The cage-free transition process has two components: state layer housing initiatives and customer pledges to buy cage-free eggs by a certain year. Egg price volatility has made it very difficult for producers to plan ahead their rate of returns on the money flows because prices have fluctuated significantly over the last six years. Considering feed cost outlook is also important because feed costs and ingredient costs are predicted to increase this year and are projected to remain at a high cost over the next few years.

The Cage-Free Transition

In 2011, UEP connected with the Humane Society of the United States to seek for federal legislation that would push the egg industry to produce colony houses with 116 square inches per bird. However, this initiative failed to pass congress. Starting in late 2015, many restaurants, grocery retailers and chain-store manufacturers made the announcement that they will purchase a hundred percent cage-free eggs by a certain year. Many companies decided to set their goal for 2020 or 2025.

Customer pledges predict that the industry needs 224 million cage-free layers by 2026 in order to supply every customer that pledged to buy only cage-free eggs by a certain year. Some states have also passed legislation that will require more space per bird than typical conventional systems do. Many of these laws require cage-free systems. The problem that arises is that one square foot per hen is normally the space that is required for cage free hens. California is the only state that has passed legislation requiring one square foot per hen, which became law in January 2020. The state will require cage free production by 2022.

“A state that is different from the rest is Massachusetts because they will require 1.5 square feet per hen by 2022,” said Ibarburu. “In a few months from now, egg producers trying to supply to Massachusetts will face a logistical problem because the state laws require a different and larger space than everyone else. And then we have Colorado, Washington, Oregon, Michigan, and Utah that would require cage free by 2024 or 2025. And finally, Rhode Island will require one square foot per hen by July 2026, but the language so far doesn't indicate that they have to be cage free. In total 78 million people live in the states that have legislation that would require at least one square foot per hen in order to supply to this state. And 70 million people live in a state that would require cage free production.”

The combination of state laws and customer pledges means that different places may offer conventional or cage-free eggs, and this exact number is very hard to quantify. It’s difficult to predict how many cage-free eggs are going to be needed in the next few years because there’s an overlap of state legislative laws and customer pledges. Before laws are even set in place, there are existing customers that pledge to solely buy cage-free eggs by a certain year. However, some customers do not have a preference for cage-free eggs, and some states may not pass legislation that requires cage-free eggs.

The greatest challenge is to figure out how much a cage-free production is going to be needed for the combination of customer pledges and state legislations in the next few years, along with how many cage-free eggs are currently being offered. Another difficulty is that many of these state laws only include fresh eggs or minimally processed eggs. These laws do not cover processed food items that are made from eggs like ice cream or pasta. Therefore, it’s difficult to predict how much of food items going to these states are going to be produced inside the state that must comply with the legislation because the facilities use fresh eggs. It’s also impossible to know how much food is going to be produced outside the state. Further processes for food production represent about 15% of all the eggs produced in the United States, making it an important part of the industry.

“There are new trends on the cage-free layers divided into organic cage-free and non-organic cage-free,” said Ibarburu. “Cage-free production has been increasing steadily and is mostly explained by the growth on the non-organic sector. The organic sector have been growing but at a much slower pace. Last month we had 86 million cage-free layers in the United States, which represents 26% of the US flock. 17 million of them were organic and 69 million were non-organic. Looking at the last three years, we increased 33 million cage-free layers, which is about 11 million per year. But if we need to reach that 224 cage-free layers by 2026 to supply all these customer pledges, we will need to grow at the rate of 28 million cage-free layers per year, which is more than what we’ve grown in the last three years. This should be for the next five consecutive years.”

One of the problems with this type of transition is that billions of dollars of investment are necessary to move to the new system with a higher cost of operation. When a company does a big investment it's usually because they are going to either reduce the cost of production in the long run or they are going to produce a product that is going to be more valuable to the consumer, so therefore they are going to be able to sell that with a higher price. Because this needs a high investment and a higher operating cost, this investment will only make sense if they raise the price to cover this additional cost.

Another challenge with the transition is that 76% of places to buy cage-free eggs only are from grocery stores and grocery stores provide their customers with many options compared to restaurants. For example, when you go to a restaurant and you order a meal, that meal might contain conventional eggs or cage-free eggs, but you don't have a choice in the type of eggs provided. You buy the meal and there is a price, but customers don't have the choice to buy with a different type of egg, with a different price. Grocery stores have the conventional eggs at a certain price and the cage-free eggs at another price. Most of the time, when consumers are faced with the choice of egg they have been choosing the less expensive conventional egg. If the supermarket is not able to add a premium to the cage-free eggs, they cannot turn around and transfer this higher price to their supplier, their producers.

“In 2020, 14.4% of the eggs sold in the supermarkets were cage-free or organic,” said Ibarburu. “Almost 86% were conventional, even though the production of cage-free eggs and organic represented about 23% of the total USA production. So the organic and the cage-free eggs grow more percent-wise, 37% for the organic and 27% of the cage-free with respect to the previous year. But the conventional eggs grow more in term of quantities than the combination of the two. The growth in the grocery stores have been very high in the last year because of the transition from consumers buying for the restaurants to buy more food at the other grocery stores, just because they had to stay home because of the pandemic.”

Price Votality

The second challenge that speaker xx discussed is price volatility. The volatility price is a collective measurement of weekly prices with respect to the change per week. The prices of eggs and corn and oil constantly fluctuate from week to week. The egg industry has become very vulnerable during the past few years, especially with the pandemic. In the last six years, the world has faced had three major events that have led to significant increases and decreases in egg price.

The first event occurred in 2015 during the Avian influenza outbreak that reduced the supply of eggs significantly, resulting in a sharp increase in prices. Following the outbreak, there was a period where the price of eggs was at a 10 year low, a historical low.

The second event, which occurred at the end of 2017 and beginning of 2018, was called the “retailer price war”, where retailers lowered the price on eggs and to bring consumers into their stores, hoping that they would buy these items. With that, there was a sharp increase in demand for eggs, which resulted in an increase in egg prices. This event was also followed by a period of 10 year low prices.

The third historical event that happened was last year with the Coronavirus pandemic was a shift in demand from liquid egg to dried egg for hotels and restaurants. Because of this, the shell egg price increased and the liquid egg price decreased to a historical low. The increase on the shell egg price did not last long. In these last six years, these three historical events have impacted the egg market, which has created volatility that was hard to imagine before. When demand shifts, it occurs much faster than the producer can keep up with, and this creates volatility.

“Producers need to recognize the difference between customers and consumers,” said Ibarburu. “Because consumers are vague industry customers, our customer might be a grocery store chain or restaurant chain. And sometimes they make decisions that are not a hundred percent in line with the consumer. Like for example, when the supermarkets made this pledge to buy only cage free eggs, at the time more than 90% of the eggs that they were selling to consumers were conventionally produced eggs, even though they had the choice to buy them cage-free. Another example may be when winter comes and there is a higher demand for conventional eggs.”

At this point, the supermarkets use eggs to attract customers. They lose money on eggs at a time of high demand to attract more customers to their store. But the demand for a product doesn't always move in the same direction as the demand for eggs. This was evident last year during the pandemic when the shell eggs demand increased and the price did not increase.

Feed Cost Outlook

“The cost of the feed represents more than 60% because of egg production in general. When the feed ingredients prices increase, we expect an increase on the cost of production,” said Ibarburu. “The corn price is predicted by the Food and Agriculture Policy Research Institute to increase 19% this year with respect to last year and it's predicted to stay kind of high for the next couple of years. Similarly, the Food and Agriculture Research Institute predicts that the [inaudible 00:17:17] price is going to increase 28% from last year to this year. With the combination of these prices, these two ingredients would represent an increase of 5.40 cents per dozen on the cost of production or 11% overall. If this projection comes through, then this is what we expect the cost of production to grow this year.”

Producers can expect several changes as the 2025 deadline comes near. It will be difficult to determine the overlap between the state laws and customer pledges in the egg industry. In states without this legislation, some consumers will still have options because not every retailer or restaurant chain wants to move to cage-free. With the options, a consumer might decide to go to a different grocery store to buy the conventional eggs that are less expensive. This makes it hard to foreshadow if this will affect how many eggs these customers that already make pledges are going to be selling. At the current rate of growth it's difficult to imagine that the egg industry will ever reach the 224 million cage-free layers goal by 2025 because the year is coming very close. This will present retailers with a dilemma. They may decide to reverse the pledge to buy cage-free and continue offering conventional eggs. Some of them might decide to seek these cage-free eggs more aggressively, increasing the demand for these cage free eggs because they hope to stick with their pledge to be a hundred percent cage-free. Some of them may ask for more time to fulfill this pledge, and they may move the deadline down another five years.

“Some retailers might decide that they differentiate themselves from the rest and use the commodity. Saying, “we want to have something different, so we're going to offer a hundred percent free range,” said Ibarburu. “The thing is that not all the retailers are equal and neither are their customers. Some of these retailers have customers or consumers that have stronger preferences for price or quality or animal welfare. These retailers are going to make different decisions depending on what their customers want. The producers' dilemma is that this higher up from investment creates a barrier to enter the market and they will need to ask for a very large loan to make that investment. They have to come up with many million dollars to combat to cage-free, but that also creates a barrier to exit the market in the short run, because that's once you have that investment up and running and you are paying this huge loan.”

Retailers cannot compete in the conventional market with a cheaper price tag with expensive production costs. If they decide to convert to cage-free they might decide to convert early, and that will be difficult to operate in the first few years with an excess supply of cage-free eggs and likely losing money. But if they decide to convert late, they might risk a time shortage and be unable to supply existing customers with the cage-free eggs that they pledged to buy, therefore losing those customers. Some producers might decide to stick to the conventional market. If they convert to cage-free eggs later, they must decide which kind of cage-free facility they’d like to use, because the long-term demand from their customers is important.

They may want a facility that can be converted to free range if their customers eventually decide that they will only purchase free range eggs. This creates a challenge for small cage-free producers because this transition means that they're facing competition from large companies that have been forced to move cage-free. Bigger companies tend to have lower costs of production than smaller producers, so these small cage-free producers might be in a situation where they need to convert to another system of production. This requires an investment, which can be expensive.

“Good news for the egg industry in general is that food service sales in the last month of March increased a lot,” said Ibarburu. “It didn't reach the level that we were before the outbreak but it's just three billion shy of the level that we were in February 2020. So the food service sales fell $25 billion from 65 in February 2020 to 30 billion in April 2020 and now it's just at $62 billion in March of this year. Grocery store sales increased during the pandemic by 16 million. Now it's about six billion higher than what it was before the pandemic. We may see a decrease on the grocery side as more people start going to the restaurants, but so far the sales of the grocery stores have been consistent in the last few months.”

Some opportunities have opened for producers that have been decreasing their flock because of the lack of demand for liquid egg. The restaurant and grocery store sales returning closer to pre-pandemic levels is very encouraging for the liquid eggs sector because growth is projected, and they can repopulate some of these facilities.

“The transition times always present some challenges, but also some opportunities, depending on what the competitive advantage that the companies have,” said Ibarburu. “Some companies are much better at managing one production system than the other, so that might create a competitive advantage to one company versus another company. So that might create some opportunities, might be managing the system, might be writing better contracts, but some of them will capitalize on this transition as an opportunity. And then there are a lot of opportunities for allied companies because with a new production system, we need new technologies, new equipment, maybe some new feed additives as well. So I only think in the production system had to be adjusted to your new system and that might create opportunities for some of these allied companies as well.”