As we move into the new year and begin to prepare for calving, the direction of the feeder cattle market is an issue that will need to be addressed. The price of feeder cattle results from the supply of feeder cattle by cow-calf producers and the demand for feeder cattle from feedlots.
Market expectations for feeder cattle demand are exceptionally positive given strong domestic demand for meat and a historically strong export market. Supply is expected to be lower due to an increasing contraction in the feeder cattle market in recent years. Together, this suggests that there is a high likelihood, with current market conditions, that feeder cattle prices will be higher in 2022.
With stable to positive price outlook through 2022, what needs to be done (if any) regarding feeder cattle price risk management? If market situations remain in the “stable to higher” scenario, then the best option for producers is to stay in the local spot market.
If prices start to weaken given the changing market fundamentals (i.e., Chinese beef demand starts to weaken given a stronger dollar), then we have need a base expectation (i.e. base = cash – futures) to determine which risk management tool to use.
In a weakening market, if the futures price is expected to weaken faster than the local spot market, then selling CME futures or buying hedge against breeding risks is the best form of trading. risks. However, if the spot market weakens faster than the futures price, then futures or spot contracts are preferred.
Animal production risk
If prices drop between the start of the year and calving, the USDA Risk Management Agency’s livestock hazard protection product is an option producers should consider. LRP was first proposed in 2002, but its use by cattle producers has been relatively minor.
For example, only about 0.5% of all cattle in the United States are insured under some form of USDA insurance. In 2018, the USDA-RMA began a series of changes to LRP to try to increase its use by producers. Three of these changes have direct implications for cow-calf producers.
The first was to increase the level of subsidy from 13% to 35%. This has made it cheaper for producers to insure livestock. Second, it allowed insurance premiums to be payable when the insurance product was terminated rather than when the product was purchased. This change more closely matches the cash flow from operations and frees up more working capital to use during the growth phase.
Third, he created a new insurance product for unborn feeder cattle. Historically, LRP required that calves were born before they were insured. With long, uneven calving windows, this change allows producers to insure against price movements before calves are born. Together, these changes have a positive effect on the use of LRP feeder cattle. During the 2020 and 2021 crop years, LRP contracts and primary policyholders reached historic highs.
Insurance quote for unborn calves
As an example of getting insurance quotes for unborn calves – if I looked at the USDA-RMA reports from November 29, 2021, for Nebraska unborn feeder cattle for sale September 26, 2022 (see table 1) – here is how I would read these quotes:
The second quote listed in Table 1 has an expected final value of $ 186,920, or what the market on November 29, 2021 expects feeder cattle to sell, nationwide, on September 26. 2022. The coverage level is the proportion of the end value that you want to insure – in this case 0.999800.
The cover price is the price to which the actual price of feeder cattle must fall before compensation is paid to producers. It is calculated by multiplying the expected end value and the coverage level (186.920 x 0.999800 = 186.890).
The cost per hundredweight is the unsubsidized insurance premium set by the USDA-RMA. The rate is the proportion of the unsubsidized insurance premium to the price of the cover (i.e. 11.449 / 186.890 = 0.061262) and gives an indication of how much the price should drop below the price of the cover. coverage before the premium is fully recovered. The producer premium per cwt is the subsidized rate and is the premium that the producer actually pays. In this case, $ 7.44 per quintal.
Although not indicated, the level of subsidy can also be calculated ([11.449-7.44]/ 11.449 = 0.35016). This is the amount of the premium that the USDA-RMA pays. The total premium to be paid to the USDA-RMA would be the producer premium multiplied by the number of hundredweight insured. In the case of a production of 500 quintals, the total insurance premiums would be $ 3,720 (ie 500 x 7.44 = $ 3,720).
Differences between LRP and CME put options
LRP works like CME puts by creating a floor price. Both are subject to basis risk (i.e. the difference between what we expect from the basis and what the basis actually becomes). However, there are two significant differences between these two products.
First, once the LRP is purchased, it must remain in place until the insurance product expires. This is different from CME, which allows options to be bought and sold until they expire worthless. Second, it allows producers to ensure a flexible quantity of output rather than a fixed quantity prescribed in CME contracts.
For example, if a cow-calf producer planned to sell 40 head of steers of 550 pounds, the total production would be 220 quintals (i.e. 40 × 550/100 = 220 quintals). A CME feeder cattle options contract requires 500 quintals of production. If this producer used the CME options to ensure its production, it would be more exposed to movements in the domestic market. In this case, a producer who wanted to set a floor price might be in a better position to use LRP versus CME put options.
In recent years, there has been an increasing contraction of the national stock of beef cows. This trend appears to continue through 2022. Most analyst estimates suggest that beef cow inventories will decline by 1% nationwide. This, combined with strong demand for domestic and export meat, created a situation for high prices for feeder cattle.
If market situations remain unchanged, it is acceptable to take all the price risk in the spot market. However, if the market prices start to deteriorate, then we should expect the direction of the base. The use of USDA-RMA LRP products is one product that can be used if the base needs to be strengthened. In each market scenario, we must strive to use the right market tool to match the current market risk.
Elliott is a livestock marketing economist at the University of Nebraska-Lincoln.