By Nathan G. Briggs
Have you lost money selling cattle due to the recent market downfall?
Contracting cattle is a way to mitigate the financial burden that can result from volatility in cattle prices. Contracts can be made between feedlots and packers to purchase cattle prior to reaching their finished market weight. Contracts can vary in size, but generally require a minimum of a semi load of cattle. Sometimes half loads will be accepted for Holstein cattle. Generally, a semi load of cattle is around 40 head of cattle, depending on the average weight of these animals (60,000 pounds per semi load).
Within the contract, cattle prices are often based on a grid system, which gives premiums and discounts depending on quality and yield grades of the resulting carcasses.
There are two types of contracts — set-price and open
A set price contract is used to lock in a price to sell your cattle as far out as six months prior to slaughter. During the recent market decline due to COVID-19, feedlots that contracted a set price for cattle back in December would have received around $113 per hundredweight to sell their cattle in April. The open market price for live cattle in April was actually around $88 per hundredweight. This is a difference of $15,000 per semi load, which could easily be the difference between turning a profit or a loss for the year. In addition, when packers were shut down, contracted cattle were prioritized for processing because the packers essentially already owned those cattle. Thus, contracts gave producers an outlet for their cattle during these uncertain times.
In a more stable world, if producers know what their breakeven price is, then they can take advantage of contracting cattle by locking in a price to ensure a profit. Thus, most producers will contract cattle at a price above their breakeven price. There is a risk that by the time cattle are finished, the open market price is actually greater than the contracted price. The contracted price will not change even if the market price is greater at that point in time. While a great deal of risk is mitigated, some added profit can be missed. But the goal of contracting is to ensure that your operation generates income above your breakeven price. One strategy often employed is to use set-price contracts when live cattle prices are high, not low.
An open contract is similar in some ways, but the biggest difference is not having a set price for the cattle. Cattle sold on an open contract go by the current market price for that specific day, and the price will change daily. The benefit of this type of contract allows the producer to pledge a certain number of cattle at a certain point in time in the future. The downside to contracting cattle this way is the risk of market volatility. The main goal of this type of contract is to ensure you have an outlet for your cattle. When packers were shut down due to COVID-19, cattle that were on an open contract were still contracted and, thus, prioritized over those that were not contracted. If you know you will have cattle ready and are planning to market your cattle to a packer, then the open market is a nice way to ensure your cattle have a place in line at the packer.
If your cattle business strategy aligns with selling cattle directly to the packer, then contracting cattle can be a tool used to hedge against market downfalls. Before you decide to contract cattle, you need to know your business expenses. Do not forget to add your time into your total business expenses.
Once you have determined your business expenses, you can determine a breakeven price to determine when to contract cattle.
Hindsight is 20/20; do not get caught looking back. Use the tools available for marketing cattle. If you are able to contract cattle, then you can ensure the profitability of your operation in the future. Source : psu.edu