Price Protection Against COVID-19
By Larry Stalcup, Contributing Editor
With projections for losses of $6/cwt., or more for cattle going on feed in mid-summer, there aren’t many paths to potential profits. Price pressure from COVID-19 may not be as prolific after the spring’s Black Swan market. But risk management remains a priority, even if it only helps prevent more magnified losses.
It’s still too soon to refer to markets as “post-COVID-19.” The pandemic was stampeding across many states in mid-July. State fairs were canceled in Texas, Oklahoma, Kansas and other states. There remained questions about whether schools would start on time, if teaching would go back online and if classrooms would remain darkened.
Projected closeouts for fed cattle were also dreary. With a finished breakeven price pegged at about $113/cwt., a 750-lb. steer placed in mid-July and fed 150 days in the Texas Panhandle showed a loss of $6/cwt. That was based off live cattle futures price trading at about $107 – penciling a loss of about $82 per head.
Prior to the coronavirus, fed prices were forecast to average about $120 for 2020. This price came from CattleFax during its protein outlook seminar at the Cattle Industry Convention in early February. But by mid-March COVID-19 had taken over. August futures dipped from above $110 to $103. By mid-April, they scraped $80 – and didn’t recover to $103 until July 15.
If cattle had not been hedged before the disastrous markets, losses hit well over $200 per head as cash cattle hit low marks and were at $94/cwt., in mid-July. COVID-generated Paycheck Protection Program checks from the government helped offset part of the loss, but not near enough.
As much as price risk management is needed, many producers and feeders remain weary of the hedging tools available through the Chicago Mercantile Exchange (CME). However, there are options other than using a commodity broker (although most broker-analysts can provide sound marketing plans to soften the impact of an event like COVID-19, BSE or other so-called Black Swans).
Livestock Risk Protection (LRP)
LRP is offered through the U.S. Department of Agriculture (USDA) Risk Management Agency (RMA) to provide an insurance plan for fed cattle and feeder cattle. Like a straight futures hedge or option, it helps insure against declining prices. A variety of coverage levels and insurance periods are available to correspond with the time market-weight cattle would normally be sold.
Bought through RMA-approved livestock insurance agents, LRP premium rates, coverage prices and actual ending values are posted online daily at
https://public.rma.usda.gov/livestockreports/main.aspx. Users will be guided through specific LRP prices based on their state and commodity type.
Users may choose coverage prices ranging from 70 to 100 percent of the expected ending value. The lower the percentage covered, the lower the price premium. LRP’s website notes that at the end of the insurance period, “if the actual ending value is below the coverage price, you may receive an indemnity payment for the difference between the coverage price and actual ending value.”
Users submit a one-time application for LRP-Fed Cattle coverage. After the application is accepted, users may buy specific coverage endorsements for up to 2,000 head of 1,000- to 1,400-lb. heifers and steers that will be marketed for slaughter near the end of the insurance period.
Users may insure up to 4,000 head per producer for each crop year (July 1 to June 30). All insured cattle must be located in a state approved for LRP-Fed Cattle at the time you buy insurance coverage, LRP says.
LRP-Fed Cattle is available in: Alabama, Arizona, Arkansas, California, Colorado, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, West Virginia, Wisconsin and Wyoming.
The length of insurance coverage available for each specific coverage endorsement is 13, 17, 21, 26, 30, 34, 39, 43, 47 or 52 weeks.
Users may buy multiple specific coverage endorsements with one application. Insurance coverage starts the day the user buys a specific coverage endorsement and RMA approves the purchase, LRP states.
For LRP-Feeder Cattle coverage, users can buy specific coverage endorsements throughout the year for up to 1,000 head of feeder cattle that are expected to weigh up to 900 pounds at the end of the insurance period. The annual limit for LRP-Feeder Cattle is 2,000 head per producer per year (July 1 to June 30).
As with the fed cattle LRP, length of feeder insurance coverage available for each specific coverage endorsement is 13, 17, 21, 26, 30, 34, 39, 43, 47 or 52 weeks. The feeder LRP is available in virtually every cattle producing state.
A small operator’s put option
LRP insurance operates similarly to a simple put option. It enables producers or feeders to set a floor price when cattle will be marketed.
Shari Holloway, an insurance agent for AgDefense Risk Management in Chattanooga, Okla., says the LRP program is a different way for producers to hedge themselves without needing a large load of cattle.
“LRP is the security of a put option or even a contract without the strings,” she says. “You can set that safety net where you need it so unexpected events don’t cost you all of the progress you’ve made with your calf crop. You can sell high if the market is good.”
LRP prices are typically set daily by RMA. They are similar to the day’s current futures market. Here are examples of typical LRP offerings:
For an LRP policy for fed cattle placed on feed in July that will finish in October, the expected ending value was about $102/cwt. Using a 96 percent coverage level, the cattle could be covered at about $99/cwt., at a premium cost of about $3.30/cwt.
For cattle placed in August to finish in December, the end value would be set at about $106. At about 90 percent coverage, the cattle would have about a $94.80 floor price, at a premium cost of about $1.60.
For “hedging” calf prices based on their expected LRP-Feeder value, the LRP end value for October sales was about $140/cwt. For coverage at about 95 percent, the coverage price is $135, with a premium cost of $3.10.
For calves to be sold as feeders in November, the end value was projected at $141. For a premium cost of about $2/cwt., for 90 percent coverage, the cattle would have a $127 floor price.
In each of these cases, cattle could be sold in a market rally to capture higher prices. The premiums paid for the LRP coverage would be lost, like any insurance premium, if a policy is not collected on.
“More people are looking at LRP and are interested in how it works,” Holloway says. “Before, LRP users had to pay premiums in advance. In a new provision introduced in July, they don’t have to pay until the contract ends.
“The main thing is to know your bottom line. Where do you need to be in order to stay profitable on your cattle? It’s all about managing your risk. If you can’t manage a large risk, you need to do something to protect yourself. If you’re not used to dealing in the futures world, LRP is a surefire way to do it.”
Holloway adds that the LRP daily price offers are available until 9 a.m., the following morning. “That gives cattle producers time to sleep on the offer and not have to immediately pull the trigger,” she says.
The future looks better for cattle prices, but there’s never a guarantee. In July, Kansas State University listed projected values of finishing steers in Kansas. Through March 2021, there were actually four months in which closeouts showed a profit (October, December, February and March).
Is it worth the risk of not having a floor price set on fed cattle or calf prices? Projections are just projections. And if COVID-19 worsens, the value of hedging in a plague could help keep a lot of folks in business.