Risk Management Issues Facing Beef Cattle Production

ERME Pre-Conference

The Changing Role of Risk in Livestock Production Management

April 2, 2013

Shannon Neibergs Associate Professor Extension Economist, Director WCRME

Overview of Presentation

• Price variability and market risk in beef markets

• Cattle risk management options

• Production management risk issues• Feed additives - Ractopamine• New management tools

Monthly Meat Price Spreads

http://www.ers.usda.gov/data-products/meat-price-spreads.aspx

Beef Price Spread Analysis

• Net Farm Value share of retail value increasing since 2010 • Derived demand market is driven by the consumer (domestic and export)• Beef demand continues to struggle in the start of 2013• First quarter beef production is lowest since 2006 down 3% from 2012• Beef production down due to decreased slaughter numbers – carcass weight increasing• Composite cut-out value has an apparent price ceiling at $200 cwt • Fed cattle trading to trend below $130 cwt• Substitution effects between protein products limits price gains

Meat in cold storage is relatively high

Source: DLR Vol. 11, No. 16 / January 23, 2013

Beef export trendsU S BEEF EXPORTS TO MAJOR MARKETS

Carcass Weight, Monthly

0

10

20

30

40

50

60

70

80

90

2005 2006 2007 2008 2009 2010 2011 2012 2013

Mil. Pounds

Japan

Canada

Mexico

SouthKorea

I-N-3503/11/13Livestock Marketing Information Center

Data Source: USDA-ERS & USDA-FAS

Cattle on Feed Profitability

AVERAGE RETURNS TO CATTLE FEEDERSFeeding 725 Lb. Steers, S. Plains, Monthly

-325-275-225-175-125-75-252575

125175225275

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

$ Per Head

Livestock Marketing Information CenterData Source: USDA-AMS & USDA-NASS, Compiled & Analysis by LMIC

C-P-2203/15/13

Negative profit pressure on feeder prices

MED. & LRG. #1 FEEDER STEER PRICES700-800 Pounds, Southern Plains, Weekly

90

100

110

120

130

140

150

160

170

JAN APR JUL OCT

$ Per Cwt.

Avg.2007-11

2012

2013

C-P-4903/25/13Livestock Marketing Information Center

Data Source: USDA-AMS, Compiled & Analysis by LMIC

And calf priceMED. & LRG. #1 STEER CALF PRICES

400-500 Pounds, Southern Plains, Weekly

115

135

155

175

195

215

235

JAN APR JUL OCT

$ Per Cwt.

Avg.2007-11

2012

2013

C-P-49A03/25/13Livestock Marketing Information Center

Data Source: USDA-AMS, Compiled & Analysis by LMIC

Cow – calf returnsCOW-CALF RETURNS

AND CATTLE INVENTORYU.S., Annual

-100

-60

-20

20

60

100

140

180

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

$ Per Cow

85

90

95

100

105

110

115

120Mil. Head

Cow-CalfReturns

CattleInventoryJan 1

C-P-6712/18/12

Livestock Marketing Information CenterData Source: USDA-AMS & USDA-NASS, Compiled & Analysis by LMIC

Cattle on Feed – will declining supply drive price?

CATTLE ON FEEDUS Total, Monthly

9.5

10.0

10.5

11.0

11.5

12.0

JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC

Mil. Head

Avg.2007/11

2012

2013

C-N-1003/22/13Livestock Marketing Information Center

Data Source: USDA-NASS

Cattle Risk Management Options

Cow-Calf Market Risk

Favorable calf prices have eased market risk management for cow-calf producers – given adequate forage availability.

Market Risk Management Options

1. Forward Contract• Direct to feedlot• Backgrounding operation

2. Hedging – risk transfera. Offset futures market contract transaction with local cash

marketb. Futures Market

• Feeder Cattle Contract 50,000 lbs, 650-849 lbs • Live (Fed) Contract 40,000 lbs, 55% Choice, YG 3

c. Options Market• Put and call collar strategy

Basis – Price difference between Chicago and Toppenish

428 S. G StreetToppenish WA 98948

Market Risk Management - Basis

www.BeefBasis.com

BeefBasis.com current hedge analysis

Market Risk Management Options

3. LRP (Livestock Risk Protection) insurance is an USDA RMA insurance policy intended to provide protection against a price decrease for feeder and fed cattle.

• If the Actual Ending Value is below the Expected “Insured” Ending Value a loss may be paid relative to the Producer’s chosen coverage level.

LRP Parameters

To Execute a LRP insurance policy

When purchasing an Specific Coverage Endorsement (SCE) through an insurance agent (http://www3.rma.usda.gov/tools/agents/companies/indexLPI.cfm)

Producer Determines:Number of head to insureDate and weight expects to market livestock

Producer Selects:Coverage priceEndorsement length

Producer Pays premium:Endorsement in effect upon receipt of RMA approval number

LRP Purchase Coverage Prices, Rates

http://www3.rma.usda.gov/apps/livestock_reports/main.aspx

LRP Actual Value Feeder Cattle Price Index

http://www.cmegroup.com/market-data/datamine-historical-data/cash-settled-commodity-index-prices.html

LRP Coverage Prices, Rates and Actual Ending Values

http://www3.rma.usda.gov/apps/livestock_reports/main.aspx

RLRP Coverage Prices, Rates and Actual Ending Values

Risk Averse Scenario - choosing highest coverage availableEndorsement  

Length    13 weeks NotesExpected end value $159.739 From RMA TableCoverage Level 0.9629 Producer ChoosenCoverage Price $153.813 From RMA TableCost / cwt $2.644 From RMA TableAssume 100 600 lb Feeders 600 Cwt insuredInsured Value $92,288 Insure coverage pricePremium Payment $1,586 Cost * insured weightSubsidy 13% $206 13% subsidyNet Premium Payment $1,380 Net premium paymentActual End Value $138.83 CME price indexIndemnity Payment $8,989.61 (Coverage-end)*cwtsGain/(loss) in expected market value ($12,545.40) ROUGH estimate of market loss

   Gain/(loss) in LRP investiment $7,609.44 Indemity - net premium paymentROI on LRP 551% Gain / net premium payment

Market Risk Management Options

3. LGM Cattle (Livestock Gross Margin Cattle) insurance is an USDA RMA insurance policy intended to provide gross margin protection between fed cattle price and (cattle feeder cost and feed cost).

LGM Cattle

LGM for Cattle is different from traditional options in that LGM for Cattle is a bundled option that covers both the cost of feeder cattle and the cost of feed. This bundle of options effectively insures the producer’s gross margin (cattle price minus feeder cattle and feed costs) over the insurance period.

Indemnity at end of 11-month insurance period is the difference, if positive, between gross margin guarantee and actual gross margin

Does not insure against loss due to death or damage to cattle

LGM Cattle

Expected/Actual gross margin per head of cattle for a yearling finishing operation =

(12.50 * Live Cattlet) – (7.50 * Feeder Cattlet-5) – (50 * Cornt-2)

Gross Margin Guarantee = Expected gross margin – deductible Deductibles from $0 to $150 per head

The premium is calculated by a determinant Monte Carlo simulation procedure

Indemnity payment = Gross margin guarantee – actual gross margin if greater than zero

U.S. LRP and LGM Summery of Use

LRP LGM LRP LGM LRP LGM

2008 715 32 500 22 1.62 1.30

2009 410 21 242 8 1.60 0.37

2010 803 9 441 0 0.48 0.00

2011 1460 8 447 2 0.16 0.10

2012 1228 2 669 1 1.15 1.58

Loss Ratio

LRP and LGM Policies and Loss Ratios

Federal Crop Insurance Corp. Summary of Business - Livestock as of 03/28/2013 http://www3.rma.usda.gov/apps/sob/soblpi/commodity.cfm

NumberPolicies Earning

Premium

NumberPolicies Earning

Indemnity

2012 LRP by State Use2012 By State LRP Feeder Cattle Summary of Business and Loss Ratios

StatePolicies

Earn PremPolicy

IndemnityNumber of Head

Avg head policy Liabilities

Total Premium Subsidy Indemnity

Loss Ratio

ALABAMA 2 2 50 25 43,417 1,272 164 2,862 2.25ARKANSAS 2 1 157 79 162,756 1,591 207 7,530 4.73CALIFORNIA 0 0 0 0 0 0 0 0 0COLORADO 22 5 2,416 110 2,502,953 55,826 7,256 28,313 0.51GEORGIA 2 2 346 173 373,240 11,716 1,523 27,302 2.33IOWA 29 15 4,839 167 5,027,134 119,003 15,471 177,078 1.49IDAHO 12 5 1,006 84 1,046,433 27,950 3,635 32,099 1.15ILLINOIS 1 1 7 7 5,986 91 12 162 1.78INDIANA 3 2 340 113 357,539 7,049 917 3,182 0.45KANSAS 157 96 24,199 154 23,766,208 434,697 56,523 684,973 1.58KENTUCKY 9 5 911 101 908,370 12,388 1,610 21,152 1.71MICHIGAN 0 0 0 0 0 0 0 0 0MINNESOTA 14 7 1,305 93 1,508,524 36,715 4,774 17,302 0.47MISSOURI 47 27 9,716 207 10,373,453 227,288 29,550 382,629 1.68MISSISSIPPI 1 1 75 75 69,774 2,570 334 2,298 0.89MONTANA 34 26 5,005 147 4,997,361 161,322 20,973 266,565 1.65NORTH CAROLINA 0 0 0 0 0 0 0 0 0NORTH DAKOTA 126 68 15,745 125 17,722,975 381,829 49,634 687,019 1.8NEBRASKA 231 136 27,202 118 27,122,685 773,296 100,527 976,992 1.26NEW MEXICO 2 1 2,180 1090 2,850,892 94,867 12,332 98,814 1.04OHIO 0 0 0 0 0 0 0 0 0OKLAHOMA 87 33 25,743 296 27,217,127 467,110 60,724 425,890 0.91OREGON 11 8 2,267 206 2,751,545 79,886 10,384 95,394 1.19SOUTH DAKOTA 278 133 40,855 147 41,475,990 1,278,042 166,138 1,046,667 0.82TENNESSEE 21 12 3,884 185 4,095,138 43,029 5,594 29,647 0.69TEXAS 8 5 1,608 201 1,603,665 22,698 2,951 30,420 1.34VIRGINIA 23 17 1,843 80 1,984,994 40,916 5,319 95,248 2.33WASHINGTON 10 9 580 58 592,993 24,283 3,157 44,078 1.82WISCONSIN 5 3 253 51 275,398 6,970 906 1,069 0.15WEST VIRGINIA 20 5 1,569 78 1,736,826 33,933 4,415 21,927 0.65WYOMING 17 11 2,944 173 3,481,959 98,369 12,787 181,760 1.85

Federal Crop Insurance Corp. Summary of Business - Livestock as of 03/28/2013 http://www3.rma.usda.gov/apps/sob/soblpi/commodity.cfm

AGR – Lite Revenue Insurance

Adjusted Gross Revenue (AGR) –Lite is a whole-farm/ranch revenue protection plan of insurance.

• Uses a Producer’s 5 year historical farm average revenue as reported to IRS on Schedule F.• Provides insurance for multiple commodities in one insurance product.• Widely available (WA, ID, OR and several others).

• Subsidized premium:

• Insurance based on revenue but Schedule F expenses are reviewed.

• March 15 purchase deadline.

Revenue Premium CoverageSubsidy Levels

48% 80%55% 75%59% 65%

Market Risk

No matter what market risk tool you chose to use, you still need to market the cattle and deliver them to a sale point.

http://texashistory.unt.edu/ark:/67531/metapth43358/

Production Management Risk – Feed additive

Change in beef production management due to ractopamine hydrochloride

• Very effective feed additive to promote lean muscle growth • FDA approved and commercially available since 2004• Optaflex and Zilmax for beef, Paylean for swine• Partitions nutrients from fat growth to lean growth through increased protein

synthesis • Trials show 17 to 21 lbs increased gain and increased dressing percent with

limited impact on quality grade

Production Management Risk – Feed additive

Impacts in beef production management due to ractopamine hydrochloride

• Cattle can be placed in feedlots heavier but are on feed relatively longer to increase lean carcass weight

• Packaging issues• Larger rib eyes increases ability for thin cut steaks and maintain adequate portion size • Traditional grilling steaks are larger and priced on weight are expensive• Changing how families eat steak as they are passed around the dinner table, or will consumers

accept steaks cut in half• Increased size of roasts are not as much an issue and increased trim is beneficial in the

hamburger production chain

Production Management Risk – Feed additive

Market risk due to ractopamine hydrochloride

• FDA approval does not ensure consumer acceptance• bST and fluid milk • Ammonium hydroxide treatment of Lean Finely Textured Beef

• Trade restrictions on ractopamine • Russia, China, European Union• Separate production / processing systems if packer wants to serve those markets

• Differential demand across the carcass cuts• Agreeing to ship ractopamine free pork and beef to these markets could lead other countries to

introduce similar restrictions• If producers stop using ractopamine at a time of record-high feed prices, they will see their

losses increase

Production Management Risk – Marker assisted selection

Examples of genetic markers under investigation• Disease susceptibility to BRD • Feed efficiency • Meat quality• Grazing tendency • Reproductive efficiency

• Marker assisted selection • Marker assisted selection effective for individual trait phenotypes• Work needed on determining the co-variance between genetic markers

• Positively or negatively correlated• Heritability of traits• Economic importance

• Marker assisted selection implemented at cow-calf level• Extract market value of improved genetics at weaning

• Value of preconditioned calves• Retained ownership

Summary and Questions

Thank you

Shannon Neibergssneibergs@wsu.edu

509 335 6360