Hog Stock: Inside China's Strategic Pork Reserve
—Americans know that the United States keeps a huge petroleum reserve. Other countries store oil or crops. But China takes stockpiling to an entirely different level: It runs a strategic pork reserve.
Last week's announcement that Shuanghui Group, a Chinese meat producer, struck a deal to snap up America's largest pork producer, Smithfield Foods, has generated new interest among consumers and market watchers about the inner workings of China's massive hog industry.
And it is, in fact, massive: Hogs are culturally and economically important in China, and Chinese consumers devour more than half the pork produced in the world, according to data from Northstar Commodity Investment.
That consumption is growing as Chinese families gain more expendable income and spend it on meat products that were once out of reach. Chinese now eat about 70 million tons of meat annually, more than double the total Americans eat.
The Chinese central government, famously sensitive to domestic instability of all sorts, created the pork reserve in 2007 with an official mandate to "stabilize live hog prices, prevent excessive hog price drops, which damage the interests of farmers and to ease the negative effects of the cyclical nature of hog production and market prices."
When hogs get too expensive in China, the reserve releases animals onto the market, trying to hold down prices for consumers. When hogs get too cheap, the reserve buys up pigs, trying to keep farmers profitable.
Not an Exact Science
Pork prices have gyrated in China since 2006 as the country has lurched from traditional farming to large-scale agriculture. Small "backyard" farms have disappeared as big, commercial farms have been brought along to replace them.
Only about 37 percent of live hogs in China came from backyard farms last year, compared with about 74 percent in 2001, according to research from Rabobank International.
The Smithfield acquisition is largely seen by China-watchers and commodities experts as a move to help accelerate the development of Chinese mega-farms by grabbing U.S. know-how.
For now, at least, it's also about grabbing U.S. pork: Even though 95 percent of the hogs eaten in China are home-grown, 11 percent of all the pork produced in the United States in the first four months of 2013 wound up getting shipped to China (including Hong Kong) as well, according to the U.S. Meat Export Federation (USMEF).
The strategic pork reserve's system for gauging the right price isn't something set in stone, but more of a guideline. According to Rabobank, the reserve usually buys up pigs when the price of a kilo of pork relative to the price of a kilo of corn falls below 6 to 1. The government sells when the ratio hits 7 or 8 to 1.
The most recent ratio, according to May 29 data from China's Ministry of Agriculture, is 5.53 to 1—below the unofficial break-even point for farmers.
In April and May, China's hog farmers took a loss of about 200 yuan ($32.60) per head, said Rabobank senior analyst Chenjun Pan.
As a result, the strategic reserve recently has made two big efforts to haul pig flesh off the market—once in March and again last month, according to Michael Pareles, a Beijing-based trade manager for USMEF.
The last time the reserve released swine onto the market was over a two-week period in late January and early February. That was just before China's New Year, a time when celebrating Chinese gobble up pork in staggering quantities and prices hit annual spikes.
But Does It Work?
In a country that consumes as many pigs as China does, it's difficult—maybe even impossible—to build and operate a pork reserve big enough that it can steer the gargantuan, national swine market by holding intermittent pig-sales or hog-grabs.
The pork reserve's two rounds of buying this year came in at 75,000 and 93,700 tons, respectively, combining to account for only 0.3 percent of the total Chinese market, according to Rabobank's Pan. Some analysts put the percentage even lower.
"It is not very effective, because the volume is too small," Pan said.
The precise size of China's pork reserve is a closely held secret, but what is known is that there are two types of hog on reserve: the kind that's alive, and the kind that's frozen. Some company-owned farms in China are designated as state reserve hog farms, but even those farms operate under a normal market mechanism.
"They will serve the government only when there is a need," Pan said. "They're scattered everywhere, in almost every province."
China introduced the frozen part of the hog reserve in 2008, after a particularly acute shortage. But freezing hog meat and holding it for when the market gets hungry is an iffy business, at best: Sources who spoke with CNBC put the cap on how long such meat will safely "keep" for consumption at anywhere from four to six months.
Pareles of the USMEF agreed that the strategic reserve doesn't possess the heft in terms of tons of pigs under its control in order to decisively move markets. He further pointed to the fact that the size and price of pig purchases "aren't announced until after the pork has been acquired."
Other pork subsidies, many of them offered by individual Chinese provinces and municipalities, sometimes undercut the effectiveness of the strategic hog reserve by bringing their own influences to bear on the market. Those can include subsidies per sow or per veterinary vaccine, for instance.
The central government's own efforts can get in the way, as well. As China tries to industrialize its hog production and bring it into the hands of fewer, larger entities, it has introduced subsidies that favor big producers over independent farmers, and big slaughter facilities over smaller ones. Such subsidies can, in turn, shape the market more than the pork reserve itself.
"Many Chinese industry analysts think that the reserve's ability to significantly control prices is waning," Pareles said.
—By CNBC's Ted Kemp
Correction: This story originally misstated the amount of pork shipped from the US to China in the first quarter of this year.