Cattle prices go down as consumer
beef demand declines due to decreasing beef quality, and risk
increases. That’s what happens when you try to legislate the
market.
Specifically, that’s what would
happen if Alternative Marketing Agreements—basically anything
that isn’t a cash trade in the spot market—were restricted,
according to the recently concluded $4.5 million dollar GIPSA
Livestock and Meat Marketing Study. It was conducted by RTI
International for USDA at the behest of the industry, including
the National Cattlemen’s Beef Association (NCBA).
“During debate of the 2002 Farm
Bill, concerns from producers about packer concentration led
NCBA members to ask Congress to study the livestock and meat
marketing complex,” explains John Queen, NCBA president. “In
2003, Congress authorized $4.5 million to conduct an independent
study of the livestock and meat marketing complex and provide a
report that would be the definitive answer on this issue.”
In sum, the cattle portion of the
study concludes that if Alternative Marketing Agreements (AMAs)—including
packer-owned fed cattle, formula pricing and forward
contracting—were reduced or eliminated feeder cattle producers,
feedlots and packers would all make less money, while the
consumer would pay more for a product of less quality.
“The cost savings and quality
improvements associated with the use of AMAs outweigh the effect
of potential oligopsony market power,” says the report. “In
model simulations even if the complete elimination of AMAs would
eliminate market power that might currently exist, the net
effect would be reductions in prices, quantities and producer
and consumer surplus in almost all sectors of the industry
because of additional processing costs and reductions in beef
quality. Collectively, this suggests that reducing the use of
AMAs would result in economic losses for beef consumers and for
the beef industry.”
Try this on for size,
researchers—some of the top agricultural economists in the
nation—simulated both a 25% reduction in AMAs and the complete
elimination of them. When AMAs were reduced by 25%, what is
termed producer surplus—basically what would be compared to what
could have been—decreases by an estimated $1.9 billion and
consumer surplus decreases by an estimated $0.4 billion in the
short run. Consumer surplus decreases because consumers would
have to pay more, yet no one in the production chain would be
making any more. By year 10, producer surplus declines by an
estimated $0.7 billion and consumer surplus declines by an
estimated $0.2 billion.
In the scenario where AMAs are
eliminated, producer surplus decreases by an estimated $10.5
billion and consumer surplus decreases by an estimated $2.0
billion in the short run. By year 10, producer surplus declines
by an estimated $4.0 billion and consumer surplus declines by an
estimated $0.8 billion.
According to these simulations,
salt in the wound comes with the fact that any market power such
restrictions would take away from packers would be overwhelmed
by other economic losses.
“The positive effect of reduced
potential oligopsony market power that might result from
restricting AMAs is unable to offset the negative effects of
increased processing costs and reduced quality associated with
restricting AMAs. In describing these results, it is important
to note that the economic incentives associated with using
individual types of AMAs by individual industry participants may
differ from the results for the industry as a whole,” say the
researchers. Oligopsony is basically the condition that exists
when there are a relatively small number of participants who
control a relatively large proportion of market share.
The study includes prices for fed
cattle during the October 2002 through March 2005 period. The
survey data are from 293 beef cattle producer and feeder
responses and 64 beef packing plant responses across a range of
sizes. The purchase data represent all purchases of fed cattle
by 29 of the largest beef packing plants during the time period
and include 58,066,440 head sold in 591,410 transactions. This
is also the first industry study to include actual Profit and
Loss data from the packing industry.
Furthermore, approximately 60% of
the transactions were either cash or direct trade. The AMA
cattle represented about 40% of the transactions—marketing
agreements (29.5%); forward contracts (4.2%); packer-owned (less
than 5%). Thus the focus of the study on how AMAs affect the
market.
Marketing Agreements Decrease Cost—Increase Quality
“The direct cost savings from AMAs is approximately 0.9% of
Average Total Costs, or approximately $1.22 per head,” says the
study. “Packers also experience additional cost savings from
reduced variability in cattle supplies ($1.70 per head) and
increased slaughter volumes ($3.56 per head) at packing plants.
The total cost savings associated with AMAs is approximately
$6.50 per animal. For an industry with an average loss of $2.40
per head during the 30-month sample, this is a substantial
benefit.”
According to the study, feedlots
identified cost savings of $1 to $17 per head from improved
capacity utilization, more standardized feeding programs, and
reduced financial commitments required to keep the feedlot at
capacity. Both feeders and packers agreed that if packers could
not own cattle, higher returns would be needed to attract other
investors and that beef quality would suffer in an all-commodity
market place.
In fact, states the report: “Beef
producers said that cattle quality would suffer in an all-cash
market environment because it is more difficult to control
quality when using the cash market rather than using long-term
or forward contract arrangements. Although many believe it is
possible to purchase quality cattle in the cash market, they
also believe that the quality of cattle procured in the cash
market is more variable… Some producers stated that they need
formula sales under a marketing agreement to obtain premiums for
producing cattle for customized buying programs. Packers said
the ability to obtain quality cattle under AMAs was a much
stronger incentive than issues related to procurement costs.
Because beef product buyers are demanding higher quality
products, packers use AMAs to ensure that cattle purchased meet
the quality standards needed to meet buyer requirements for beef
products…”
In other words, decrease quality
and consistency, and you decrease beef demand.
“Consumer demand for meat is affected by the use of AMAs if
those arrangements allow for the production of higher quality
products and/or sale of beef products at lower prices. Based on
the analysis of the transactions data, we found that fed cattle
purchased through marketing agreements had a higher percentage
of Choice and Prime Quality Grade cattle without a higher
percentage of Yield Grade 4 and 5 cattle,” say the researchers.
“Restrictions on the use of AMAs would decrease the quality of
beef products. Beef products are substitutes for other types of
meat and poultry, and thus a decrease in the quality of beef due
to reductions in the use of AMAs would decrease the
competitiveness of beef relative to its substitutes.”
It’s About Risk
Spin this around, AMA’s provide both producers and the industry
a sturdy, reliable risk-management tool, in more ways than many
usually consider.
Looking at packer ownership,
specifically, the study concludes: “One implication of
restricting AMAs that was noted by several respondents was the
impact on risk-bearing ability and capacity utilization. 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.”
The study results comprise a massive volume (you can find it at
www.gipsa.usda.gov). But it’s one every producer should give
a gander. Aside from accomplishing its purpose of quantifying
the impact of arbitrarily deciding cattle businesses can’t do
business with one another how they choose, the study serves as a
short course for what drives industry economics beyond the
cow-calf pasture.
“Buyers of livestock and meat may
choose to use specific marketing arrangements because they
reduce the cost of procurement, improve the quality of animals
and products purchased, aid in risk management, and generate
efficiencies in procurement and marketing. Likewise, sellers of
livestock and meat may choose to use specific marketing
arrangements because they facilitate market access, reduce the
cost of selling, increase the price received, and reduce risk,”
says the report.
The benefits outweigh the costs. |
