ANALYSIS - Illinois hogs eating more wheat may ease China prices

CHICAGO Thu Apr 21, 2011 9:41pm IST

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CHICAGO (Reuters) - Steve Ring's 400,000 hogs in Illinois may soon have a change of diet; if they do, China's central bank governor Zhou Xiaochuan may breathe easier.

Like so many people grappling with record high food prices, Ring is desperately trying to keep a lid on costs; at the same time, Zhou is seeking to contain inflation that's threatening growth, driven in part by corn, which China has been importing in greater volume than any time since the mid-1990s.

As with most of the world, consuming less isn't an option as Ring looks to capitalize on near-record pork prices by fattening his hogs. But a rare opportunity has arisen this month, as Chicago corn prices rose above wheat for the first time in 15 years -- use less corn, and more wheat, in rations.

It's not a choice he makes lightly: having made the switch only once before, in 2008, he's acutely aware that short-term changes can slow weight gain and require additional nutritional supplements.

Top chicken producers such as Tyson Foods Inc and Sanderson Farms are equally leery. Many have already adjusted their feed mix to include cheaper alternatives such as cottonseed meal or ethanol byproducts like corn gluten meal or distillers dried grains, also known as DDGs.

But if the wheat/corn inversion widens, the economic incentive to use wheat may become overwhelming. As other ranchers face similar choices, the use of wheat in animal feed could rise by 25 percent from last year and by another 10 percent next year, easing the strain on global corn stocks at their tightest since the Great Depression.

"I'm not going to say we are not going to do it, because corn supplies are going to be tight this summer," says Ring, who runs a farm cooperative named Hog Inc. in western Illinois.

"In order for us to cost effectively use wheat, it needs to be 10-20 cents priced below the cost of corn."

Corn at Hog Inc. on Tuesday was $7.44 a bushel, while wheat was 3 cents a bushel higher at $7.47. Ring is far from alone.

"South Korea and the Philippines have increased the use of feed wheat in animal rations and we have even seen countries like Malaysia buying feed wheat," said Adam Davis, a senior commodity analyst at Merricks Capital, a Melbourne-based funds manager that invests in agriculture.

"It's likely to continue for a while as corn supplies remain tight."

DWINDLING CORN SUPPLIES

The choice may grow more pressing as the year progresses. By late summer, prior to the autumn harvest, commercial grain elevators and end-users are likely to be scraping the bottoms of their corn bins; the U.S. government forecasts inventories will dwindle to 675 million bushels by Aug. 31, an 18-day supply.

At the same time U.S. farmers will bring in their biggest soft red winter wheat crop in three years.

The impact of swapping out up to 50 million bushels of feed would be asymmetric. A small dip in wheat stocks won't do much to erode U.S. inventories that are now equal to a third of annual demand; but a similar rise in corn stocks would elevate stockpiles that are a bare-bones 6 percent of consumption.

Corn prices could subside if faced with further evidence of "demand rationing," or a reduction in consumption that analysts say is necessary to prevent inventories falling to next to nothing. U.S. data on Wednesday showed ethanol output dropping to its lowest in nearly seven months, but traders see little sign of a deeper reduction as margins remain strong.

Instead they're looking at other uses, primarily in the feed sector; with livestock prices holding strong, unlike in 2008, many see little reduction in overall demand, and instead are focusing on the substitutability of one grain for another.

"The hog guys are going to make phenomenal profits this summer so they have no intention of dropping production," said Rich Nelson, analyst with agriculture consultancy Allendale Inc. "Cattle feeders are ... not really too interested in switching up feed supplies to something else."

WHEAT LESS HIGH

Chicago Board of Trade front-month corn futures traded at an average $1.36 premium to wheat over the past decade; so far this year it has traded at 98 cents.

The spread fell to a discount of more than 13 cents on April 14 as corn prices hovered near all-time highs, but the spread since recovered after wheat futures soared for three straight days amid crop weather concerns in the United States and Europe.

Still, analysts say corn may rise to as much as 50 cents above wheat if poor weather in the next weeks delays corn planting in the Midwest.

Nutritionally, wheat offers a different mix than corn -- more protein, but less energy from fat. Most of the soft red winter wheat is used in human food, from Egyptian flat bread to Asian cakes.

"If you add it instead of corn in the diet, you have to tweak the formula and maybe add some additional fat and some other things to keep the nutritional value of the feed," said Mike Cockrell, chief financial officer at Sanderson Farms, the fourth-largest U.S. chicken company.

"If you substitute wheat along with the other changes, the other tweaks, it just hasn't priced into our rations."

Tyson Foods, the No. 1 U.S. chicken producer, is considering alternatives, says spokesman Gary Mickelson.

While grain prices in general have rallied sharply from a year ago, it's corn that's causing the most price pain, having more than doubled from a year ago, surging beyond its previous peak in 2008 due to unexpectedly strong Chinese demand, strong ethanol use and ever-shrinking stock estimates.

Wheat prices are up 62 percent from this time in 2010 after disastrous harvests in Russia and Australia last year, but still 41 percent below their record high three years ago.

Eventually the change in usage would likely cause the spread to widen and reduce the incentive; but even relatively brief inversions can have a substantive impact.

In the summer of 1996, corn traded above wheat for about a month, peaking at 62-1/4 cents, and some cash grain traders said wheat's discount to corn would need to approach that level again to trigger a bigger shift in feed rations.

That year, wheat feeding ballooned to 314 million bushels, more than twice the previous year.

In 2008, wheat used for feed surged from nearly nothing to 250 million bushels as wheat prices peaked in February before slumping in the summer as corn hit record highs.

MEAT COMPANIES EYE WHEAT TOO

Analysts said as much as an additional 50 million bushels of wheat could go toward feeding livestock before the next corn harvest.

"We could get 50 million more bushels than normal of wheat feeding," said Dan Manternach, analyst with Doane Advisory Services in St. Louis, Missouri.

"It's unusual to get a surge in wheat feeding in the fourth quarter (of the June-May wheat marketing year). But this is one of those years, with the price relationship between wheat and corn in the cash market. I think that we could get such a surge," Manternach said.

Feeders do not make snap decisions when changing animal rations, preferring to have a longer-term supply of feed on hand rather than shifting with fast moving markets.

But those in the livestock and poultry sectors may have to get creative as they struggle to maintain an affordable feed supply this summer.

"You are trying to balance a ration to get the nutritional requirements for the pigs, and meet those needs with a cost formulation you can live with," Ring said.

"We try to keep it simple but in a year like this it's complicated. We are trying to make it through the year."

(Reporting by Julie Ingwersen and Karl Plume, additional reporting by Naveen Thukral in Singapore; Editing by K.T. Arasu and Lisa Shumaker)

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