Cage-Free Egg Insight

The road to cage-free eggs has truly become a “chicken or the egg” scenario, testing whether consumers or producers will push the industry forward. Major egg producers are hesitant to undertake the necessary capital improvements to convert operations to cage-free due to uncertainty surrounding the longevity of cage-free demand. Simultaneously, consumers have been slow to purchase cage-free eggs as limited supplies have kept prices relatively high. While both sides have been reluctant to fully commit, we expect that producers will likely push the industry toward cage-free and unlock this market potential. Legislation creating cage-free demand on the West Coast and the ability for producers to use convertible facilities—which can switch between conventional and cage-free production—is making the investment more attractive. Furthermore, producers who quickly make the transition may achieve high margins before expanding supplies reduce the price premium over conventional.

Executive Summary

Agricultural Finance

January 2020

MetLife Investment Management | Cage-Free Egg Insight 2

How Corporate Pledges and State Legislation May Create a Cage-Free Supply Deficit In November 2018, California passed its third regulatory change related to egg consumption in seven years. Proposition 12 requires all liquid and shell eggs sold in California to come from cage-free operations by 2022. Cage-free operations must have at least 144 square inches (in2) for each laying hen (layer) and provisions for perches, nest boxes, and dust bathing areas.1 Washington and Oregon also recently both passed similar legislation that will require all eggs sold in the state to be cage-free by 2023 and 2024, respectively.

While these laws will increase cage-free demand on the West Coast over the next few years, we expect corporate pledges to use only cage-free eggs will be the primary demand drivers. Based on data from EggTrack, it is estimated that current corporate pledges to go cage-free will require roughly 220 million layers by 20262 (Figure 1). Pledges by these companies are estimated to account for approximately 79% of future cage-free demand. The deadline for most of these pledges is 2025— including commitments from McDonalds, Walmart, and Kroger—who combined will require about 69 million cage-free layers annually to satisfy their demand.

The blue line in Figure 1 plots the cage-free flock size over time and shows that at the current growth rate, a significant supply deficit will emerge in 2025 even if only a fraction of corporate pledges are kept. To meet cage-free demand, producers will need to accelerate conversion

from conventional to cage-free output. However, operators remain skeptical of whether corporations will follow through on their pledges. Simultaneously, companies have previously delayed their pledges when their commitment becomes unreasonable from a profitability or availability perspective.3

A Producer’s ConcernMajor egg producers remain uncertain as to whether cage-free eggs will become the new conventional egg, or due to past precedent, demand will shift towards another egg with a higher standard of animal welfare.

In 2008, California passed Proposition 2, requiring all eggs sold in the state to come from layers with at least 116 in2 of space by January 2015.4 California’s layer flock had been in a long-term decline, falling from 24 million in 2000 to 16 million in 2014. However, when Proposition 2 went into effect in January 2015, California’s layer flock fell 34% year-over-year (yoy) (Figure 2).5 Some marginal California producers supplying the local market likely opted to close operations rather than adhere to new standards. Additionally, the industry was still dealing with an outbreak of Avian Flu that significantly decreased layer flocks in the Midwest and weakened the incentive to make the transition.

Today, producers that modified their operations to adhere to Proposition 2 will have to upgrade their facilities again to satisfy requirements for Proposition 12. With cage-free gaining popularity, operators are incentivized to make the transition due to the price premium paid for cage-free eggs. However, cage-free production costs are about

Figure 1 | Cage Free Flock Size Compared to Demand from Corporate Pledges (millions)

Flock Size Projection Corporate Pledges

Source: EggTrack, USDA, MIM

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2017 2018 2019 2020 2021 2022 2023 2024 2025 2026

Figure 2 | Table Egg Layer Population by State (millions)

Iowa California Other Midwest

Source: USDA, MIM

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2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

MetLife Investment Management | Cage-Free Egg Insight 3

23% higher than conventional6 (Figure 3), primarily due to increased costs for cage-free pullets and labor compared to a conventional system. Additionally, the conversion necessitates significant capital investment, because the space requirement for a cage-free system results in fewer layers. Corporations delaying their pledges or consumers’ slow shift to cage-free eggs could both prolong the payback period for the capital expenditure required to convert operations to cage-free.

A Consumer’s ChoiceProducers’ slow adoption of cage-free eggs has limited market supply and resulted in a significant price premium over conventional for the last ten years. Since 2016, the price of cage-free eggs has declined slightly, but low conventional egg prices have also bolstered the premium. Following an outbreak of Avian Flu in the Midwest in 2015, conventional egg production increased significantly to take advantage of high prices. This caused a surplus in conventional eggs, and today, retail prices remain near a decade low.

With low conventional prices and limited supply of cage-free eggs, the average retail price premium for cage-free eggs has averaged approximately $1.52 per dozen since 2016.7 However, this premium could be pressured in the near term as the conventional egg layer population declined 2% yoy in November 2019, while the cage-free layer flock increased 24% yoy during the same period. These dynamics could pressure cage-free prices and support conventional prices, causing the premium to contract.

A recent study concluded that most consumers are willing to pay a premium of approximately $0.30 for a dozen of cage-free eggs.8 However, it also determined there is strong heterogeneity in cage-free demand, and about a third of consumers may be willing to pay as much as a

$1.00 premium for cage-free eggs. Therefore, while it is unlikely the premium for cage-free eggs will decline to less than $0.30 in the short term, modest price decreases could incrementally add cage-free demand.

Producers Will Likely Drive the TransitionChanging consumer preferences often create demand and carve out market potential, but producers are ultimately responsible for choosing to commit to the opportunity by producing the good. Egg producers remain concerned whether cage-free eggs are just a fad and may be replaced by a new egg with higher welfare standards. To hedge this risk, some major egg producers are upgrading facilities to convertible systems—which can be converted between cage-free and conventional production.

The primary challenge for producers and retailers will be inducing additional cage-free demand in the near term, beyond increased consumption on the West Coast driven by legislation. Additionally, corporations are likely more inclined to uphold their pledges if general cage-free demand grows. To incentivize companies and consumers to make the shift to cage-free, the premium for cage-free

Figure 3 | Operating Cost of Egg Production Systems ($ per dozen eggs)

Conventional Cage-Free

Feed Cost $0.43 $0.44

Pullet Cost $0.15 $0.22

Labor Cost $0.02 $0.07

Energy Cost $0.01 $0.02

Misc. Cost $0.01 $0.01

Operating Cost $0.61 $0.75

Source: UC Davis, MIM

Figure 4 | National Shell Egg Retail Prices ($/dozen)

Conventional Cage-Free

Source: USDA, MIM

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0.50

1.00

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2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

A reduction in cage-free retail prices may

benefit retailers by inducing additional

consumer demand, and producers will likely

still achieve higher returns for cage-free

compared to conventional.

MetLife Investment Management | Cage-Free Egg Insight 4

eggs may need to decline in the short term. Cage-free retail prices are still typically twice as high as conventional prices despite a 2015 UC Davis study showing cage-free operating costs are only 23% higher than conventional.6 This disparity is primarily driven by limited market supplies and retailers inflating cage-free’s premium over conventional. A reduction in cage-free retail prices may benefit retailers by inducing additional consumer demand, and producers will likely still achieve higher returns for cage-free compared to conventional. Regardless, we expect that the premium will contract over the long term as supply expands. Therefore, we believe that the operators who quickly convert facilities and first fulfill corporate pledges will benefit the most.

Endnotes1 California Secretary of State, Text of Proposition 12 , November 20182 Compassion in World Farming, EggTrack 2019 Report, 20193 Effective Altruism Forum, Animal Welfare Commitments,

February 20194 University of California, Proposition 2, November 2008.5 USDA NASS, October 20196 UC Davis, Effects of housing system on the costs of commercial egg

production, 20157 USDA AMS, October 20198 Food Marketing Institute Foundation, Consumer Beliefs, Knowledge,

and Willingness-to-Pay for Sustainability-Related Poultry Production Practices Egg Survey Report, January 2018.

Authors

BLAINE NELSONAssociate Director, Agricultural Research & Strategy

Blaine Nelson is an Associate Director on MIM’s Agricultural Research & Strategy team and is responsible for market research and investment strategy development in support of the Agricultural Finance Group. In this role, he produces research publications and agricultural forecasts, and monitors various sectors within the agricultural space. Prior to joining MetLife, Nelson worked with The Atkins Group as an Agricultural Analyst. He earned his M.S. in Agricultural and Consumer Economics at the University of Illinois and holds a B.S. in Applied Economics from the University of Minnesota.

TOM KARMELAssociate Director, Agricultural Research & Strategy

Tom Karmel is an Associate Director on the Agricultural Research & Strategy team. He is responsible for quantitative market analysis to help drive investment strategy for MetLife Investment Management’s agricultural platform. In this role, Tom produces market insights, models agricultural credit conditions, and forecasts commodity prices to support MIM’s agricultural portfolio. Tom earned his M.S. in Agricultural Economics from Purdue University and completed his B.S. in Meteorology from Florida State University.

MICHAEL GUNDERSON, PHDDirector, Agricultural Research & Strategy

Michael Gunderson is Director, Head of Agricultural Research & Strategy. He provides leadership to market analysis of annual and permanent agricultural crops, forest and timberland products, and agribusinesses to help drive investment strategy for MetLife Investment Management. In this role, Mike shares market insights regarding agricultural credit conditions, commodity price forecasts, and industry dynamics to support MIM’s agricultural portfolio. Mike earned his Ph.D. in Agricultural Economics from Purdue University, an M.S. in Agricultural Economics from Cornell University, and a B.S. in Agribusiness, Farm, and Financial Management from the University of Illinois.

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