Implications of Mexican Beef Demand Change on Cattle and Beef Production in Mexico and U.S.-Mexican Cattle and Beef Trade§ Introduction The initiation of the North American Free Trade Agreement (NAFTA) in January 1994 implied that the historical economic differences in the U.S. and Mexican beef cattle industries should begin to narrow as the two markets integrated. Additionally, one would expect that trade flows would emerge or strengthen which reflect the comparative advantage of specific products in the two markets. This is generally observed to be the case. Over much of the last two years, average beef carcass values in Mexico City have been at or above average U.S. values. In November, 2002, the average beef carcass price in Mexico City was $1.07/lb. while U.S. prices were reported at $1.02/lb. for Choice and $0.94/lb. for Select (carcass basis) (SNIIM). Apparent economic and income growth is resulting in increased beef demand in Mexico and changes in beef consumption preferences. Beef demand growth is the major driver of a sweeping set of changes affecting domestic Mexican cattle and beef production and international trade patterns (Peel, 2002a). In the last five years, Mexico has risen to a strong second place as an export market for U.S. beef. From a Mexican perspective, this is a source of concern as imports have risen to account for roughly 30 percent of domestic beef consumption. There are many questions among Mexican producers about the future of the their Derrell S. Peel, Professor, Department of Agricultural Economics, Oklahoma State University. Presented as a Selected Paper for the Southern Agricultural Economics Association annual meeting, February, 2003, Mobile, Alabama. § 1 industry and what changes are needed to maintain a viable industry in a global market (Peel, 2002b). At the same time, despite growing beef demand in Mexico, imports of Mexican cattle into the U.S. continue to average roughly 1 million head per year. U.S. producers struggle to understand why Mexican cattle continue to be exported when domestic Mexican beef production appears to be insufficient. There is a growing need on both sides of the border to have a clear understanding of the economic forces at work, which determine production in, and trade between, the two countries. Objectives There are two specific objectives for this study: 1) To develop and specify plausible scenarios for beef demand change in Mexico which reflect apparent changes in total beef consumption and quality profiles in consumption. 2) To analyze these demand scenarios with the GANAMEX model to determine impacts of demand change on domestic Mexican production and international trade. Methodology Results presented in this paper are based on scenario analysis using the GANAMEX (Ganadería Mexicana) model. GANAMEX is a linear programming model that represents regional production alternatives and consumption patterns in the Mexican cattle and beef industry. The focus of the model is the long run structure of the industry 2 and it is most useful to understand the long run implications or tendencies of the industry in response to changes in internal and external economic forces. The objective function in the GANAMEX model is to minimize the cost of providing a specified quantity of beef consumption in the Mexican market. The optimization determines the level (or quantity) for the subset of production, transportation and trade activities among possible alternatives that minimizes the national cost of providing the quantity and type of beef consumption specified. The perspective is that of viewing the entire industry as being under a single management control and choosing the least cost management plan for a given set of circumstances. Principal characteristics of the GANAMEX model are summarized below with respect to endogenous variables, exogenous variables and technical parameters needed in the model. Complete documentation of the GANAMEX model is available in Peel (2001a). Endogenous Variables The activities or endogenous variables in GANAMEX includes each of the following groups of activities: - - - Forage use by region (by type, up to maximum) Quantity, type and location of - Cow-calf production (four cow-calf production systems) - Stocker production (intensive and extensive systems) - Slaughter animal production - Finishing in feedlots (two finishing systems) - Finishing in pasture Domestic shipments of cattle by type - Stockers between production regions - Feeders between production regions - Feeders from production regions to feedlots Production of meat by type and location (four meat qualities) Quantity, type and location of Slaughter (two slaughter systems) Domestic shipments of meat by type 3 - - From production regions to consumption regions (Grass-fed and Cull beef) - From feedlot regions to consumption regions (Fed beef) Exports of calves by production region - Male and female Exports of feeders by production region - Male and female Exports of rodeo calves (constrained) Imports of meat by consumption region (two meat qualities) Imports of slaughter cows by production region Exports of meat by production region Imports of Central American calves and feeders (constrained). Exogenous Variables and Parameters (Technical Coefficients) Exogenous variables represent the availability and productivity of resources; contributions of sectors exogenous to the model; and the requirements that must be met in each model solution. Input costs and trade sector values are specified as cost parameters. The GANAMEX model includes exogenously specified levels of each of the following: - - - Quantity of beef consumption - Regional population - Regional per capita consumption - Regional consumption profile Forage availability, productivity and cost Dairy sector contributions to cattle supplies and cull meat production by location Feedlot capacity by feedlot region Trade sector values - Value of export calves - Cost of meat imports (two qualities) - Cost of slaughter cow imports - Value of meat exports - Value of rodeo calf exports - Cost of Central American cattle imports Animal production and feed costs - Cow-calf by type and location - Stocker by type and location - Feedlot by type and location - Ration cost and conversion 4 - - Daily charge - Receiving cost Slaughter costs by type of slaughter Transportation costs for live animals and meat - Load Sizes - Cost per loaded kilometer Each of the above values must specified for each model solution and can be changed to reflect different scenarios of interest. Other parameters in the linear programming model reflect the input requirements and productivity of production activities. The GANAMEX model includes explicit specification of animal production parameters in order to facilitate understanding of specified systems and to permit maximum control of production system assumptions. For example, the linear programming model includes a parameter for the quantity of calf produced per cow for each cow type. However, this value is the net result of several production assumptions including weaning weight, birth percentage, calf death loss, and cow culling rate. Each of these parameters is specified individually in the model and can be changed individually with the impacts automatically reflected in the model. The GANAMEX model includes the following exogenously specified parameters: - - Forage productivity by type and location - Stocking rates for native pasture - Forage yield of crop residues - Forage yield of irrigated pasture Cow-calf production by animal type and location - Male and female weaning weight - Birth (calving) percentage - Calf death loss (preweaning) - Cow culling rate - Cow death loss - Cow:Bull ratio 5 - - - Cow mature and slaughter weight - Cow dressing percentage Stocker production by animal type, production system and location - Beginning weight (same as calf weaning weight) - Total stocker gain - Gain per day - Death loss - AU factor per animal - Ending weight Animal finishing systems by animal type and location - Beginning weight (same as stocker ending weight) - Days on feed - Gain per day - Death loss - Feed conversion rate (for feedlot and supplementation systems) - AU factor per animal (for pasture systems) - Ending weight - Dressing percentage - Carcass weight Regional delineation used in this paper includes four cow-calf and stocker production regions, six feedlot regions and five consumption regions. In tableau format, the model used for the analysis presented here consists of 200 activities (or columns) and 136 constraints (or rows). The choice of linear programming methodology for the GANAMEX model reflects considerations of the types of analysis desired and the realities of data requirements and availability. The strengths of linear programming in this application include: - The ability to represent different production systems in considerable detail and to understand conditions under which each would be economically preferred. 6 - The ability to understand the impacts of resource limitations (availability and productivity) and how changing market conditions will affect the optimal allocation of those resources. - The ability to represent regional differences in production and consumption; transportation of inputs and outputs; and the impacts of changes on product flows. - The ability to analyze impacts of changes in specific factors in isolation. - The ability to analyze scenarios of hypothetical situations for which no historical data exists - The ability to overcome limitations in data availability or quality and to incorporate data from diverse sources. In general, the GANAMEX model can be used to evaluate the regional and national impacts of changes in technology and management, domestic and international market conditions, changes in consumer demand, development or expansion of production systems, government programs and policies, and severe climatic conditions. Model Validation and Baseline Values Linear programming is sometimes referred to as a normative methodology. This term derives from the fact that the structure and parameters are specified subjectively. The GANAMEX model incorporates data and information from a wide variety of sources. As is typical of this type of large structural model, it is not possible to validate linear programming models objectively. Validation is a subjective consideration of the overall plausibility of the total set of results, including levels of production and the particular combination of activities included in the optimal solution. GANAMEX model solutions include a large set of values for regional production activities, product flows, levels of resource use, and trade activities. A summary of the 7 major results is presented as the Baseline scenario in Table 1. These results are believed to generally represent the overall production and trade situation in Mexico in 2000. Each of the demand change scenarios will be compared to the initial values in the Baseline scenario. Alternative Demand Scenarios Government officials, analysts and Mexican industry participants all agree that beef demand in Mexico is increasing. However, official data sources disagree on overall levels of production and consumption. Aggregate consumer surveys confirm that income is growing and that meat consumption is increasing in Mexico (Peel, 2001b; INEGI, 1998 and 2000). Just as important, but even more difficult to document is that the components or profile of beef consumption are changing as well. Peel distinguishes four types (qualities) of beef consumption in Mexico (Peel, 2001b). Two of these are different types of fed beef, which are easily aggregated and will be presented as an aggregate here. It is important to remember that what is demanded (preferred) by Mexican consumers as fed beef is not necessarily U.S.-style fed (quality) fed beef Peel (2001b). Therefore, the results presented in Table 1 include 3 beef types: Fed beef, Grass-fed beef, and Cull beef. Baseline Scenario: Initial Beef Demand The initial beef demand scenario is determined as a result of the validation of the GANAMEX model to realistically represent production and trade patterns in the year 2000. In the absence of detailed data on the precise level and profile of beef 8 consumption, these factors are determined as part of the validation process. The resulting beef demand characteristics can then be evaluated subjectively. The overall level of beef consumption per capita is set at 15.3 kilograms per capita (Table 2). This level does not include consumption of beef offals and offals are excluded from all analysis presented here. Consumption at this level is less than Mexican government official estimates but is more consistent with consumer surveys on expenditures and meat consumption (Peel, 2001b and 2001c); Los Porcicultores y Su Entorno). Table 2 also indicates that the baseline beef demand consists of a consumption profile of 42 percent Fed beef, 33 percent Grass-fed Beef, and 25 percent Cull beef. With total consumption at 15.3 kilograms per capita, this profile implies the following annual per capita consumption quantities: Fed beef, 6.43 kg., Grass-fed beef, 5.05 kg., and Cull beef, 3.83 kg. Scenarios of Beef Demand Change Three scenarios of beef demand change are specified and evaluated. Each of these is based on a 10 percent increase in per capita consumption with no change in population. However, Scenarios A, B and C differ in that the profile of consumption of this higher level is different in each scenario. The scenarios are summarized in Table 2 and can be characterized as follows: Scenario A: A 10 percent increase in beef consumption with no change in the proportions of each beef type from the Baseline. This scenario implies an increase in consumption for each beef type. 9 Scenario B: A 10 percent increase in beef consumption and a decrease in the proportion of Cull beef consumed from 25 percent to 15 percent, with a corresponding increase in the Fed beef proportion from 42 to 52 percent of the total. This scenario implies a net increase in consumption for Fed and Grass-fed beef and a decrease in consumption for Cull beef. Scenario C: A 10 percent increase in beef consumption and a decrease in the proportion of Grass-fed beef from 33 percent to 22 percent, with a corresponding increase in the Fed beef proportion from 42 to 52 percent of the total. This scenario implies a net increase in consumption for Fed beef and Cull beef and a decrease in consumption for Grass-fed beef. Results Results comparing of each of the demand scenarios to the Baseline is presented in Table 1, although much of the regional detail has been omitted from this summary. Additionally, details of specific production alternatives and changes in production systems are not included here due to space limitations. Generally, these results confirm that the impacts of demand change depend critically on the precise nature of the change in demand. Most basic to the results is the impacts of demand change on the overall size of the Mexican cow herd. Although beef demand is increasing in each scenario, the total cow inventory decreases in two of the three scenarios. The decrease occurs in each of the scenarios where demand for Grass-fed beef is increasing. Since Grass-fed beef and cow-calf production compete for use of limited forage resources, increased Grass-fed 10 production can only happen if cow numbers are reduced. The regional impacts are even more pronounced as most of the cow herd declines in scenarios A and B happen in the Central and Tropical regions. The impacts on the calf crop do not exactly match the changes in the cow herd because the are changes in the types of production systems being utilized in each scenario. For example, in Scenario A, the calf crop increases slightly despite a nearly three percent decrease in the cow herd. This occurs as the result of shifting cow-calf production to more intensive (and costly) production systems. In scenario B the decrease in calf crop is similarly less pronounced than the decrease in the cow herd. In both Scenarios A and B, the calf crop percent is higher, reflecting the change to more intensive cow-calf systems. However, in Scenario C, a 10.5 percent in the cow herd is accompanied by only a 2.5 percent increase in the calf crop because the industry once again switches to cheaper, less intensive production systems. The impact on stocker production also varies by scenario. Scenario A results in a 3.1 percent increase in stockers while Scenario B results in an 11.3 percent reduction in stocker production. Again there are changes in production systems with regional shifts in stocker production and switching between intensive and extensive stocker production. In Scenario C, stocker production declines despite an increase in overall cow-calf production. The only source of Grass-fed beef in the GANAMEX model is grass finished beef produced domestically. As expected, Scenarios A and B result in increased grass finishing of cattle to meet Grass-fed beef demand. The reduction in grass finishing in 11 Scenario C is the primary source of additional forage to allow increased cow-calf production in this scenario. Total domestic cattle slaughter is increased in Scenario A and reduced in Scenarios B and C. Although slaughter is a basic measure of productivity in a beef system it is also important to consider exports since the sum of slaughter and exports represents the total extraction or productivity of the system. This is the intent of the harvest percent in Table 1, which is the sum of cattle slaughter plus calf exports divided by the total cattle inventory. Thus, Scenario A represents the only scenario with a higher harvest percent than the baseline. In Scenario B, the reductions in slaughter and exports represent a lower harvest percent relative to reduced cattle inventories. In Scenario C, an increase in exports partially offsets the reduced slaughter to restore the harvest percentage closer to baseline levels. The breakdown of Fed, Grass-fed and Cull beef production in Table 1 reflect the tradeoff occurring in Mexico as a result of the increased beef demand and changing consumption profile. The strictest constraint on the system in Scenarios A and B is the need to increase Grass-fed beef pound for pound to match the increased demand. This forces the rest of the system to adjust as well as possible and make up the difference with imports of Fed beef and cows for Cull beef. Calf exports, which represent a high value market for Mexican producers, depend on the overall levels of calf production in the country and on the relative demand for cattle for domestic beef production. In Scenarios A and B, exports are reduced as a result of the squeezing of the system, primarily to meet the needs for Grass-fed beef 12 production. However, exports continue in all scenarios despite the increased need for imported meat for domestic consumption. Calves (of suitable quality) are usually more valuable in the U.S. market, even when there is insufficient domestic production in Mexico. Historically, cow (or Cull) beef has played an important role in Mexican beef demand. In the Baseline, Cull beef is assumed to represent 25 percent of total beef consumption. To meet Cull beef demand, limited numbers of cows have been imported into Mexico to be slaughtered in many recent years. In the Baseline these imports represent less than 9 percent of total Cull beef production. Increases in Cull beef demand in Scenarios A and C result in increased cow imports, slightly less in Scenario C because domestic cow numbers are higher. However, in Scenario B, the reduction in Cull beef demand from 25 to 15 percent (of total consumption) results in a net surplus of Cull beef such that Cull beef is now available for export. Overall, beef imports into Mexico represent a larger percentage of total consumption in each of the scenarios. In all cases it appears that Mexico is unable to meet the increased demand for Fed beef. Beef imports increase by 37 percent in Scenario A, by 86 percent in Scenario B and by 63 percent in Scenario C. Mexican selfsufficiency in beef production drops from 77 percent in the Baseline to 71 percent in Scenario A, 61 percent in Scenario B and 66 percent in Scenario C. Beef imports represent 23 percent of domestic consumption in the Baseline, increasing to 28.7 percent in Scenario A, 39 percent in Scenario B and 34.1 percent in Scenario C. 13 Since linear programming is a mathematical optimization, there is “one” answer, which in the case of the GANAMEX model, is the minimum cost of providing the specified levels of beef consumption in the Mexican market. Dividing the total (minimized) cost by total beef consumption provides an estimate of the average cost of beef in the Mexican market. The average cost of beef in the Baseline is 19.04 pesos/kilogram (about $0.92/lb in 2000), wholesale basis. This cost rises to 19.17 pesos/kilogram in Scenario A, an increase of 0.7 percent. In Scenario B, the cost rises to 19.98 pesos/kilogram, up 4.9 percent and in Scenario C, the cost rises to 19.84 pesos/kilogram, an increase of 4.2 percent. Conclusions and Implications Historically, Mexico has had a beef cattle industry that was very forage intensive and was essentially isolated economically from other agricultural sectors. Recent growth in beef demand and increasing consumer preferences for fed beef are causing a multitude of changes in the industry. The full set of results from the GANAMEX model for the scenarios reported in this paper carry many implications for the Mexican beef cattle industry and Mexico’s global trading partners. Although many of the regional and production results were excluded from this summary, several general conclusions can be made. The Mexican beef cattle industry appears to be “maxed out” in term of production capability at the current time with limited ability to respond to needed increases in beef production in the short run. In part, this is a short run limitation due to drought reduced cattle numbers and the current economic constraints, which limit 14 producers’ ability to expand production. As shown in these results, growth in beef demand, especially fed beef demand generally pushes the Mexican industry to more intensive production systems. However, these are more costly and dramatically change the economic environment in which the industry is operating. The opportunities presented by increased fed beef demand to the fledgling Mexican feedlot sector actually imply a very difficult situation. In order to increase fed beef production, Mexican feedlots must compete for nonforage feed resources against other livestock sectors (dairy, pork and poultry) in unprecedented fashion and more generally, increased derived demand for crop-based feed resources puts livestock production more in competition with production of crops used directly by humans. This is a growing issue as total food demand increases rapidly. Mexico faces generally strong constraints on arable land and water resources for crop production. This, in effect, puts cattle and beef into serious economic competition with the rest of agriculture for the first time in Mexican history. Additionally, Mexican cattle feeders must compete for limited cattle supplies against a traditional domestic demand for grass-finishing of cattle and the economic pull of the U.S. market for high-quality Mexican cattle. It is clear from the results presented here that one of the keys to relieving the constraints in the Mexican beef cattle industry is if Fed beef demand is replacing traditional Grass-fed beef demand such that net Grass-fed beef demand is actually decreasing despite increased overall beef consumption. 15 This simultaneously allows more Fed beef production and exports of calves to the U.S. market. Given that Mexico is likely to require imported beef to meet demand, this tendency suggests that economic integration of the U.S. and Mexican cattle an beef industries would have Mexico specialize in cow-calf production, with a limited feedlot industry and the U.S. would provide efficient grain feeding and processing of cattle, which are then exported back to Mexico as beef for consumption. Improved productivity might be suggested as a solution for inadequate levels of beef production in Mexico. Table 1 shows that the overall calf-crop percentage is barely 50 percent in Mexico. In general, the GANAMEX model Baseline suggests that Mexican beef productivity, on a per cow basis, is less than half that of the U.S. beef cattle industry. Obviously, even small increase in calf crop percentage would reduce forage use to produce the same number of cattle. However, technology (in most all forms) and capital are more expensive in Mexico. There is little indication that, with current resource values, Mexican production is economically inefficient to any large degree. However, if beef demand significantly changes relative values for various types of cattle or systems of production, there could be an economic need to shift to more intensive production activities. Moreover, even in the current situation, there may be policy or macro level considerations for affecting relative values in ways that increase the economic efficiency of more intensive production systems. Finally, the results presented here highlight the need for additional data and analysis of Mexican beef demand and meat demand generally. The increased beef demand specified in these scenarios is not a forecast per se, although few would likely 16 dispute that it will or has (since 2000) happened. However, the breakdown of overall consumption by type of beef is much less well understood and there is an almost total lack of data on beef consumption by quality. There are regional differences in preferences and consumption that are also very important but poorly understood and documented. Thus, is difficult to anticipate which of the three scenarios analyzed here is more likely to represent the actual situation. Nevertheless, these results clearly demonstrate that such knowledge is absolutely vital as the impacts on production and trade depend critically on precise nature of demand changes. With somewhat increased global market tensions at the current time and both the U.S. and Mexico considering various trade and domestic policy alternatives, it is particularly important for the industries and policymakers in both countries to understand and carefully consider the complex forces behind evolving international market environments. 17 References Instituto Nacional de Estadisticas, Geografía e Informática (INEGI)., “ENIGH-1998: Encuesta Nacional de Ingresos y Gastos de los Hogares.” Instituto Nacional de Estadisticas, Geografía e Informática (INEGI)., “ENIGH-2000: Encuesta Nacional de Ingresos y Gastos de los Hogares.” Peel, Derrell S., “Major Factors Affecting the Mexican Beef and Cattle Industry: What to Expect in the Coming Years.” Analysis and Comments, Letter #10, Livestock Marketing Information Center, March 8, 2002a. Peel, Derrell S., “The Mexican Beef Cattle Industry Faces the Future.” The Cattleman, December 2002b, pp 10-18. Peel, Derrell S., “GANAMEX: Ganadería Mexicana.” Working Paper, 2001a. Peel, Derrell S. “Mexican Income, Consumption and Beef Demand Summary.” Working Paper, 2001b. Peel, Derrell S., “Mexican Beef Production and Consumption: Data Issues.” Working Paper, 2001c. Los Porcicultores y Su Entorno, “Indicadores Del Consumo de la Carne de Cerdo.” Año 5, No. 27, Mayo-Junio 2002. Sistema Nacional de Información e Intergación de Mercados (SNIIM). “Abasto de carne de bovino en el D.F. y A.M.” Boletin Informativo Mensual, Noviembre, 2002. 18 Table 1. GANAMEX model results BASELINE SCENARIO A SCENARIO B % TOTAL COWS1 10842082 10547831 -2.7 9894062 COWS - NORTH1 2065323 2065323 0 1915697 COWS - N EAST1 1325524 1281358 -3.3 1231603 COWS – CENTL1 2304298 2206936 -4.2 1969940 1 COWS – TROPL 5146937 4994215 -2.9 4776822 CALF CROP1 5565888 5588325 +0.4 5151446 CALF CROP % 51.3 53.0 == 52.1 STOCKERS1 3759180 3875995 +3.1 3336180 GRASS FINISH1 2477600 2707087 +9.3 2774110 FEEDLOT1 1166984 1085803 -7.0 760803 SLAUGHTER1 4826058 4935162 +2.3 4598827 FED PRODUCTION2 311053 285589 -8.2 209292 GRASS-FED PRODUCTION2 487494 536244 +10.0 536244 CULL PRODUCTION2 347807 346186 -0.5 325422 TOTAL CONSUMPTION2 1489634 1638598 +10.0 1638598 CALF EXPORTS1 1324190 1261620 -4.7 1137473 COW IMPORTS1 148824 329550 +121 0 2 BEEF EXPORTS 0 0 0 70760 BEEF IMPORTS2 343280 470579 +37.1 638400 HARVEST %3 23.8 24.1 == 22.9 IMPORT %4 23.0 28.7 == 39.0 BEEF COST5 19.04 19.17 +0.7 19.98 1 Head 2 Metric Tons 3 (Domestic Slaughter + Cattle Exports)/Total Cattle Inventory 4 Total Imported Beef / Total Domestic Consumption 5 Cost (Pesos) per Kilogram of Beef Consumed % -8.7 -7.2 -7.1 -14.5 -7.2 -7.5 == -11.3 +12.0 -34.8 -4.7 SCENARIO C 11379721 2065323 1449948 2777261 5087190 5706536 50.1 3425072 1965979 1385803 4500784 % +10.5 0 +9.4 +20.5 -1.2 +2.5 == -8.9 -20.6 +18.8 -6.7 -32.7 356018 +14.5 +10.0 371772 -23.7 -6.4 351237 +1.0 1638598 1508488 309326 0 559571 23.0 34.1 19.84 +10.0 +13.9 +108 0 +63.0 == == +4.2 +10.0 -14.1 -100 +INF +86.0 == == +4.9 Table 2. Mexican Beef Demand Scenarios Beef Type Fed Grass-fed Cull Total Units % of total % of total % of total Kg/capita Baseline 42 33 25 15.3 Scenario A 42 33 25 16.83 19 Scenario B 52 33 15 16.83 Scenario C 52 23 25 16.83