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HUNTIN' DAYLIGHT -- POLICIES - PRODUCER GROUPS SPUR CONSOLIDATION

by: Wes Ishmael

You can agree that the Canadian border should have reopened last month as proposed by USDA or not.

You can be mad or glad that the group asking for and receiving the preliminary injunction that stalled the border opening for an indefinite period of time, effectively removed producers from any say in the matter, leaving it completely up to the courts.

If you believe science must be the objective reference point from which to make such decisions, though, it's tough to argue that the border opening should have been delayed.

Moreover, if you're a believer in basic market fundamentals, you have to recognize that odds are in favor of increased packer consolidation because of the border delay, and the policies that had already kept live feeder and fed cattle out of the U.S. for so long.

Say what?

Yes, it's true that relative to constant demand, decreased supplies should increase the price of a perishable commodity like beef, at least in the short-term. The industry has seen as much during the past year when cyclically low cattle numbers and the loss of Canadian import cattle have teamed up with record large beef demand to serve up historically high cattle prices. That, even though the U.S. has regained only about a third of its beef exports on a value basis.

However, it's also true, even with strong beef demand, consumers have begun shying away from beef's price. For evidence, look no further than the fact that three of the nation's four largest beef packers have reduced production or closed entire plants for extended periods of time because they've been unable to get the price necessary from the retailer, relative to what they are paying for fed cattle.

Within two weeks of the judge's decision that delayed the border opening, both Swift and Excel announced further reductions in harvest. At the time, Bill Rupp, president of Cargill Meat Solutions, which includes Excel, explained, “While we have been operating in reduced mode for some time, current market conditions and lackluster seasonal demand are forcing us to reduce the number of cattle we process weekly.”

And yes, the delay in the border opening did boost prices, at least in the short term. Unsurprisingly, futures prices for near-month live cattle and feeder cattle rose sharply soon after the border delay was announced. On a percentage basis, some economists point out the short-term gain was equivalent to the expected degree of negative price impact when the market does open, meaning that any price bloom from the delay may have already been realized fully. It also means, that the anticipated but unknown date of the ultimate border reopening will continue to add volatility to the markets.

Plus, the futures market is not designed to manage long-term risk. And, extending the border closure appears to represent nothing but increased risk for the markets here.

Besides reduced harvest capacity overall, some regional plants in the U.S. have been struggling especially hard. In the Northwest and Northeast, for example plants that have traditionally relied on Canadian cattle to flesh out available domestic cattle supplies are becoming crippled. The economic strain is so severe that various analysts believe some plants in these regions may be forced to close and never reopen. If that happens, lost market access will force producers to accept added cost in these areas in the form of added freight and shrink.

Plants in the Central Plains are not immune to fallout, either, even if you assume they would ultimately benefit from more numbers flowing their direction from areas that may lose packing capacity. That's especially true when you consider that the expansion of slaughter capacity already underway in Canada, then spurred along by the interminable border closure, means that within several years the folks up north will have enough capacity to harvest all of their cattle. Specifically, harvest capacity is expected to increase in Canada by 18 percent this year; another 12 percent growth is projected by 2007.

While such reality may be cause for celebration among the isolationist set, it means the current over-capacity of the packing industry in this country becomes more pronounced. The crux is that there's good reason to believe the packing industry will have to become more consolidated and more geographically concentrated. Even then, packers here will be competing against newer technology built into Canada's new plants.

If recent moves in the cattle feeding business are any indication, consolidation in the packing industry may not come in the form many may anticipate, either. Rather than smaller and mid-size entities teaming up to compete with the largest players, two cattle feeding giants combined their businesses in January to take a commanding lead in size.

To wit, Smithfield Foods, Inc. and ContiBeef, LLC announced they were merging their cattle feeding businesses, giving the yet-to-be-named enterprise a one-time feeding capacity of 811,000 head, or 62 percent more than Cactus Feeders, which had been the world's largest cattle feeding operation with a one-time capacity of 500,000 head.

As you recall, Smithfield—already the largest pork producer and pork processor in the country, and the sixth largest beef packer—only entered the cattle feeding business in October when it acquired MF Cattle Feeding, Inc. (MFCF) from Swift and Company. MFCF are what many of us still think of as the Monfort feed yards.

So, you have ContiBeef, which has been the second largest cattle feeding organization in the nation—with six yards in Colorado, Kansas, Oklahoma and Texas accounting for a one-time capacity of approximately 455,000 head—combining with MFCF, which has been the third largest feeder—three yards in Colorado and one yard in Idaho with a one-time capacity of 357,000 head. For the bean counters reading this, the 357,000 number comes from Smithfield when they acquired MFCF, the 455,000 number comes from NCBA's annual survey, and the 811,000 mentioned earlier comes from a release issued by the new enterprise.

This 50-50 partnership yields a marketing position unique in the business. With the capacity to market approximately 2 million head per year—closing in on 10 percent of the annual fed cattle supply—logic says that more vertical cooperation is possible, such as large beef customers now having a proportionally large supplier they could consider signing to long-term supply agreements.

Keep in mind MFCF has long been aligned with a genetics company, building and marketing bulls, then sourcing calves back from those genetics—working farther back into the system to produce what yields the most packer value. Couple that with Smithfield's current holdings in beef and pork packing—especially their experience with vertical chains from pork production forward—and there's every reason to believe this new venture could be the fulcrum around which a new stage in supply development and management is set to turn.

However, the packing industry realigns, consolidates, or further concentrates regionally, competition for cattle here will likely decrease, even as competition to regain international market share becomes more difficult.

That's the trade-off of policy and legal decisions that effectively manipulate markets artificially.

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