) in the U.S. closed export markets to Russia and China while poultry production was up 3.8 per cent. Beef production was up only 2.3 per cent but disruptions at West Coast ports reduced exports. All this pushed an additional 9.2 pounds per capita onto the U.S. market. The only way to move that kind of product is reduced prices. But increases in production are not done yet.
In 2016 beef production is projected to end the year up 5.2 per cent, pork up 1.6 per cent and broiler meat up two per cent. Larger U.S. protein production is already set for 2017 with a larger calf crop coming forward. Initial forecasts for 2017 are for beef production to be up 3.4 per cent, pork up 2.5 per cent, and broiler meat up 0.7 per cent. Per capita protein supplies after being up 9.2 pounds in 2015, are projected to be up 4.0 pounds in 2016 and another 2.8 pounds in 2017 according to USDA. A nine per cent or 16-pound increase from 2014 to 2017.
From 1990 to 2008 U.S. protein production grew on average 2.3 per cent per year. Growth stalled after the global financial crisis in 2008 and was relatively flat for seven years. Starting in 2015 growth is back in a big way. From 2015 to 2017 protein production is projected to grow 2.9 per cent per year, almost double the previous growth rate. Part of this additional growth was anticipated to go to the export market. However, international demand has softened as China is looking for a soft landing and the strong U.S. dollar is also making U.S. product more expensive compared to competitors. Faster annual growth combined with softer international demand is pressuring all protein prices.
Canadian protein production also larger, exports keeping domestic supplies stable
In 2015, total protein production in Canada was up a modest one per cent. Larger pork (+6.3 per cent) and poultry (+3.3 per cent) production was offset by decline in beef production (-9.0 per cent). In 2016, that has changed as all three proteins are seeing larger production year to date — pork is up two per cent, poultry up 4.1 per cent and beef up nine per cent. Total protein production is projected to be up four per cent or 447.2 million pounds. At 11.55 billion pounds this is still below the peak of 12 billion pounds produced in 2008.
The difference between Canada and the U.S. is that the majority of this increased production will not be consumed in Canada. Exports are being supported by an attractive exchange rate. In addition, there is room for more protein in the domestic market. Per capita consumption dropped from a high of 181 pounds (retail weight) in 2011 to a low of 162 pounds in 2014. The increase of 3.5 pounds in 2015 leaves consumption four pounds below the long-term average of 169 pounds with room for larger per capita consumption in 2016.
The AAA cut-out as a percentage of the retail beef price trended down from 1999 through 2009. The bottom of 25 per cent was made in January 2010 before reversing and trending up until April 2015 when it peaked at 37 per cent. This stronger percentage reflected tighter supplies of beef in North America and packers had more leverage with retailers. Since then it has reversed and dropped out of its trading range over the last five years. Since October 2015 it has been around 30 per cent, further declines would indicate a loss of packer leverage with retailers as more protein becomes available and lower prices for competing meats pressure the beef complex.
Canadian herd steady
Statistics Canada reported Canadian cattle inventories on July 1, 2016 up 1.3 per cent at 13.2 million head. All classes of cattle were up with the exception of steers (>one yr.) which were down 2.6 per cent. The largest increases came from beef heifers for breeding (+4.5 per cent) and calves (<one yr.) up 3.9 per cent. The larger calf crop was due to a combination of larger beef cows and improved reproductive efficiency (going from 86 per cent in 2015 to 90 per cent in 2016). This will support production moving into 2017 as long as there is not a big jump in feeder cattle exports to the U.S. this fall.
Beef cow inventories were up 0.3 per cent at 3.8 million head; this remains the lowest inventory since 1991. Beef cow inventories were up in B.C. (+3.8 per cent), Manitoba (+2.0 per cent), Saskatchewan (+1.0 per cent), Quebec (+1.0 per cent), and the Atlantic provinces (+0.2 per cent). Inventories declined in Alberta (-0.6 per cent) and Ontario (-3.0 per cent).
Beef heifer retention was up 4.5 per cent at 641,800 head, the largest since 2008. While encouraging this remains two per cent below the 10-year average and 15 per cent below the 20-year average. Beef heifer retention was up in all provinces: Atlantic provinces (+13.7 per cent), Manitoba (+9.3 per cent), B.C. (+6.0 per cent), Quebec (+5.5 per cent), Alberta (+3.9 per cent), Saskatchewan (+3.7 per cent), and Ontario (+1.5 per cent).
The supply of feeder and calves outside of feedlots on July 1 was up two per cent or 110,600 head. Smaller feeder exports since September 2015 combined with the larger calf crop this spring mean there are more feeders to place this fall. Ample feeder numbers in both Canada and the U.S. have dramatically shifted leverage from the cow-calf producers back to the feedlot as there won’t be as much competition for supplies.
U.S. growth slows
USDA has suspended the July 1 Cattle Inventories report. Therefore, U.S. numbers will not be available until January. U.S. beef cow slaughter is up 11 per cent from January through September; while heifer slaughter is steady — implying the rapid expansion seen since the fall of 2013 is slowing down. Beef cow slaughter started picking up compared to 2015 in April; but remains eight per cent below 2014 and 17 per cent below the five-year average.
Culling rates rebound to liquidation levels
Cow slaughter is up seven per cent from January through September while exports are steady leaving cow marketings up 4.6 per cent to date. The beef cow culling rate dropped to 10.5 per cent in 2015 but it has rebounded to 11.5 per cent in 2016. D1,2 cow prices are down 28 per cent from the record highs made in 2015 and have been trending in line with the five-year average since April.
Heifer placements also up
Increased heifer retention on July 1 was confirmed in a lower heifer slaughter ratio in 2016. At 57 heifers for every 100 steers this is down from 61 in 2015 and the 20-year average of 69. While it appears producers are focused on developing a younger herd it is not clear on if replacements will be large enough to offset culling rates. Particularly as heifer placements into feedlots went from being below the five-year average in 2015 to well above the five-year average as of March 2016. From January through August heifer placements have averaged 42 per cent of the total up from 32 per cent in 2015 and the five-year average of 36 per cent. Heifer slaughter is anticipated to pick up in the fourth quarter contributing to lower carcass weights and a smaller year-over-year increase in beef production.
Prices and profitability
Fed cattle and AAA cut-out prices
In September Alberta fed cattle prices averaged $131/cwt down 24.5 per cent from last year, and 1.9 per cent lower than the 2011-15 average ($133/cwt). From January through April as the exchange rate strengthened 11 per cent, the drop in fed cattle prices was a direct reflection of the dollar. But since then the drop has been about larger protein supplies and softer international demand.
The AAA cut-out averaged $242/cwt in September, down 17 per cent from last year’s $292/cwt and three per cent below the three-year average of $251/cwt. Moving into the fall, the market will seasonally shift from middle meats to end meats with increased demand for roasting items. In September the rib and loin primals had the smallest year-over-year decline, down four per cent ($11/cwt) and 10 per cent ($68/cwt) respectively; while chucks and rounds had larger declines, down 24 per cent ($45) and 25 per cent ($51) respectively. As focus shifts from middle meats to end meats this fall, the overall cut-out value could potentially drop further. Lower cut-outs will add pressure to fed and feeders prices.
The Alberta live fed steer prices as a percentage of the AAA cut-out dropped below 55 per cent in June 2016 for the first time since June 2010. From 2005 through 2010 this ranged between 50-55 per cent but from 2011 through 2015 it ranged between 55-64 per cent. As this drops back to that historic relationship, it signals a loss of leverage at the feedlot as supplies increase.
Feedlot margins squeezed
The drop in fed prices over the last 18 months has pushed feedlot margins into the red. Canfax TRENDS reports feedlots selling on the cash market have been losing money since September 2015. Monthly losses have been the largest since 2003. Despite lower feed grain prices, projected break-evens for shortkeep and yearling cattle placed in September at $140-$145/cwt still have negative margins around $130-$213/head, while break-evens for calf placements are projected at $131/cwt with a positive margin at $50-$82/head. The significant equity losses in the feedlot sector are expected to dampen feedlots’ willingness to pay for feeder cattle this fall and pressure feeder prices.
The lower the replacement ratio (see chart at bottom) the fewer dollars the feedlot must pay to replace a fed animal with a feeder; conversely a higher ratio means the feedlot must pay more per pound to replace those animals. Replacement ratios moved lower in the second quarter, but rebounded in the third quarter due to faster declines in fed cattle prices. Compared to 2015, the ratios have been five per cent to 20 per cent lower in the second and third quarter. Lower replacement ratios reduce the incentives for long feeding periods. As of late September, steer carcass weight was right in line with year-ago levels at 928 pounds. This compares to a six per cent year-over-year increase in the first half of 2016.
Feed grains and feeder prices
Canadian barley production is projected to increase 5.8 per cent to 8.7 million tonnes. Corn for grain is projected to decline 8.9 per cent to 12.35 million tonnes as drought in Ontario reduced yields. Lethbridge barley prices have been under pressure since June and moved sharply lower in August and September. In September, Lethbridge barley averaged at $167.50/tonne. This is 24 per cent below last year and 12 per cent below the 10-year average of $190/tonne. In addition to larger barley production, rains throughout Western Canada this summer have resulted in ample feed supplies this winter as product was downgraded.
In August as feed grain prices started to drop it was looking like feeder prices might hold steady around $200/cwt. Despite significant drops in barley prices and cost of gain for feedlots, feeder prices have declined seasonally as feedlots pocket the difference in an effort to rebuild equity. Alberta 850-pound feeder steers averaged $171/cwt in September 2016 down 35 per cent from last year’s $262/cwt, and four per cent from the five-year average of $179/cwt. Alberta 550-pound steer calves averaged $188/cwt in September down 39 per cent from last year’s $309/cwt, and 10 per cent from the five-year average of $209/cwt.
Lower feeder prices in 2016 have dampened any producer enthusiasm for expansion. The decline in calf prices combined with higher hay prices last winter have reduced cow-calf profits in 2016. Alberta cow-calf returns are projected to drop 83 per cent from 2015 to $123/cow. This is still higher than the 10-year average of $76/cow. Producers who have lower per-unit production costs will continue to be in the black. However, high-cost producers may be considering liquidation.
There is a major difference between this downturn in profitability and the last downturn in 2003. In 2002, drought meant that many producers were already looking at ways to reduce costs. In contrast, the record-high profitability of the last two years means that many producers have made major infrastructure investments that are going to impact depreciation and cost of production for the coming five years. Instead of being lean and mean some producers are going to feel the squeeze and be looking for innovative ways to reduce costs.