Analysis: Spot Market Hog Purchases Provide Accurate Price Discovery Mechanism

Economists say number of negotiated hogs will likely stop at around 10% of slaughter, providing for an accurate base price for market contracts. Compiled by staff

Published on: Mar 2, 2006

A checkoff-funded analysis of U.S. Department of Agriculture price data shows fewer hogs sold through daily negotiated transactions (the spot market) during January 2006 than during previous years, although the prices of more than half the hogs in the United States still are determined by the spot market.

"If the rate of decline in the percentage of negotiated or spot market hogs returns to the pre-2004/'05 rate, it will increase the urgency for the industry to find another form of price discovery for most of the contracts," says Glenn Grimes, professor emeritus at the University of Missouri. "However, the slowdown in the rate of decline in negotiated or spot purchase hogs gives us some hope that the number of negotiated hogs will stop at around 10% of total slaughter. If it does, we believe it will do a satisfactory job of representing the true supply and demand situation and can be used as the base price for market contracts."

Grimes, Ron Plain, professor at the University of Missouri, and Steve R. Meyer, president of Paragon Economics, are the three economists who conducted the analysis.  

The data that was reviewed came from reports that were created by the Livestock Mandatory Reporting Act of 1999, which went into effect in 2001. However, in October 2005, the reporting system became voluntary because the law requiring mandatory reporting expired on September 30, 2005. The reports cover all but the smallest harvest facilities. Total hog slaughter under Federal Inspection in January 2006 was 8,030,370 head. Data for 7,261,064 head (90.4% of federally inspected slaughter) were reported through the mandatory price reporting system.

 Annual studies since 1999 show the percent of hogs sold at negotiated prices has fallen from 35.8% for all of 1999 to 10.2% in January 2006. By adding the percentage of hogs purchased in the negotiated markets to the percentage purchased on hog or meat market formulas, the current study indicates that the price of at least 52% of the hogs in the United States was directly determined by the negotiated market.

"The true percent is higher because a high number of packer-owned and packer-sold hogs are priced with a market formula," Plain says.

More than a third of hogs were sold through a price-shifting arrangement, including 16.6% through other purchase arrangements and 8.8% on contracts tied to the futures market.

"About 25.4% of the hogs in January 2006 were bought under some system that supposedly reduces price risk to producers," Meyer says. "I suggest 'supposedly' because some of the pricing systems do not actually affect the variance of the price received by the producers. Only cash contracts ‑ the ones usually tied to futures ‑ and contracts without ledgers reduce producers' price risk. Other arrangements may or may not result in a realized average price that is different from the actual average negotiated price."

The mandatory price reporting legislation required packers to report percent lean, carcass weight, base price and net price for each type of marketing arrangement. Data for January 2006 are in Table 2.

The negotiated hogs had the second lowest percent lean, the lightest average weight and the lowest net carcass price. The other market formula hogs had a percent lean close to the negotiated hogs and the highest average carcass weight.

"The packer-owned hogs had the highest base and net prices," Meyer says.

Direct comparisons for all of the marketing arrangements cannot be made. The definitions for the marketing arrangements in the mandatory price reporting legislation are not the same as the definitions of arrangements reported by similar studies conducted by the University of Missouri and the National Pork Board. However, the spot market or negotiated groups are directly comparable across all time periods, so this very important portion is consistent with previous studies.

Table 1.  Percent of U.S. hogs sold through various pricing arrangements,  January 1999-2006*

 

1999

2000

2001

2002

2003

2004

2005

2006

Hog or meat market formula

44.2

47.2

54

44.5

41.4

41.4

39.9

41.8

Other market formula

3.4

8.5

5.7

11.8

5.7

7.2

10.3

8.8

Other purchase arrangement

14.4

16.9

22.8

8.6

19.2

20.6

15.4

16.6

Packer-sold

 

 

 

2.1

2.2

2.1

2.4

2.6

Packer-owned

 

 

 

16.4

18.1

17.1

21.4

20.1

Negotiated-spot

35.8

25.7

17.3

16.7

13.5

11.6

10.6

10.2

* 2006 data were reported to USDA voluntarily; 2002 through 2005 data are based on USDA Mandatory Reports; 1999-2001 are based on industry surveys by the University of Missouri.

Table 2.  Hog marketing arrangements averages, January 2006

 

Percent Lean

Carcass Weight (Pounds)

Base Carcass price/cwt.

Net Carcass price/cwt.*

Negotiated

53.95

202.21

$54.68

$55.52

Swine-pork market formula

54.68

205.61

$54.25

$56.40

Other market formula

54.34

209.9

$55.25

$58.11

Other purchase arrangement

54.03

206.22

$55.62

$56.83

Packer-sold

54.29

205.11

$56.51

$59.42

Packer-owned

53.57

204.57

 

 

* Net price includes credits for quality, transportation, time of delivery, etc.