Would moving to the wholesale beef market provide a more accurate and
transparent cash price equivalent? Let the conversation begin.
By Burt Rutherford, Contributing Editor
Does the cash market for fed cattle have any relevance in a market that has clearly moved past selling cattle on the average?
Short answer: yes. Many alternative marketing arrangements (AMAs) use cash price as the base point, so having a viable cash price is essential.
The real question, then, is the weekly cash price as it’s currently derived representative of the fed cattle market?
Short answer: not really.
The four major packers account for around 85 percent of the fed cattle trade. Depending on the region, the portion the cash trade represents can be very thin to nonexistent.
“Are we better served with four packers with very similar business models or would we have more transparency from tens of thousands of transactions between the host of end users – HRI, retail and beef exports?” asks Don Close, senior analyst-animal protein with Rabo AgriFinance.
Given all the angst, arm waving, gnashing of teeth and infighting over perceived problems in the cattle and beef marketing chain, Close took a look at the wholesale market and asked himself if there was a way to take those tens of thousands of individual transactions and work back to determine a live price equivalent.
Short answer: yes there is.
Just as there’s a range of cash prices today, there’s a range of the percentage the live animal is to the cutout. “So if we have that ratio of live to cutout and drop, whatever it is for that week, you can take the cutout price times that percentage and get a live price equivalent,” Close says.
“What I’m talking about here is transferring negotiation on the live animal price to negotiating the ratio of live to cutout and the drop. So, if we have the simplicity of that transaction to get a live equivalent, then those price relationships between the fed steer, a feeder steer and a calf are all still in place.”
Close’s analysis shows the long-term average of the ratio of aggregated steer and heifer values to the combined value of comprehensive cutout values and drop credits is 53.23 percent. That percentage is the multiplier to determine the cash equivalent price.
Since cutout values are dynamic, being established with every transaction in the wholesale beef market, that percentage will vary week to week, depending on availability of fed cattle, seasonality of cutout values and timing within the cattle cycle, Close notes.
The analysis excluded negotiated net grid live sales because there were too many voids of trade volume to have a reliable price series, Close says. While forward contract sales are categorized as a formula transaction, they were not included because they are a different type of transaction for a future delivery that isn’t determined by week-to-week prices.
“For all the dressed transaction types, we matched the live FOB weights with the carcass weights of dressed transactions to get an estimated hot carcass yield in order to convert carcass transactions to a live price equivalent,” Close says. “For live and dressed FOB and delivered sales, a weighted average was made to avoid price distortion for freight allocations between FOB and delivered sales of the same transaction type.”
Establish a Base Price
The cutout-derived live price equivalent establishes a base price. “The buyer and seller still have to negotiate over cattle quality, cattle condition, weighing conditions, the yield history of the individual plant and the freight differential between the feedyard and the plant,” he says.
To that end, AMAs and the various value-added programs wouldn’t change. They would simply use a more accurate and transparent base price to negotiate premiums and discounts.
One thing that would change, he says, is the historical basis. The live cattle futures contract, in and of itself, would still remain, but it would affect historical basis.
“If we start with a cutout price and work it back to a live animal price, then the relation with futures is consistent. And the ability to determine basis levels, that stays the same,” he says. “The one thing it will change is it would disrupt historical basis levels.”
That’s because cutout prices are driven by the seasonality of cutout values. Thus, a new basis value would be established. Given that, it would take some time to establish enough historical price points to establish new historical basis.
Another impact of establishing a live cattle price from cutout prices is the violent price swings, brought on by things like packing plant fires, pandemics and gyrations in the cattle cycle like we saw in 2014-15, would flatten.
“During periods of exceptionally tight cattle supplies, when packer margins are typically underwater, packers would be able to avoid paying up the full extent for cattle,” Close says.
Then there’s the other side of the marketing dollar. “During periods of large or excess cattle supplies, when packers hold all the leverage, or during periods of market disruptions when packers typically have extreme margins, they would pay more than cash market fundamentals would warrant.”
No Price Disparity Between Segments
Close looked at the possibility of using cutout prices to calculate a live price equivalent as a way to bring more transparency to the marketing chain and make the infighting about cattle prices irrelevant. In the process of his investigation, he discovered that claims of market manipulation have no merit.
AMAs are often the target of such accusations, with calls for a return to a cash market for live cattle. However, returning to a traditional cash market for fed cattle would not serve the beef business well, Close argues.
“Many involved in the current debate insist that the share of cash sales be increased, claiming it is the purest and most transparent form of price discovery. That is a very antiquated perspective of the market,” according to the Rabo report.
By trading fed cattle on an average, cash sales breed mediocrity by assuming all cattle are the same. “On the other hand, transactions that are determined by individual carcass merit continuously push the market toward quality improvement,” the report says.
Consider that over the past 25 years, the percentage of Choice and Prime cattle has increased from just a tad over 50 percent in 2005 to better than 83 percent now. “While a number of contributors has enabled the improvement in cattle quality, none have been more influential than selling cattle on individual carcass merit and rewarding producers for cattle quality,” he says.
But do AMAs lead to an unfair market? “There are advantages to selling cattle on a formula or grid, but net price advantage is not one of them,” Close says.
The advantages are knowing that rail space is committed and there are advantages in knowing when the cattle will ship, which leads to more efficiency, as well as advantages in liquidating hedge positions.
But concerns about price disparity aren’t one of the advantages. “A close examination of sales by transaction type shows there is as much price disparity between live FOB and delivered sales (feedyard to packer) as there is between dressed FOB and delivered sales (packer to wholesale).”
Then there’s this. “Over time, the dressed FOB and delivered sales most often lead prices in an escalating market and hold within the middle of the range in declining markets. It is equally important to acknowledge that the net price of formula and grid sales, when aggregated, hold the middle of the trading range in both ascending and declining markets.”
Industry Reaction
Early feedback on the idea of a cutout-derived fed cattle price equivalent has been mixed, Close says. The lion’s share of the feedback is from those who understand the idea conceptually, but who simply don’t like change. “I get it and I respect that,” he says.
Then there are those who are ready to make the change because they think it will put them closer to the determination of value. “And they think it puts them closer in line to increase cutout values over time because of the growing trend to value-added products,” he adds. “And they think it would get them closer to consumer signals that would make the market more responsive.”
Then there are those who like the idea but don’t want to be the first ones out of the box and throw a hoolihan or miss completely. And those who understand basis and use it successfully and have the expertise to manage a volatile and unpredictable futures market like things just the way they are.
What’s Next?
“I don’t think I’ve got the holy grail, but I think the industry is at a critical crossroads,” Close says. “And I think the attempt to insert legislative mandates to the number of cash sales is misguided because of the detrimental impact it would have on cattle quality, grading percentages and going back to buying cattle on the average,” he adds.
“So I think we can, being at a critical crossroads, take steps to move the industry back 25 years or we can collectively think about creating a foundation that will move the industry forward 25 years,” he asserts.
“I’m not saying I have the answer, but it’s time somebody brings an idea to the table to move us forward.”
Let the conversation begin.
