By Matthew Diersen,
Professor & SDSU Extension Risk/Business Management Specialist.
When developing a cattle marketing strategy for 2017, producers should consider basis as well as the multitude of factors which contributed to the continued price decline, said Matthew Diersen, Professor & SDSU Extension Risk/Business Management Specialist.Click here to see more...
"Sound price histories and benchmarks can help guide future marketing plan decisions," Diersen said. "Even with the changes in prices and futures contract specifications, average basis levels for fed and feeder cattle seem reasonable for South Dakota. However, the historic basis on calves is not likely to reflect the value of such calves in South Dakota and such prices should be derived differently moving forward."
Looking back on 2016, Diersen contributes price declines (over 2015 and 2014) to a continued expansion of cattle inventory levels, ample feed availability which contributed to heavier slaughter weights as well as expanded supplies of competing meats, such as pork.
Looking ahead, Diersen said early in the year is a good time to assess what those changes mean for price levels and basis expectations to help implement a cattle marketing plan.
The data behind cattle price trends are available in Monthly Cattle Prices and Basis Levels, which can be found on iGrow here.
Leading price to consider is fed cattle
The only Agricultural Marketing Service (AMS)-reported location with fed cattle sales in South Dakota is the Sioux Falls Regional Livestock (SFRL) market.
"Generally, the SFRL price for fed cattle tracks or is similar in level and changes with the five-area price, a national benchmark," Diersen said.
He explained that the SFRL price can also be compared to the Live Cattle futures price. "The basis can be monitored for any localized price changes and to arrive at an expected price level to use for planning purposes," said Diersen.
Basis is the difference between the cash price and the nearby futures price.
"The historically prevalent pattern in fed cattle prices is readily seen in the basis," he said.
For example, Diersen explained that the basis in May is often positive, reflecting an expectation of lower cash prices during June.
In other months, such as September through December, the basis is often negative, reflecting the transportation cost to slaughter markets.
The SFRL prices and basis levels include cattle with yield grades of 2-4, slightly wider than the futures specifications of 2-3. Looking at 2016 numbers, Diersen noted that there was a discount implemented for delivery on the October contract at SFRL in Worthing.
"Despite these factors, the impact on basis going forward is not expected to be significant for the same quality of cattle. Thus, to cover typical variability in basis, a 5-year average basis could be used for planning purposes," he said.
The latest 5-year average fed cattle basis for South Dakota, by month, ranges from above $5 per hundredweight in May to less than $5 per hundredweight in December (see Figure 1). "Expected basis should be adjusted if seasonality in futures is significantly different than in other years," Diersen said.
He explained that with an expected basis, forward bids for cattle can be compared to what would be likely using futures contracts for different months. "If a forward bid is less than a basis-adjusted futures price, then a producer could negotiate for a more favorable bid," he said.
The value of feeder cattle, and the resulting prices, reflect the feed and feeding costs involved in finishing cattle.
Beginning in November of 2016, the feeder index reflects feeder steers weighing 700-899 pounds. Prior to that, the feeder index reflected steers weighing 650-849 pounds.
"The change in weights may change the number and timing of feeder cattle from South Dakota included in the index. However, the relative value of feeder cattle in South Dakota compared to national levels is not expected to change," Diersen said.
To this point, Diersen said a 5-year average of historic basis could be used as an expected basis for the coming year.
The average feeder cattle basis has ranged from about $3 per hundredweight in January to above $9 per hundredweight in July and August (see Figure 2).
In most years cull cow revenue is a significant portion of total cattle revenue for cow-calf operations. "Calf prices can fluctuate and culling percentages can vary to affect the share of revenue, but overall cull revenue is important," Diersen said.
He explained that typically, the price of cull animals is measured or considered as a percentage of fed cattle prices. "During the past five years, the monthly cull cow price in South Dakota has averaged 66 percent of the live cattle futures price," Diersen said.
He added that more detail or scrutiny may be warranted for pricing or cross-hedging as the ratio has varied from 54 percent to 77 percent. However, for planning purposes a cull cow price could be found using two-thirds of the live cattle futures price.
Average basis on calves difficult to come by
The largest segment of cattle producers in South Dakota sell calves at or closely after weaning. A price series to monitor is that of 500-599 pound steers.
"Historically, there was a stronger seasonal pattern in calf prices throughout the year, roughly reflecting seasonality in fed cattle and feeder cattle at other times throughout the year," Diersen said.
Pricing and protecting tools and strategies for calves (for example, Livestock Risk Protection) still rely on some comparison to feeder cattle prices. However, Diersen said moving forward, caution should be taken before using any kind of average basis on calves.
"The wide price swings in feeder cattle and feed prices in recent years is masked by looking solely at the basis. The weight change in the feeder index would also bias any historical comparison," he added.
Cattle producers could search for a comparable year, but Diersen said this does not seem like a practical option given the many moving parts.
An alternative to consider for a calf basis is to estimate the feed cost to achieve gains from a 550 pound to an 800 pound animal. Subtract the feed cost off of the feeder value to find a per-head value of a 550 pound animal and back out a price.