Corn continues to be the ingredient everyone is watching. The latest price run-up in corn has many people talking about a new all-time high. Of course, wheat and soybean prices also have been exploding.
While the decision is primarily between corn and soybeans in the Corn Belt area, the decision on the fringes of corn country is between corn and wheat. In many cases, wheat and soybeans look like a more profitable alternative right now.
Corn is hurt by the fact it has by far the highest input costs. Breakevens in corn production in areas where it must be irrigated due to increased energy and fertilizer costs have seen corn breakevens increase by 30% or more. Right now it's a competition to establish the acreage mix; until those decisions are made, it's difficult to see anything but continued strength in the grain markets.
The live-cattle market has strengthened, as well. Ironically 2007 was the highest average ever posted for live cattle, but it was a brutal year for profitability for the feeding and packing segments. Meanwhile, profitability for the cow-calf producer fell toward the marginal category.
The impact of inflation and input costs, along with the average producer age, has changed the way the industry interprets profitability relative to expansion. In the 1970s, a $30 profit/head for cow-calf producers was enough to trigger expansion. But $30 bought a whole lot more then than it does today, and cows were a lot less, too. Paying 9% interest on a $1,300 cow is a whole lot different than paying 7% on a $600 cow.
Take a producer who is 60 years old, running 200 cows on a diversified farming operation, and beginning to think about retirement. Let's say he has no children who plan to take over. His $20 profit/head on the cow-calf side amounts to only $4,000. He can't even make payments on a new truck with that. The real profits are being generated through farming, and cows are a way to utilize byproducts of the farming, as well as untillable ground.
Will he be expanding? Sure, someone with excess feed may expand a bit in order to spread out fixed overhead. But, for the most part, expansion will be limited to those with larger operations, and even then only in the narrow sense that expansion would have to improve overall operation efficiency.
That's good news for cow-calf producers -- while overhead costs are rising, prices should continue to rise, as well. Expansion in the longest cattle cycle in history in any substantive way is a ways off.
From a feeding and packing perspective -- two segments already burdened with excess capacity -- this does not bode well. Losses will be incurred until consolidation occurs.
In the short term, this is positive for cow-calf producers, as they will capture a larger share of the dollar. Longer term, you'll hear a lot of concern that this downsizing of the industry is a negative. Unquestionably, everyone benefits from a growing and expanding industry, but the industry must respond to the change in the economic structure of our industry and that means a smaller industry.
Global beef demand remains the one potentially mitigating influence to industry consolidation. Certainly, it will continue to be cheaper to import a pound of grain-fed beef than it will be to buy, transport and feed the 6 lbs. of corn needed to produce it. And with half the world's population moving toward more of a free-market economy, the demand outlook remains positive, as well.