The (Food) Chain

In 1977, Fleetwood Mac released the song, “The Chain” on its Rumors album. While the lyrics of the song address breaking of a “chain” – as in personal relationship –  we have a break-up in our “food chain” as represented by producers (farmers), processors (slaughter, butchering, packaging, distribution), and food delivery channel (at home or away from home). As someone who enjoys eating (perhaps a bit too much), I was struck by recent news reports of milk producers having to dump milk, hog farmers aborting sows, chickens being euthanized, and cattle being killed. All this was happening while, at the same time, there were empty shelves at the grocery stores and/or limits on the number of certain grocery products I could buy. What happened? People still need to eat, famers and producers are still raising animals or grains and produce, cows still need to be milked, and grocery stores are still open.

A May 14, 2020 article in the Federalist by Christopher Bedford provided some insight. He indicated that in the 1980s, Americans spent the majority of their food budget at the retail grocery. By 2010, eating-out spending surpassed at-home food spending for the first time. Prior to the coronavirus, it is estimated that half of all meals were consumed away from home. Accordingly, food production and processing were geared toward the food service industry including restaurants, cafeterias, and institutions such as schools. Closing schools and restaurants and other hospitality-related businesses across the country resulted in an unbelievably rapid shift in eating habits.

The (Food) Chain

This shift in habits caused by the closing of restaurants and schools has significant implications for all agricultural products. Prior to the coronavirus, food production was geared toward food services, which generally requires a different size of animal. While meat processing plants require a great deal of human labor, they tend to be highly mechanized with machinery and equipment designed to process specific-sized livestock to specific proportions or products for specific packaging and highly regulated labeling requirements. Milk for the food service industry, as an example, might go to smaller portion-pack creamers or five-gallon boxes. Supermarkets need quarts, half gallons, and gallons. Chicken for food service are generally up to three pounds and are specifically cut for restaurants and fast food establishments.

The retail market requires larger birds (up to five pounds) either whole or cut up into breasts, legs, or thighs. With beef, it is primarily whole cuts of beef versus crates of frozen burger patties. Prior to the coronavirus, less than half of beef went to the retail sector. Now it is closer to 80%. This relationship between producer, processor and customer is a very finely tuned system which has evolved over time. While it certainly can be a good thing in a market that needs to survive on low margins, it is not a good situation when things change very abruptly.

Food Chain Relationship

While processing plants could change over to meet the new demands, it is both costly and time-consuming. No one can predict with any certainty how long the current market dynamics will last. In turn, we don’t know how long a “recovery” might take. This moving target is further complicated by local, state and federal governments moving “reopening dates” in two-week intervals. In addition to capital considerations, virus-related labor shortages and temporary plant shut-downs due to infections further complicate the planning. Changes in health and safety protocols for processing facilities, including distancing rules, may inhibit a plant’s processing ability overall even as workers return to work.

In the meantime, cows still need to be milked. Eggs still hatch and grow to be chickens. Hogs grow. Cattle still need to be fed. There is plenty of product out there, but getting it into the proper “format” is a major concern. Farmers are then faced with the terrible decision of what to do with their product which continues to eat (costly) and grow (to a size that may not be marketable) or may be perishable (such as milk).

COVID-19 Effect

In our March 26, 2019 blog, which examined the prospects for the Agricultural sector for 2019, nearly all sectors of agriculture were expecting higher farm incomes with stronger pricing and higher volumes. According to the USDA Economic Research Service report dated May 18, 2020, the agricultural sector was experiencing continued strong performance into the first quarter of 2020. Beef production reached record levels on the largest number of cattle slaughtered for the quarter since 2002. Beef production peaked the week ending March 28. From there, production quickly declined at an exceptional rate. Dairy experienced similar impacts.

Almost overnight, domestic demand for dairy products fell due to financial hardships for some Americans and the shift from away-from-home consumption to at-home consumption; at-home consumption is typically lower than away-from-home consumption. This shift brought about logistical and packaging problems causing supply-chain bottlenecks at a time when the USDA Dairy Market New (DMN) reported that cheese, butter, and dry product inventories were growing during the month. As of early April, pork processing facilities were running at nearly 100% utilization according to USDA/AMS data. By the week ending May 1, capacity utilization rate averaged 58.5%.

Future Farming Needs

The prospects for 2020 are certainly less rosy than 2019. Beef forecast for 2020 per the USDA have been reduced 1.7 billion pounds, about 5% below 2019 levels. Prices are expected to remain low as the supply of market-ready cattle remains above the sector’s ability to process them. On the dairy side, some dairy cooperative and milk handlers have instituted base-excess plans to discourage increase milk production. Under these plans, a dairy farmer is paid less for milk in excess of a base amount. All-milk price forecast is $14.55 per hundred weight for 2020 against an estimated $16 to $17 per hundred weight breakeven. Hogs, like cattle, are expected to have ample supply against limited slaughter capacity. This will result in an average of $42 per hundred weight which is nearly 28% below a year ago.

It looks to be a very tough year for the agricultural sector. Because of the processing limitations including labor shortages, consumers should expect to be paying more even though there is plenty of product. In the absence of an additional major “hit,” the imbalances that we currently see and the challenges faced will likely be addressed by late 2020 and early 2021 according to the USDA.

Richard Rudolph is Senior Consultant at Enlighten Financial, a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape, and lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Rick directly, please call: 920.445.8133.