Supply and demand drive the market. However, the economics that support a financially sound industry or a firm is much more complex. A Canadian pork packer/processor in its recent announcement to close a plant revealed two key issues concerning that complexity - capacity and labor.
The many market forces that drive the economics of a successful business are all coming to bear this year and while, as an economist, it might be easy to consolidate those forces into simply a supply/demand equation, there is much more to it than that. Capacity is critical to the P & L of a business – any business. And, tandem to capacity is labor. So, as cattle numbers decline, the topic of optimizing plant capacity is critical. This is not just economic theory. It is business reality. Tighter cattle numbers may deliver sharp gains to the cattle market, but those market gains can become short-term gains that are quickly erased as business adjusts capacity. Olymel’s announcement is one example and there have been similar announcements by U.S. firms. This is more than risk management. It is business management.
While under-utilized capacity is currently a packer problem, there is plenty of outcry by environmentalists advocating against cattle production to “manage” climate change. “What if” is becoming an increasingly relevant response. What if the environmentalists are successful in creating a regulatory environment that limits or reduces herd growth? Ranchers with Federal grazing permits have always faced this question and yes, it can and does impact their business decisions, particularly when tied to lending.
On March 30, the Department of Interior released a “Proposed Plan to Guide the Balanced Management of Public Lands.” I am inclined to believe “change is coming” regarding grazing federal lands, but other global warming initiatives can also change cattle production on private lands. From a business perspective, the same capacity issues currently addressed by packers become every bit as relevant to many ranchers and feedlots.
The cattle inventory will likely be reduced another 2% during 2023. Market economics go beyond supply and demand and other key drivers are becoming increasingly meaningful in the current market environment including adjustments to production capacity. While record prices are welcome, it is also a critical time to assess the economics of the “big picture” and potential business risk.
