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Depending on how you look at it,
short of buying a new cowherd periodically, you only have the
chance to turn your cowherd over—new genetics beginning to end
through selection and replacement—about 4 or 5 times in your
lifetime, give or take. That’s if you start young and stick it
out. If you started before the price freeze of 1970s that means
that half the time you’ve been turning the herd over into a
brand new business environment.
In the 1970’s it was runaway inflation, fueled by an energy
crisis, soaring commodity prices, wages and interest rates—not
necessarily in that order—which spawned stagflation: stagnant
economic growth accompanied by dramatic inflation. Interest
rates went through the roof and ultimately price controls were
implemented, which arguably caused more harm than good.
Today, it’s skyrocketing commodity prices driven mostly by
growing global wealth, a homegrown credit and financial crisis,
encroaching inflation and fears of stagflation.
“The current economic and financial situation reflects, in
significant part, the unwinding of two of these longer-term
developments—the housing boom and the credit boom—and the
continuation of the pressure of global demand on commodity
prices,” said Bern Bernanke, Chairman of the U.S. Federal
Reserve at the International Monetary Conference in June. “The
housing boom came to an end because rising prices made housing
increasingly unaffordable. The end of rapid house price
increases in turn undermined a basic premise of many
adjustable-rate sub-prime loans—that home price appreciation
alone would always generate enough equity to permit the borrower
to refinance and thereby avoid ever having to pay the
fully-indexed interest rate.”
Considering home prices had ballooned by about 90% between 1995
and 2006, according to Bernanke, when the housing bubble burst
there was enough air to blow down home-owners and the
institutions relying on sub-prime mortgages.
“A third longer-term factor contributing to recent financial and
economic developments is the unprecedented growth in developing
and emerging market economies,” said Bernanke. “From the U.S.
perspective, this growth has been a double-edged sword. On the
one hand, low-cost imports from emerging markets for many years
increased U.S. living standards and made the Fed’s job of
managing inflation easier. Moreover, currently, the demand for
U.S. exports arising from strong global growth has been an
important offset to the factors restraining domestic demand,
including housing and tight credit. On the other hand, the
rapid growth in the emerging markets and the associated sharp
rise in their demand for raw materials have been—together with a
variety of constraints on supply—a major cause of the escalation
in the relative prices of oil and other commodities, which has
placed intense economic pressure on many U.S. households and
businesses.”
Unlike the wage-price spiral precipitated by spiking commodity
prices and inflation in the 1970’s, Bernanke pointed out that so
far wages have remained flat, unemployment is still
significantly lower than it was then and inflation has remained
moderate, in part due to softening demand wrought by the higher
prices.
Speaking at the Northern California Regional Financial Planning
Conference in May, Janet Yellen, president and CEO of the
Federal Reserve Bank of San Francisco said, “I see little reason
to believe that we have entered, or are about to enter a period
of stagflation. For one thing, although current data on growth
and inflation have departed from desirable levels, matters
looked far worse 30 years ago than they do now.” She explained
the wage-price spiral associated with stagflation, “was spun
from the pass-through of rising food and energy prices to
inflation, which was in turn passed along to wages and, then
again, through to final goods prices. Fueling the movement were
expectations that monetary policy would allow inflation to
continue to rise for the foreseeable future.”
Back then, Bernanke explained inflation was in the double
digits, not the average 3.5% experienced by the U.S. during the
last year.
No matter the economic theory behind today’s situation, cattle
producers in all segments are facing increased challenges to
swing a profit.
Supply Cushions the Blow
Going clear back to 2003 and the aftermath of the first case of
Bovine Spongiform Encephalopathy discovered in the United
States, the supply side of the equation has prevented the market
from running south hard and fast. Consensus among market
analysts is that both the cattle feeding and beef packing
sectors have 20-25% excess capacity, relative to cattle numbers.
Part of that stems from organizations betting on the come and
part due to cattle attrition that has driven the longest and
flattest cattle cycle in history. Bottom line, so much pen and
rail space has been chasing so few cattle that prices have
remained higher than they would have in the face of BSE and
commodity prices that began escalating two years ago.
When you see deferred futures for live cattle at around $108
(the first part of June), even after corn futures broke new and
higher ground at $7 per bushel, it’s tempting to believe the
supply situation will continue wrapping a protective bubble
around calf and feeder prices, in relative terms.
Don’t bet on it.
At some point, logic says cattle feeding and packing capacity
will decline through consolidation to bring capacity into closer
balance with the supply. We’re already seeing it (see Ante Up
page 28). Moreover, little of the added cost of beef production
has been passed along to the consumer in the form of higher
prices. At some point, it will be and then consumers with
slimmer wallets will be choosing from a record supply of poultry
and red meat, meaning that beef demand may be difficult to
sustain, which in turn will pressure prices.
Already, a growing number of consumers are choosing low-priced
cuts of beef. That’s one reason—along with supply—that cull cow
prices have been so steamy.
According to the Livestock Marketing Information Center (LMIC)
the cutter cow cutout value peaked in May last year at
$119.48/cwt. In May this year the value hit a new record of more
than $130/cwt.
“A major factor has been rather small tonnage of imported beef,
attributable to several factors including lingering impacts of
drought in Australia and a weak U.S. dollar. In addition, a
weakening U.S. economy and rising fuel prices have shifted
consumer demand away from more expensive beef cuts towards lower
priced beef products such as hamburger, which cows provide,” say
LMIC analysts.
In turn, weekly live cull cow prices in the Southern Plains have
averaged $53.17/cwt., which is $2.59 higher than last year and
$5.00 more than the average for 2002-2006.
“Although supplies of slaughter cows continue to run larger than
last year, attributable in part to the addition of Canadian
slaughter cows to U.S. plants, cull cow prices should be
relatively strong this year due to stronger demand from the
wholesale sector,” say LMIC researchers. “If recent tends
continue, the annual average cull cow price in 2008 could easily
be record high. Still, seasonal lows are likely to be posted in
the fall quarter.”
Barring a major economic wreck—a deeper and sustained economic
recession or a bust in this year’s corn crop—there’s little
reason to expect the bottom to drop out of the market. Again,
because of supply and higher input costs, there’s every reason
to believe fed cattle prices will set a record high average this
year and that calf and feeder prices will continue to defy the
pressures of the corn market (see What’s Going On, page 20) for
at least another year or so.
But, prices and profit are obviously plumb different.
In fact, escalating input costs are spawning the first average
losses in the cow-calf business in a decade, according to
researchers at the Livestock Marketing Information Center (LMIC).
Specifically, LMIC estimates net returns for 2008 at -$20, based
upon estimates of typical Southern Plains annual cow-calf
returns over cash costs. In 2007, LMIC estimated returns were
+$34 per cow; the record high +$150 per cow occurred in 2004.
The picture appears just as gloomy once you get past the home
pasture. By June of this year cattle feeders had been losing
money by and large for about a year. For the first five months
of 2008 LMIC reckoned average losses were more than $134 per
head, based on feeding a 750 lbs. steers in a southern plains
commercial feedlot and accounting for all production costs. The
two heaviest loss months since the organization’s series began
in 1974 occurred in January and March of this year with per head
losses right at $170. At the time LMIC analysts explained,
“Although fed cattle prices have been quite strong, prices have
not been high enough to counterbalance feeder cattle and corn
costs. Looking ahead, given feed grain prices above a year ago,
as well as rather tight feeder cattle supplies, average feeder
returns will more than likely be negative for several more
months.”
The Costs Ahead
Projecting prices is a whole lot like predicting the weather:
the only safe bet is that reality will wind up on either side of
the expected average, either a little or a whole lot. With that
said, given current commodity price trends, and assuming the
corn crop doesn’t deteriorate more than it had by mid-June, this
is how the near-term appears to be shaping up.
Cattle
The World Agriculture Supply and Demand Estimates (WASDE) issued
in June called for the Choice steer price for the third quarter
this year to be $89-$93/cwt. and $88-$96/cwt. for the fourth
quarter. That’s way lower than what the futures market for live
cattle was predicting at the time, with August and October
futures at $100 and $108, respectively, and December priced at
$110. Fall feeder cattle contracts were trading for $111.
Barring a major spike in the corn market, lots of folks expect
fall calf and feeder prices to be similar to last fall, albeit a
bit lower, and likely with more demand for heavier weights (see
below). The average calf price last year was $119/cwt.,
according to the National Agriculture Statistics Service (NASS),
compared to $133/cwt.in 2006
Corn
As of June 10 WASDE estimated the 2008 corn crop at 11.7 billion
bushels. Ending stocks for 2008-09 were projected at 673 million
bushels, 760 million bushels below the 2007-08 forecast. If
realized, WASDE researchers say the 2008-09 ending stocks would
be the lowest since 1995-96. At the time, they forecast the
2008-09 marketing-year average farm price for corn at $5.30 to
$6.30 per bushel.
Wheat
The 2008/09 marketing-year average farm price is projected at
$6.75 to $8.25 per bushel
Soybeans
In June the U.S. season-average soybean price was projected at
$11.00-$12.50 per bushel by WASDE. Soybean meal prices were
projected at $295 to $355 per short ton. Soybean oil prices were
projected at 52 to 56 cents per pound.
Hay
As of the end of May the index of prices paid for hay and forage
(National Agricultural Statistics Service) was 26% more than a
year earlier. The all-hay price, $166 per ton, was $28 per ton
more than a year earlier.
Fertilizer
As of May the index (National Agricultural Statistics Service)
was 69% higher than the previous year.
Oil and Fuel
According to the federal Energy Information Administration (EIA)
in June West Texas Intermediate Crude prices, which averaged $72
per barrel in 2007, was projected to average $122 per barrel in
2008 and $126 per barrel in 2009.
Regular-grade gasoline was expected to average $3.78 per gallon
in 2008, or 97 cents above the 2007 average price. The U.S.
average regular gasoline price, over $4 per gallon at the time,
was projected to peak at $4.15 per gallon in August. Retail
diesel fuel prices were projected to average $4.32 per gallon in
both 2008 and 2009, an increase of $1.44 per gallon over the
2007 average.
World oil consumption was projected to grow by 1 million barrels
per day (bbl/d) in 2008. U.S. consumption of liquid fuels and
other petroleum was expected to decline by about 290,000 bbl/d
in 2008 because of higher petroleum product prices and slower
economic growth. Adjusting for increased ethanol use, U.S.
petroleum consumption was projected to fall by 440,000 bbl/d in
2008.
Odds-on Opportunities
Say what you will about value-added opportunities—and they do
exist—beef and cattle continue to be commodity businesses that
seek breakeven level pricing and returns. As such, pounds drive
returns and there’s only two ways to protect or enhance the
bottom line: cut costs and/or increase returns from the raw
product.
As feedlots seek cattle at heavier weights due to the high cost
of gain wrought by corn, the price spread between calves and
feeders has narrowed. That means there’s more opportunity to add
weight to calves ahead of marketing and come out ahead on both
ends of the equation. The caveat as always is adding weight if
the net economics allow it.
Even without adding weight, even with tight numbers, the price
spread is growing between same-weight, same-sex, same-class
cattle offered in the same area at the same time. It’s not
unusual to see spreads of $20/cwt. and more. What separates
cattle between the top and bottom of the range—be it a health
program, source and age eligibility, good old reputation or
something else—is the opportunity producers have to
differentiate their product more than ever before. Again, the
caveat is obtaining the differentiation a given market wants as
long as the net economic merit it. Identifying the opportunities
requires planning and communication, marketing rather than
selling. |
