Feed cost sensitivity and commodity risks in pork production in South Africa

Abstract

Risks and uncertainty of the future are two of numerous key drivers that decision makers need to take into account when considering opportunities and embarking on new business ventures. As with all agricultural industries, another few factors that need to be considered during decision-making are the pressure of food security, weather changes, input and output price volatility, changes in consumer preference and political instability. Farmers of the 21st century are becoming business executives of their farming enterprises. The rules of the farming industry, and particularly the South African pork industry, are rapidly changing. Information on trends regarding future possibilities is changing the way that pork producers used to do business and view the industry. Economic analysis, animal health, production, genetics and feed utilisation are the standards to measure and evaluate performance for current pork producers and new entrants to the industry. The objective of this study is based on the economic principles that examine feed price sensitivity and the associated commodity risks in a pork production unit. These principles are applied in the evaluation of possible risk aversion alternatives. This was achieved by redesigning an out-dated pork price-sensitivity model to produce outputs that are of value to decision makers in the industry. These outputs assist in testing different risk aversion alternatives that are available to a pork producer to hedge input cost risks in order to achieve a sustainable profit margin and the ability to expand operations in a sustainable way. The main objective of this study was to redesign a feed input price-sensitivity model for pork producers who mainly use home mixing of feeds. Risks directly affecting feed costs and thus profit margins, needed to be identified and different risk-minimising strategies and alternatives evaluated and tested on a farm level. Scenarios based on possible price ranges of commodities were calculated, as well as the impact and scale that fluctuations in these prices could possibly have on a pork producer’s profit levels. Redesigning the pork price-sensitivity model was achieved by using the principle of a dynamic approach to modelling, whereby all varying factors and inputs can be captured in an MS Excel setup according to changes in industry prices and dynamics. This application was a requirement because of the high volatility of the input commodity price for the major feed commodities such as maize, sunflower and soya oil cakes, and wheat bran. As part of this study, the following economic applications were combined to answer the research questions. These applications included the market environment for South African pork production, strategic planning, scenario analysis and hedging feed commodity prices with options as well as alternative pricing contracts. Risks classified as priority and of highest concern in the pig industry in South Africa were price volatility in especially the grain market of feed commodities, financial and economic instability and the political [instability] risk. These risks needed to be factored into the decision-making and strategic planning process when the model outputs were evaluated. The methodology applies was to measure the sensitivity that feed commodities have on the gross income (income minus feed cost at a predetermined price for commodities and quantity level), the principle of price elasticity was applied, by using the changes in commodity prices over the changes in gross income. The sensitivity of yellow maize, soya (full fat and oil cake), and sunflower and wheat bran was tested to determine the impact that these commodities individually contribute to the overall feed cost in a pork unit. From the price elasticity and sensitivity calculations and evaluations, it became clear that volume, in conjunction with commodity cost, are important considerations on which decisions from a managerial perspective can be based. A pork producer can choose to be price-elastic/-inelastic according to the levels of sensitivity towards price changes consistent with his/her preference to risk. The scenarios illustrated the risk that a producer can face on an annual basis, and which commodities have the biggest impact on profit levels when prices fluctuate. Maize was seen as being the highest contributor and risk to upward/downward movements. Different alternatives to hedging price risks on the market were tested and the impact of making a decision in the market illustrated. From these calculations, it was clear that each alternative yielded its own risks and opportunities. The minimum price option posed the lowest risk, although a premium is paid, it still allows a pork producer to benefit from rising prices. The recommendation to the pork industry is to expand the study of the industry on a financial basis. Due to recent changes to the National Credit Act (No. 34 of 2005) on the regulation of credit, credit management are becoming stricter from a financial institutional point of view. A producer must be able to prove that his/her farm is sustainable and does not pose a risk to the institution granting the loan. Loan grant decision makers are not always knowledgeable about the different farming industries and practices. It is therefore important that this model is used to identify risks and that the results, together with an indication of how these risks will be dealt with given different market scenarios, are included in pork producers business plans. Other recommendations included the following: <ul> <li> This study should be used by decision makers in SAPPO and the industry to base decisions regarding the economic value of production on;</il> <li> Home mixers should evaluate the financial impact if inputs in their existing feeding system change, as well as possible ways in which these changes might affect their cash flow;</li> <li> Producers should acquire a better understanding of SAFEX in the industry by obtaining more case study examples of how hedging risks could be applied to the advantage of a pork producer;</li> <li> Technology should be used more frequently to communicate relevant and updated market information to role players to equip them for decision-making processes on current and future market developments and scope;</li> <li> Opportunities to engage in pork meat price futures contracts (trades as pork bellies in the US) should be investigated to give open market producers a tool to contract their products in the future;</li> <li> Consumer trends needs to be analysed and constantly revised to ensure that producers will be able to deliver products in line with the needs of future consumers; and</li> <li> Interdisciplinary relationships with respect to animal science, animal health nutrition, agricultural economics, soil science, SAFEX and offset markets should be fully incorporated in the outputs. This will facilitate the true delivery of an exact research output that can be used by role players in the applicable industry to base good judgement decisions on in future.</li></ul> AFRIKAANS : Risiko’s en onsekerheid is twee van vele sleutelareas wat besluitnemers in ag moet neem wanneer hulle geleenthede oorweeg en nuwe besigheidsgeleenthede ontgin. Soos met alle sektore in die landbou, is nog ‘n faktore wat tydens besluitneming in gedagte gehou moet word onder andere die druk van voedselsekuriteit, weerveranderings, prysvolatiliteit van in- en uitsette, veranderings in verbruikersvoorkeure en politieke onstabiliteit. Boere van die 21ste eeu is besig om hoof uitvoerende beamptes van hulle eie boerdery-ondernemings te word. Die spelreëls van boerdery, en spesifiek die Suid-Afrikaanse varkindustrie, is besig om vinnig te verander. Inligting oor huidige tendense, wat toekomstige moontlikhede inhou, verander die manier waarop varkprodusente besigheid doen en die industrie beskou. Ekonomiese analises, in kombinasie met dieregesondheid, produksiegenetika en voeding, word die winsdrywers en meet-instrumente waarteen huidige varkprodusente sowel as nuwe toetreders in die industrie hulself kan meet. Die fokus van hierdie studie word gebaseer op die ekonomiese beginsels wat voedingspryssensitiwiteit en die gepaardgaande kommoditeitsrisiko’s in ‘n varkproduksie-eenheid ondersoek. Hierdie beginsels word aangewend in die evaluasie van moontlike risiko-vermydingsalternatiewe. Dit is bereik deur die herontwerp van ‘n verouderde varkpryssensitiewe model om waardevolle uitsette vir die varkprodusente industrie te lewer. Hierdie uitsette help met die toetsing van verskeie risiko-bestuursalternatiewe wat vir die varkprodusent beskibaar is om insetkosterisiko’s te verskans en sodoende ‘n volhoubare winsgrens en die vermoë om werksaamhede op volhoubare wyse uit te brei, te bereik. Die hoofdoelwit van die studie was om ‘n voedingspryssensitiewe model vir varkprodusente wat voer hoofsaaklik tuis meng, te herontwerp. Risiko’s wat voedingskostes en dus winsgrense direk affekteer, moet geïdentifiseer word en verskillende strategië en alternatiewe om risiko’s te beperk moet op plaasvlak geëvalueer en getoets word. Scenarios gebaseer op moontlike kommoditeitsprysreekse is bereken, sowel as die impak en skaal wat skommelings in hierdie pryse moontlik op ‘n varkprodusent se winsgrense tot gevolg kan hê. Die herontwerp van die varkpryssensitiewe model is bereik deur die gebruik van die beginsel van ‘n dinamiese benadering van modellering, waarby alle wisselende faktore en insette in ‘n MS Excel-spreiblad ingevoer kan word, volgens veranderinge in industriepryse en -dinamika. Hierdie toepassing was ‘n vereiste as gevolg van die volatiele aard van insetkommoditeitspryse van die hoofvoedingskommoditeite soos mielies, sonneblom- en soja-oliekoeke en koringsemels. As deel van hierdie studie, is die volgende elemente gekombineer: die markomgewing, strategiese beplanning, scenario-analise, verskansing met afgeleide instrumente (deur gebruik te maak van termyn- en opsiekontrakte) asook alternatiewe aankoopkontrakte. Prysvolatiliteit in veral die graanmark; finansiële en ekonomiese onstabiliteit; en die politieke [onstabiliteit] is geïdentifiseer as die hoogste risikofaktore in die vark-industrie. Daar moet rekening gehou word met hierdie risiko’s tydens die besluitnemings- en strategiese beplanningsproses. Om die sensitiwiteit te meet wat voerkommoditeite op die bruto inkomste het, is die beginsel van pryselastisiteit toegepas deur die veranderinge in kommoditeitspryse oor die veranderinge in bruto inkomste te gebruik. Die sensitiwiteit van geelmielies, soja (volvet en oliekoek), sonneblom en koringsemels is getoets om die impak te bepaal wat hierdie kommoditeite individueel bydra tot die oorkoepelende voerkoste in ‘n varkeenheid. Uit die pryselastisiteits- en sensitiwiteitsberekenings en -evaluasies het dit duidelik geword dat volume, tesame met graanpryse, belangrike oorwegings is waarop besluite uit ‘n bestuursperspektief gebaseer moet word. ‘n Varkprodusent kan kies om pryselasties of -onelastis te wees volgens sy/haar vlakke van sensitiwiteit teenoor prysveranderinge in ooreenstemming met sy/haar risikovoorkeur. Die scenario’s het die risiko geïllustreer wat ‘n produsent op jaarlikse basis kan trotseer en watter kommoditeite die grootste impak op wins het wanneer pryse wissel. Mielies blyk die grootste impak en dus ook risiko, met op- en afwaartse bewegings te wees. Verskeie alternatiewe tot die inperking van prysrisiko’s op die mark is getoets en die impak van besluitneming in die mark geïllustreer. Uit hierdie berekeninge was dit duidelik dat elke alternatief sy eie riskso’s en geleenthede voortbring. Alhoewel ‘n premie betaal is, hou die minimumprys-strategie die laagste risiko vir varkprodusente in deurdat dit steeds ‘n produsent toelaat om voordeel uit wisselende pryse te trek. Daar word aanbeveel dat die studie uitgebrei word om ook die finansiële posisie van 'n varkprodusent in die besluitnemingsmodel in te sluit. Na aanleiding aan die onlangse veranderings aan die Nasionale-kredietwet (Wet No.34 van 2005), word kredietbestuur strenger toegepas. ‘n Produsent moet in staat wees om te kan bewys dat sy/haar besigheid volhoubaar is en nie ‘n risiko inhou vir die instansie wat die lening toestaan nie. Besluitnemers wat lenings toeken is nie altyd ingelig oor die verskillende boerderyindustrië en -gebruike nie. Dit is daarom belangrik dat hierdie model gebruik word om risiko’s te identifiseer en dat die resultate (produksie en finansies), tesame met ‘n aanduiding van hoe hierdie risiko’s hanteer moet word gegewe verskillende markscenario’s, ingesluit moet word in varkprodusente se besigheidsplanne. Ander aanbevelings sluit die volgende in: <ul> <li> Hierdie studie behoort deur besluitnemers in SAPPO en die industrie gebruik te word om besluite met betrekking tot die ekonomiese waarde van produksie op te baseer;</li> <li> Tuismengers behoort die finansiële impak te evalueer indien insette in hulle huidige voedingstelsel verander, sowel as moontlike maniere waarop hierdie veranderinge hulle kontantvloei en winsgewendheid kan affekteer;</li> <li> Produsente behoort ‘n beter begrip oor SAFEX in die industrie te verkry deur meer gevallestudies te bekom oor hoe om die inperking van risiko’s toe te pas tot voordeel van ‘n varkprodusent;</li> <li> Tegnologie behoort meer gereeld gebruik te word om toepaslike en die nuutste markinligting aan rolspelers te kommunikeer om hulle sodoende toe te rus vir besluitnemingsprosesse;</li> <li> Geleenthede om betrokke te raak by varkvleistermynkontrakte behoort ondersoek te word om varkprodusente in staat te stel om ook hul uitsette te verskans;</li> <li> Verbruikersneigings behoort ontleed en voortdurend hersien te word om te verseker dat produsente in staat sal wees om produkte te lewer ooreenkomstig die behoeftes van verbruikers; en</li> <li> Interdissiplinêre verhoudings met betrekking tot veekunde, diere-gesondheids¬voeding, landbou-ekonomie, grondkunde, SAFEX en verskansing, behoort ten volle geïnkorporeer te word by die uitsette. In die toekoms sal dit die lewering van ‘n presiese navorsingsuitset kan fasiliteer wat deur rolspelers in die toepaslike industrie gebruik kan word om goeie oordeelkundige besluite op te baseer.</li> </ul>