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March 2011 Archive for Out to Pasture

RSS By: Steve Cornett, Beef Today

Read the latest blog from Steve Cornett.

Hedging Feeders on the Hog Market?

Mar 21, 2011

Repeat after me: Futures prices don’t matter. It’s their relationship to cattle prices that matters. Ok, now, slower: Futures    prices    don’t    matter. It’s their relationship to cattle prices that matters.

It’s the basis, not the level. (Basis is, of course, the difference between cash prices and futures prices.)

That’s what you need to remember if and when the CFTC and CME increase the weight range on the feeder cattle settlement index. At some point in the future, with the CME providing plenty of notice, the feeder cattle futures index—key word: Index—price could decrease slightly because heavier weights will be used to calculate the index. But that won’t make CASH feeder cattle cheaper, silly wabbit.

If you don’t understand that fundamental truth, you probably don’t understand the way the cattle market works.

I bring it up because we recently saw an embarrassing news release claiming that proposals to update feeder cattle weights for the cash index are “designed to break the feeder cattle board, causing direct financial harm to every U.S. cow/calf producer, backgrounder and stocker that markets feeder cattle,” and “would literally transfer millions, if not billions, of dollars away from feeder cattle producers and directly to the packers and their cattle feeding operations…at the expense of hundreds of thousands of U.S. cow/calf producers, backgrounders and stockers….”

It would have been much more helpful to tell their members to keep their eye on the situation and be aware that, perhaps in 2012, the CME will make the move and that if they are pricing feeder cattle off the futures price, they will need to get a bigger basis. I.e.: if you’ve got 600 lb. calves and you’re selling them par the futures market now, you will need to price them a few cents over the feeder board to get the same price after the index changes. That’s pretty simple.

A little more background is in order. At their annual convention, NCBA’s live cattle market committee recommended the removal of the 650-699 pound category from the calculation of the CME Feeder Cattle Futures Index, replacing it with an 850-899 pound category.

You’ll recall that feeder cattle are settled based on an index calculated from a 7-day moving average of cash feeder cattle prices.

Obviously, the lighter cattle bring more per pound than the larger cattle. So when you take them out of the numbers used to calculate the index, the index will be lower. So long as traders on both sides understand that, there is no problem. Since feedyards are buying larger cattle these days, in fact, the index will be more, not less, accurate.

“With record grain prices, more cattle are remaining on forage for as long as possible before going to the feedlot,” said NCBA President Bill Donald. “The realities of the marketplace vary year to year and as a producer, I respond to those changes. The intent is to adjust the index in order to more accurately reflect the realities of the marketplace. We need the CME Feeder Cattle Futures Index to adjust as well in order to serve as a viable risk management tool.

The idea behind a cash settlement—or any other form of settlement for that matter—is to base it as nearly as possible to the actual commodity. In the modern—or at least current—industry, there are far more 800 than 600 lb. calves going on feed. Moving the weight range would, thus, make the board more accurately track what feeders are actually buying.

That’s the whole idea behind having a feeder contract, for goodness’ sake. If you weren’t worried about basis swings you could just hedge feeders off hog or fed cattle futures. The basis unpredictability would probably scalp you, but  there is usually a correlation, after all. It just isn’t good enough. You want to settle based on real world stuff. Otherwise, basis really would be a crap shoot.

It would be arguable that this is a temporary market, based on corn prices being so high and outside stocking pressure so low.  Maybe someday CME will want to get rid of the 850 lbs and go back to the 600 lbs. we used to have. But the way things are now, an 800 lb. animal is a “feeder” and a 600-pounder is a “calf.” In a market where various pressures and inputs and rains often cause those two commodities to ride different ends of the see-saw, they might as well be apples and oranges.

To argue there is some sinister plot afoot just seems almost paranoid.

Anyhow, what cowmen need to remember is what I said before. If the change is made, remember that your basis will change with it. If you’ve traded off the board in the past, you know that the size of the cattle and your trading situation impact your basis. So price the cattle as if they were better next year than they are this year and you’ll be fine.

The risk would be letting it sneak up on you. The basis will change from one settlement month to the next in one move. We should be able to calculate the change months in advance by simply figuring the index with the bigger cattle instead of the smaller cattle. There is nothing to worry about here.

Ethanol and Fed Cattle Breakevens

Mar 07, 2011

Ever since Washington fell in love with ethanol, there has been talk about the cattle feeding industry moving back to the Corn Belt because that’s where the distillers grains are.

I wrote a piece for AgWeb last week talking about cost-of-gain (Can Cattle Break $1.20?), based on ration costs in the Texas Panhandle. I heard, quickly, from some distillers grain feeders who said their costs were well under that—including a fellow in Iowa who said the custom yard where he had recently placed 530-lb. cattle was projecting gains in the .82-.85 range.

The costs of gain in Texas on cattle that size were projecting at more like $1.05. That sort of range—a 10-cent advantage in gain cost would translate to $80 per head on 800 lbs. of gain—would suggest a distinct advantage for the Iowa feeder.

So why aren’t all the cattle being fed in that part of the country? Why hasn’t the industry moved east faster?

Iowa feeders do have more cattle on feed than they did a few years ago. But they’re still well under the numbers of the 90s. Twenty years ago, there were over a million head of cattle on feed in the state. That fell below 400,000 early in the 2000s, and has since climbed back to—as of the February cattle on feed report—660,000. That reflects a lot more feeding in the state, but is hardly the wholesale shift many expected.

Kansas and Texas—the most ethanol-deprived of the major feeding states—had 45.5% of the cattle on feed in the U.S. in February 2001 and 44.5% this year. Iowa cattle on feed were up 10% over last year—meaning there were 60,000 more cattle on feed in the state. Kansas and Texas were up less, percentage-wise, but still added 210,000 head in the same period.

So, while there is generally growth in feeding in the ethanol regions, it is hardly the wholesale shift we saw during the 1960s and 70s, when the commercial feeding industry picked up and moved to the Great Plains.

Makes you wonder why, doesn’t it?

So I called around last week and talked to some smart guys.

For one, feeder cattle are priced at a premium in the Corn Belt. They tend to feed “better” cattle, and the market hasn’t been paying much of a premium for that kind of finished carcass.

For another, the rails provide a cheap way to transport grain and dried distillers grain, so not all locals are going to get too good a deal on the co-products. (I found nobody else talking bout 82-cent cost of gain.)

How much cheaper one yard can get his distillers grain depends on where he sits. The closer to an ethanol plant and the less local competition from other feeders, the cheaper.

And that makes the current situation interesting. Ted Schroeder at Kansas State University has done a lot of work on that sort of thing. He points out that with corn and gasoline prices both high, the value of distillers grains is apt to gain, relatively, on non-distillers grain rations—thus providing the ethanol area feeders with a bit more advantage.

The higher the price of fuel, then the higher the price of ethanol. As the plants push harder, the “salvage value” of the distillers grains lose some importance. There is more a tendency to “push them out the door,” and for some nearby feeders, that offers a nice advantage. Higher fuel costs also make it more expensive to dry the byproducts, making it a bit more advantageous for them to ship wet product to the nearest feeders. The higher fuel also adds more cost to longer distance shipping for corn—providing another advantage to the locals.

It’s hard to say how much advantage all that adds. It is too variable. For some Midwestern feeders, the benefit is substantial.

But, so far, there is little indication that all the benefits associated with ethanol are substantial enough to reverse the geographical shift of the feeding industry.

I’ll be surprised if it ever does. It’s not just my bias against ethanol, although when Al Gore and Bill Clinton both express doubts, you’ve got to think of rats jumping off a sinking ship.
That makes me think the ethanol industry has built its house upon the sand. But even if it stays forever, there are many differences in today’s climate and that of the 60s.

The shift to the Great Plains involved more than cheap feed. For one thing, new paradigms in packing plant technology and management—think boxed beef and union-busting—were rendering the stockyard towns’ processing facilities all at once obsolete. That’s not the case now. Packers are way over built and hardly of a mind to start building hundred million dollar facilities in the Midwest.

In those days, the locals were pleased to see the feeders and packing plants come. We said they smell like money. Nowadays, if you want to build a feedyard, you’ve got permits and neighbors and nuisance laws and mad county commissioners. It’s going to be hard to find new places to put 10 million head of poopy new feedyards. All that is going to break growth in the Midwest.

So the ethanol byproducts are a great thing for some cattle feeders. It gives them a competitive leg up, and all the more so when feed prices are high. In fact, since cattle are the main beneficiaries of the products, they give beef a competitive advantage over pork and poultry. To the extent those distillers grain feeders pay up for feeder cattle, that’s also good for cow-calf producers. In fact, there’s little doubt that the availability of cheap distillers grains is one of the props under the current calf and feeder cattle market.

But the cost of gain is just part of the equation in the regional competition. Markets, weather, facilities, expertise, feeder calf availability—those elements are just as important.

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