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OSU Extension - Fairfield County

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and the

OSU Extension BEEF Team

BEEF Cattle questions may be directed to the OSU Extension BEEF Team through Stephen Boyles or Stan Smith, Editor

You may subscribe to this weekly BEEF Cattle letter by sending a blank e-mail to beef-cattle-on@ag.osu.edu

Previous issues of the BEEF Cattle letter

Issue # 566

December 12, 2007

An Unfavorable Combination - Nevil C. Speer, PhD, MBA, Western Kentucky University (reprinted with permission on 12/11/07 from CattleNetwork.com)

November was good to the market. The month began on a lackluster note with trade mostly $92 and lacking solid direction. Buyers went to work, though, prior to Thanksgiving: active trading occurred on Wednesday at higher levels - the bulk of Thanksgiving-week sales occurred at $95-95.50. The month ended at steady money - any hope for further advances were held in check by negative pressure at the CME. Meanwhile, December's first week of business delayed finalizing trade until late Friday with sales mostly $94. Regardless, the fed market's good fortune in November is good news for cattle feeders and directly attributable to action over in the wholesale market. Boxed beef rallied during the final three weeks of November, gaining $3-4 respectively since establishing lows earlier in the month at $139-140: Choice boxed values ended at $150+. Meanwhile, the Select cutout gained nearly $7 during the same time frame.

The wholesale market's solid action bodes well from the beef complex. Beef has managed to stage an important rally despite broader macroeconomic challenges. Last month I noted, "The sloppy trend [in early-November] reflects overriding uncertainty in the market largely driven by worries surrounding wholesale beef trade… overarching economic concerns may be taking root within the beef complex." Reuters/University of Michigan's Consumer Sentiment was posted at 74.5 in December - the weakest mark in 15 years (except for October's reading in 2005 following Hurricane Katrina). December's report noted the importance of rising food costs in addition to the enduring concerns surrounding the housing/mortgage markets and fuel prices. The recent rally in wholesale prices is consistent with beef demand indices: Drs. Grim and Plain (University of Missouri) note that beef demand is up nearly 1% versus last year.

The feeder market has been subject to some important developments during the past several months. Feeder cattle are sharply lower compared to levels posted in September (~$118-9). At that time cattle were being largely purchased against the February contract (priced at $100-101) and a bottom in the corn market ($3.05 basis Omaha). The upward trend reversed in October: replacements were beginning to be priced against the April contract (which slid from $101 to $97 during the month) while corn moved sharply higher (45-to-50 cents in a 4-week period). Cattle feeders surrendered approximately $50 in revenue while incurring an additional $25 in feeding costs. That $75 has been priced directly back into the price of replacements; the feeder cattle index now stands at ~$108 - $10/cwt, or $75/head, off the previously-mentioned highs. Potential pressures on beef demand and corn's continuing ascent warrants spring sellers to carefully monitor developments as sales begin again in earnest following the holidays.

That discussion relates directly to November's Stocker Cattle Forum (cattlenetwork.com) in which I was asked to address the following question: "If I am a stocker operator should I be concerned about packer ownership?" Given the importance of the topic and due to space limitations within the forum I thought it worthy to provide more depth to my initial response relative to the issue of Alternative Marketing Arrangements (AMAs).

AMAs served as the foundation for a major study conducted by GIPSA contractor RTI International. Specific to the issue of packer ownership upon stocker operators the study noted concluded the following:

Full or partial packer ownership of a pen of cattle reduces the equity the feeder (or other cattle owners) must provide to feed cattle. Packer ownership also allows the feeders to secure better terms from lenders. Feeders may be able to own more of the cattle that are currently owned by packers, but they would face a capital constraint preventing them from owning all the cattle. The individual feedlots would have underutilized capacity or would have to find new investors to replace the capital packers once provided. To attract capital that is not in cattle feeding would require a higher rate of return than cattle feeding currently offers; otherwise, that capital would already have been invested in cattle feeding. Given that the supply and demand of beef is relatively fixed in the short run, fed cattle prices are not expected to change substantially. Thus, higher rates of return would have to come from downward pressure on feeder cattle price. Likewise, if feeders have more debt and/or more risk, the higher cost of borrowing will result in lower bids for feeder cattle.

That's an important conclusion because it addresses the issue of cattle feeding from an investment standpoint and the subsequent influence upon the feeder market.

Feedyard access to capital has been a predominant theme in the Monthly Market Profile during the past several years. That's because capital requirements have substantially increased due to widespread expansion and ever-increasing operating costs. To ensure adequate returns on investment (thus remaining competitive with other investment vehicles) feedyards must generate continuous throughput to leverage economies of scale, economies of administration and maximize operational efficiency - doing so mandates maintaining a broad customer base, including packers.

With that foundation let's address packer ownership more specifically. RTI's summary indicates approximately 5% of feedyard inventory is held by packers. What if that disappeared? Consider the following scenario upon a family-owned 20,000 head feeding operation whose inventory is consistently comprised of packer-owned cattle at the 5% level. To maintain capacity utilization the feedyard would be forced to assume ownership of those cattle (1,000 head). Assuming purchase of a 750-lb steer and feeding period of approximately 150 days, the additional capital needs are as follows:

Cattle: 1000 head @ 750 lb @ $110/cwt = $825,000

Operating costs: 1000 head @ 500 lb gain @ $75/cwt = $375,000

The grand total is $1.2 million! As such, the owner would need to: 1) produce $250,000 up-front equity ($250/head margin) to first purchase the cattle, and 2) secure $950,000 of increased operating capital from his/her lender to maintain operations. Meanwhile, an additional cost of $100,000 would be incurred annually stemming from interest and opportunity costs (9%) on $1.2 million over the course of 2-¼ turns per year.

VetLife^®'s Benchmark® Advantage Forum (2005) interactive surveys revealed that the average ownership level among feedyards is approximately 55%. Therefore, eliminating packer ownership would mandate most operation to increase their capital needs by nearly 10% - a substantial amount in a breakeven business! That challenge is compounded by increased risk exposure: feedyards would become less diversified due to higher levels of inventory ownership. That's especially true for smaller feeding operations who have less access to capital and fewer opportunities for minimizing risk across their operations. Within that scenario, cattle feeders would inherently need to bid replacement cattle lower to ensure competitive returns (risk adjusted return on capital).

The alternative is to simply operate at lower levels of capacity utilization. That scenario leads to efficiency shortfalls thus indirectly forcing higher costs. Bottom-line: the outcome is the same; to maintain profitability and avoid assuming excessive risk higher operating costs means replacements must be purchased at lower levels.

Let's look at the issue from an alternative perspective. Market volatility is the single aspect which opponents of alternative marketing arrangements persistently cite as foundation for needing increased regulation. The argument is as follows: AMA's lead to reduced market test - non-negotiated agreements enables packers to avoid the spot market thus causing artificial price deflation and increased price volatility on a weekly basis. In other words, increased volatility reflects unfavorable fed market manipulation.

To provide some perspective of that issue the graph below depicts annual average weekly price deviations (to the upside and downside, respectively) during the past 11 years. Stated another way, during 2007 the weeks in which the market moved into positive territory the average move was $1.52 to the upside. Meanwhile, weekly downward market shifts in 2007 have averaged $1.32. It's important to note that relative volatility during the 11-year timeframe, as measured by fed market coefficient of variation (not depicted within the illustration), 2007 actually possesses the 2^nd-lowest annual ranking behind only 1997.

Is legislation necessary? Pragmatic evidence would indicate otherwise. First, putting an end to packer investment within the feedlot segment would burden business operations. At current levels packer ownership proves to be an important source of capital investment for cattle feeders enabling risk transfer and improved operational efficiencies - all of which is price supportive for the feeder market. Second, eliminating AMAs would possess no upside from a feedyard revenue standpoint. Critical deficiencies in price discovery do not exist. RTI reports that, "…results of the industry survey and interviews, the use of AMAs used in the sale of fed cattle is not expected to change greatly in the future. [And] policy that affects forward contracting or packer-owned procurement of fed cattle would have little effect on individual plants or the overall market…."

Let's bring the discussion full circle: should stocker operators be concerned about packer ownership? That is, concerned about legislation which terminates the endeavor. Regulations limiting AMAs are not beneficial to cattle feeders from a sales standpoint and detrimental from a management standpoint. That's an unfavorable combination and will be adversely transferred back to the cow/calf and stocker segments. Policy makers need to carefully consider all of the complexities involved with potential new policies to prevent unintended consequences.

Forage Focus: Tight Forage Seed Supplies for 2008 - Marvin Hall, PSU Forage Specialist

Reports from the recent meeting of the National Seed Trade Association indicate that orchardgrass, tall fescue and clover seed supplies will be limited in 2008. Reasons for the limited supply include seed production fields in Oregon (location in USA where most forage seed production occurs) and overseas being taken out of production at the same time overseas demand is rising. This shortage is likely to persist for a couple years. Current seed prices reflect this shortage with orchardgass seed at over $4 per pound. If you intend to plant these crops next year it would be good to buy early to ensure you can get the variety you want and lock in the current price.

If you have any interest in producing grass fed beef or lamb production you will find this course interesting and informative. The cost for the entire eight week course is only $65 for the first participant from a farm and $30 for each additional participant from that farm. This fee will include the all handout and reference material. Reservations are required and may be made by contacting the Knox County Extension Office at 740-397-0401 or mccutcheon.30@osu.edu.

Participants may enroll by sending a check made payable (US Funds) to Michigan State University ($30 for 1st person and $20 for each additional family/farm member; FFA/4-H students can register for $10 each) and mailed to Steven Rust, Dept. Animal Science, Michigan State Univ., 2265B Anthony Hall, E. Lansing, MI 48824-1225. Please mail before January 17, 2007. If not mailed by January 17, call Steve Boyles (boyles.4@osu.edu, 614-292-7669) or Dan Frobose (frobose.1@osu.edu, 419-354-6916) if you desire to attend the program or if you have any questions about the program.

For a complete position description or to apply online: http://jobs.osu.edu/, click search postings and enter requisition # 336087. Deadline: December 17, 2007. To build a diverse workforce Ohio State encourages applications from individuals with disabilities, minorities, veterans, and women. EEO/AA employer.

Weekly Roberts Agricultural Commodity Market Report - Mike Roberts, Commodity Marketing Agent, Virginia Tech

LIVE CATTLE futures on the Chicago Mercantile Exchange (CME) closed up on Monday as profit taking cut gains near the end. DEC'07LC futures finished up $0.375/cwt at $94.400/cwt and $0.175/cwt higher than last week at this time. The FEB'08LC contract closed at $97.125/cwt, up $0.375/cwt and $0.750/cwt higher than last Monday. Gains were driven by snowy weather as cold conditions in the Texas and Oklahoma panhandles were expected to slow livestock growth there as it stresses cattle on feed. Additional cold weather is forecast for the U.S. Plains beginning late Monday. Some deliveries were noted as the first delivery-day notice for December came about. Cash cattle traded lower on Friday but didn't seem to dampen the market on Monday futures. USDA's 5-aread average price for cash cattle was off $0.50/cwt to $93.50/cwt. USDA on Monday put choice boxed beef cutout at $148.51/cwt, up $1.20/cwt. Export expectations were supportive even while Japan on Monday said it was not ready to lift more restrictive age limits on U.S. beef imports. Packer margins are seen as negative but a little better. According to HedgersEdge.com, the average beef plant margin for Monday was estimated at a negative $46.75/head, $7.57/head better than last Friday but $16.25/head worse off than a week ago. Cash sellers should take profits on these rallying prices. If the weather breaks warmer, prices will most likely decline somewhat. December prices for corn may break due to their oversold conditions. It might be a good idea to hold off until the end of the week to buy more feed inputs.

FEEDER CATTLE contracts at the CME were up on Monday chasing live cattle. JAN'08FC futures closed at $106.125/cwt, $0.175/cwt higher than last Friday but $2.225/cwt lower than last Monday. The MAR'08FC contract finished at $107.700/cwt, up $0.250/cwt but $1.100/cwt lower than a week ago. Fears of colder weather and higher corn started the market out with losses in early trading but higher prices in live cattle produced gains for feeders near week ago levels. Cash feeder average price on the CME for Friday, December 7 was $106.86/cwt, down $0.120/cwt. An oversold condition in the JAN'08FC contract provided some support. A contract is said to be oversold with a Relative Strength Index (RSI) of 30 or below. The January 10-day RSI closed at 29.69. The latest CME Feeder Cattle Index for December 6 was noted at $106.98/cwt, up $0.10/cwt. Feeder sellers ought to hold off cattle sales until the cold snap breaks if you have pasture. Immediate feed needs may be running short if you haven't priced corn on sags last week. If you did, you might consider trying to price corn on the downside dips as we go through the week.

Visit the OSU Beef Team calendar of meetings and upcoming events

BEEF Cattle is a weekly publication of Ohio State University Extension in Fairfield County and the OSU Beef Team. Contributors include members of the Beef Team and other beef cattle specialists and economists from across the U.S.

All educational programs conducted by Ohio State University Extension are available to clientele on a nondiscriminatory basis without regard to race, color, creed, religion, sexual orientation, national origin, gender, age, disability or Vietnam-era veteran status. Keith L. Smith, Associate Vice President for Ag. Admin. and Director, OSU Extension. TDD No. 800-589-8292 (Ohio only) or 614-292-1868

Fairfield County Agriculture and Natural Resources