Price Risk Management Tools for Cattle Industry

[charliep]

I involved with a group looking at price risk management tools for the cattle industry. It is hard to think of these things in the current situation but a group of industry people have said the current challenge has really idenfied some longer term issues around price discovery/risk management.

1) Any thoughts on marketing alternatives/tools that could be developed to help the cattle industry manage risk/ensure transparent price discovery? Who should these tools be targeted at - cow calf, backgrounders, finished animals?

2) Thoughts on why COPP (Cattle Options Pilot Project) didn't work in the mid 1990's?

3) Thoughts on changes to information required of/provided to cattle industry participants? Madatory price reporting of sales? Monthly cattle on feed reports? Disclosure of cattle ownership (including packer)?

[rsomer]

I am sure you are aware of the USDAs Livestock Risk Protection Insurance that was available to U.S. producers before the Washington Holstein. See: http://www3.rma.usda.gov/apps/livestock%5Freports/lrp_select_date.cfm

I am not convinced measures directed towards keeping the packers honest such as mandatory price reporting and disclosure of cattle ownership will have any merit. Simply put, they have not intention of being honest. Risk protection models built around the present system of 2 large packers buying from 130 large feedlots who buy from however many backgrounders who buy from the 38,000 cow calf operators in Alberta will not work in the new post BSE beef industry.

The best way to reduce risk and ensure price discovery is to retain ownership of the animal as long as economically practical, ideally through to the actual beef product. Producer ownership of packing plants will work to reduce the risk associated with primary beef production. You ask "Who should these tools be targeted at - cow calf, backgrounders, finished animals?" It is acknowledged that the Canadian beef industry will be different after we come out the other end of the BSE crisis. One thing I see being different is calves will no longer be sold three times before slaughter. There won’t enough profit in each animal to split profits three or four ways in the future. Most producers will own their calves through to slaughter and ship them to a packing plant that they own in association with a large number of other producers. Intermediate operations such as backgrounding and finishing would still exist but on a custom basis.
The best way and really the only way to fix the problems associated with a commodity marketing system such as we have in Canada is not to market commodities. Own the product through the value chain and market a branded product rather than a commodity. If industry efforts were to be focused in this direction rather than come up with more patchwork fixes that typically skew market realities from sector to sector, we might as a Canadian industry achieve some real competitive advantage.

[kato]

Regarding the COPP, it might have been a good program, but no one could understand it. I went to an information meeting once, and every one there came home totally confused.

Personally, I liked the old tripartite stabilization program. Ah..the good old days.

[ValueChainFX]

rsomer well said!!!

Industry leaders seem to be out of touch with the real situation. Getting to the grassroots and listening to what they have to say makes it clear that a new industry design is already in the works. Balance in the system will mean that every component of the supply chain will be involved in one way or another, knowing each component is dependent on the other. A recent issue of meat and poultry highlights the challenges faced by agriculture world wide and more importantly in North America.

Marketing tools go far beyond the actual sale, everything we do as an industry is a marketing tool. Partners from around the world are looking for a protein source that meets their demands and they want to play hands on. Closer partnerships are being developed and will become more important as we move into the future and regulations become even tighter. Price points are a good indicator of what a commodity market is doing, but when it comes to what makes a long term market, consistent product delivered on time every time stands out more than price. As far as the other points I am hearing the rumbles getting louder that the information now being supplied isn't being used properly, feedback is non-existent and the bridges that should make a seamless system are just not there.

Making the Federal inspection system more available to producers will help us in getting the product ready to meet market demands, but the partnerships that are going to make our industry grow will rely on a system that can put the Canadian moral, ethical and principal driven system at the front of the pack. Our days of being aimlessly lead down the garden path could soon be over, I'm sure the road will not be easy, but chances are at the end of the day our industry will be stronger and less dependent on those that may have good intentions but slip a little when it comes to understanding the needs of those they represent!

[cowman]

I think you have it right rsomer.
Kato: As near as I can remember the tri-partate plan was a complete bust when it came to cow calf? Wasn't it the plan where you put in so much money per calf and if prices dropped below a certain level the program brought you up to that level? And it never paid out for five years and when finally prices tanked they cancelled the program? And I believe all the money collected was not returned to the participants but was given to the CCA or Beef Info center or something?

[kato]

At that time we were finishing our own steers. It worked pretty well for them. As for where the extra money went when it was over, I know we didn't get it.

It's kind of like NISA is now, some are going to do extremely well. You know, the ones with all kinds of extra cash over the last few years who picked up the big government contributions? As for those of us with no spare change to contribute, it's not going to do much.

How anyone can come up with a program that actually works, and is good for everyone is the million dollar question.

[rsomer]

The NTSP forced us out of the cattle finishing business. The big feedlots were abusing the program by paper trading cattle and bid up the price of feeders to a point where we could no longer compete.

We do need to change as an industry. The status quo is not acceptable. People realize that the market risks associated with finishing cattle are determined basis the Canadian market but the offsetting profitability is determined in the North American market place. For the past two years I have publicly called for a made in Canada price discovery mechanism and risk management tool. After BSE people may see what I was talking about but before BSE no one got it. Now there is a realization that, yes, basis risk was greater than price risk and what was supposed to be a hedge on the CME was not a hedge at all but further speculation. It was that way before BSE too but the perception of the basis risk was different before May 20 than after May 20.

Some things I would suggest about price and risk mechanisms. The notion that stabilizing feedlot incomes will trickle down to the cow calf operators is nonsense. The cattle industry is focused on having year round importation of U.S feeders. Increasing the competitiveness of the 130 large Canadian feedlots by creating a made in Canada risk management tool will increase the profitability of these 130 people and the two packing plants and the packer owned cattle but very little of this money will trickle down to Alberta’s 38,000 cow calf producers beyond the price of what U.S. calves can be imported at.

So stabilizing the beef commodity market from the top down doesn’t work as the money does not trickle down. What about price-risk tools from the bottom up? That is what FIDP and CAISP was meant to do. These programs were supposed to reduce risk for the primary beef producer. The problem with these programs is that they are based on 5 year averages of profitability. Three strikes in five years and you are out of the safety net. Not to mention that the profitability of commodity production naturally declines because of the pressures of a nearly pure competitive commodity market. Throw in the effects that a rising Canadian dollar will have on the profitability of the Canadian beef industry in the next few years and most will see that stabilizing margins based on profitability is a sure fire way for the Canadian government to phase itself out of the stabilization game in less than five years. No one will have any margins left to stabilize.

So what to do. Encourage cow calf operators to own calves through to finishing in the short term, through to the boxed beef product in the long term. Distributing the ownership risk from 130 feedlots to 38,000 beef producers effectively manages that risk. The competitive advantage the large feedlot had was not in feeding the cattle but in marketing the cattle. The packers preferred to buy from large feedlots, it was cheaper and the large feedlots had a bargaining lever as it was practical for them to ship live cattle south if Canadian bids were not competitive. If the cow calf operator realized his own costs and profits, he would see the opportunity to double his profits per calf by feeding the calf through to slaughter. What seems to be lacking is a marketing tool that allows small operators a practical method to sell cattle into the slaughter market at competitive prices. Although computer bidding and that kind of technology is a step in the right direction, there still needs to be a way for small operators to assemble competitive loads of cattle that can match what the large feedlots are doing so that U.S. markets could be accessed once the border opens. Ultimately, owning their own packing plant removes the barriers to get the packer to accept the smaller producer’s calves.

At some point the Province of Alberta is going to need to realize that meeting its value added goals for agriculture is going to have to come from the grass roots. Politically, giving $600 million to a handful of feedlot operators and two multinational packing plants is not viable. Raising the ceiling on CAISP to $1million and beyond will destroy rural Alberta as no small operators will be able to compete.
Increase the profitability of the primary cow calf operator by creating mechanisms whereby the industry, which is really made up of 38,000 producers in Alberta and more beyond in Canada, can retain ownership of their own cattle as long as possible thereby becoming vertically integrated producers of branded beef products to North America and the world. That is my vision for how to manage risk in the Canadian beef industry.
Perhaps this vision has little place for the 130 big feedlots owning cattle in this country but their time is done in any event. Either we devise a method for Canadian cow calf producers to retain ownership of their own calves past slaughter, thereby achieving a true competitive advantage for the Canadian beef industry world wide or the calves will be owned by American feeders and American multinational firms. The first way is best.

I guess I am ranting. The five second version is manage the risk by distributing ownership to as many producers as possible, avoid commodity price risk by vertically integrating into the branded beef market on an industry wide basis.

[ValueChainFX]

rsomer you are ranting a great tune, I'm totally on track with a few slight questions but nothing so drastic as to change that tune!!!

I would enjoy a little more detail of what your thoughts are valuechain@telus.net

we may be further down that path than you know!!

[ValueChainFX]

charliep after reading over my comments on the first one here, please don't get the impression I was against you or what people are trying to do in anyway! I just think many of these folks need to slip on a pair of rubber boots and go talk directly to some of the primary producers!

[pandiana]

rsomer, I am going to print these posts and put them on my refrigerator so that I and anyone else interested can be reminded that this is the best solution offered to date. Some problems remain,of course:

How do cash strapped 'read broke' cowcalf producers retain ownership and buy into a cooperative packing facility in the short term?

How do small operators compete with large farms in making a product that is uniform and good, that will allow the packer to be competitive in the market?

Along the same line as above, if you own a hook at the packer, what criteria would you have to meet in order to use it,..or are there criteria,...or can you ship anything?

[cowman]

rsomer: I am impressed! You should be in Parliment! I find your reasoning totally correct. I might add, value chain has been preaching the same thing for quite a while now!
But like pandianna, I now ask how do we achieve this?

[ValueChainFX]

The foundation plans can be found on the following web site!

http://www.angelfire.com/folk/valuechain/

There are plenty of hurdles to overcome, however, many of the questions you ask now have been asked and solutions found, or at least explored.

We have talked to some lending institutions that have expressed an interest into lending individual producers the share money needed to buy in! (a separate set of issues here). Ownership of animals as far into the system as possible has several protective measures conceptually built in but shared input costs and shared returns are the most interesting so far. Consistency is a challenge for the whole supply chain, partnership programs and an information exchange system combined with Quality assurance, Branded programs and close working relationships throughout the supply chain will be required. These components have been included in the plan and several of the partners have already come on board to assist in these areas.

The producer group board is meeting on Thursday and will be putting meetings together for Alberta, if you are interested in a meeting in your area I would suggest sending me a short e mail that I can pass along to board members!

valuechain@telus.net

[kato]

A model to investigate might be the Manitoba Pork Marketing Board. The board is run by producers, and producers sell their hogs to the board, which then assembles loads to sell at the best price they can get. I don't hear any complaints from producers about it. They are starting to have the same problem as the cattle in that there are less packers to bid on the hogs, though.

The hogs are paid out based on their grading index, so that is probably simpler than the cattle would be. Nevertheless, there are lots of things about the setup and operation of the board that could be adapted.

A few years ago we had a Beef Marketing Commission in Manitoba. I'm not sure why they scrapped it, though. Maybe someone else can remember.

[ValueChainFX]

Kato thanks for the info, the plan we are working with now is a pilot project and designed to go national when we have proof of delivery. We have had interest from across Canada in what we are doing. The template along with plans and a tie in to the communication and information exchange system will be implemented.

[rsomer]

charliep: I've given some thought to marketing alternatives/tools that might work to support the beef industry in the short term.
I have been told by credible sources that between 60%-80% of feeders over 800 pounds are controlled by this countries two major packing plants. Probably closer to the 80%. If this is true then we will have no functioning competitive live cattle market in Canada until the border is opened to live cattle or sufficient competition is created in this country by competing firms adding packing capacity.
For this reason any efforts to transfer some of the market risk of a feedlot or backgrounder such as myself to the government will not work as there is no functioning market to base such a program on and the packing plants will simply manipulate the prices paid so all the benefits of any program are funneled directly to them.
Worst case scenario, the U.S. will not open the border to live cattle until after the elections this November as every vote is important and there are no votes to be won by granting access to Canadian live cattle. In the meantime, I think the options to assist the primary producer are rather limited in the interim period and must not be market based.
I don’t think there is time or the political will or even the ability under NAFTA rules to set up a marketing board in order to create some kind of functioning market for live cattle. CAISP will help some but that money comes some time down the road, probably after the border is opened and competition has returned to the industry. The CAISP money will come too late for many producers and the rural economies depending upon agriculture.
Something that might work. If it true that 80% of the 800 pounds and up calves are owned by packers then the focus on government support could be on calves under 800 pounds. Let CAISP deal with the 20% of finishing calves of which many would be owned by doctors and lawyers and such. A direct one time payment of money to producers holding calves under 800 pounds as of December 23, 2003 might provide the industry some cash flow without the benefits going directly to the packers.