On November 6, 2018, California voters approved a ballot proposition requiring all eggs sold in the state originate from cage-free layers by January 1, 2022. Reactions, expectedly, were mixed, with animal rights groups lauding the decision and agricultural associations, producers, and even attorney generals from egg-producing states voicing vehement opposition.

So what did California's Proposition 12 actually mandate?

The simple phrasing of the ballot measure, to some voters, might have insinuated that all hens would now roam spacious pastureland reminiscent of scenes from Charlotte's Web or Little House on the Prairie. However, that is not the case.

What California's cage-free law states is that egg-laying hens may no longer be confined in space less than required by the United Egg Producers' (UEP) Animal Husbandry Guidelines for US Egg-Laying Flocks. First, to clarify for consumers, the law did not specify "free-range," which would be illustrated as hens squawking around grassy lawns.

The birds still are raised in generally large houses. In its guidelines, UEP describes three general forms of cage-free, indoor housing systems that comprise the majority of the industry:

1. multi-tiered aviaries with a litter floor and slatted-floor platforms over manure-removal belts,
2. partially slatted systems with a litter area and a raised slatted-floor area through which manure drops into a storage pit below, and 3) single-level, all-litter floor systems.

Without spewing out the entire handbook, the gist is that one square foot of floor space is required per chicken for houses that provide multiple levels of vertical space (similar to shelves or roosts with opportunities for hens to sit above ground). For houses that only provide a single floor (hens only have access to one level), 1.5 square feet of floor space is required per chicken. Further guidelines regarding nest space, perches, and litter can be found here.

While one might wonder what all the fuss over the new requirements is about, the fact of the matter is that it requires producers to change how eggs are generated.

How will this impact producers?

California's population is around 40 million people, making it larger than two-thirds of the countries on the planet. Further, around two-thirds of its eggs originate outside of the state. This means that farmers in Iowa, Ohio and Indiana, for example, are being forced to transition their facilities to the California legislative guidelines or be shut out of the California market.

Only about 20 percent of the US layer population is cage-free. This means that, while California's needs could be met, there would be little cage-free stock for the rest of the country. In theory, this might be permissible but, across the nation, the topic of cage-free is somewhat en vogue. Michigan, Oregon and Washington all have passed cage-free laws, with other states considering or having passed similar (but perhaps more vague) legislation.

To further complicate matters, hundreds of private companies have pledged to use and sell only eggs certified as cage-free, with varying deadlines. Some include McDonalds, Dunkin, Subway, Hilton, IKEA, Hormel, Unilever, and Whole Foods. Needless to say, the current capacity to produce cage-free eggs is nowhere near what is needed to meet that amount of demand.

UEP has forecast that, to meet these cage-free pledges, the US will need at least 225 million cage-free layers in production by January 2026, which would equate to an average of two million hens transitioned to new housing per month until that time. While not impossible, this is no easy task for producers or supply chains. Clear economic incentives, governmental penalties for failure to transition, or other catalysts may be necessary at this juncture to induce producers to convert to cage-free.

What could this transition mean for the market structure, operations or prices?

It is unlikely the overarching structure of the egg market will change significantly, as eggs are sold on either a contract or on the spot market. The expected change is in the product composition of the market, with increases in cage-free eggs and the inverse in traditional cage-raised eggs. Operations should remain overwhelmingly the same, as all that is changed is the internal machinery/infrastructure in houses. Some cage-free operations will require manual egg harvest, increasing labor costs.

Is there potential that retailers might have to look outside the US for volume to meet the legislative and commercial commitments being made?

Our expectations would be in line with the US farming organization United Egg Producers' predictions, that for nearly 2/3 of the market to transition an average increase in cage-free layer flock of around 2 million hens per month is required. How smoothly or consistently producers transition (totals per month) is up for debate. The already in-place two-tier pricing system, which puts cage-free eggs at a premium, should remain. We would expect prices for caged eggs to remain volatile, with it being unlikely they drop much lower than prices experienced in fall of 2019. As long as cage-free eggs maintain a premium there will likely be a significant consumer base preferring the lower-priced item. If cage-free egg production stays ahead of demand, however, we would expect those prices to decline. The chance American retailers need to import cage-free eggs is miniscule, as in the US huge quantities of eggs are sent into processing and storage as excess inventory.

Legal battles are ongoing, with associations and states suing in hope that the laws will be overturned. The bottom line is that the cage-free battle is nowhere near decided. One might even say it is ramping-up.

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.