Price Risk Management Tools for Cattle Industry

[pandiana]

An excerpt from News Roundup, Cattleman p40 January 2004 certainly seems to confirms your concerns.

"Packers have been making most of the money in the last few months and those funds appear to be put to work purchasing more and more of the available cattle. Cattle feeder John Prentice of Calmar believes captive supplies are growing at an alarming rate. From 1998 to 2000 about 68% of the cattle in Alberta were purchased on the cash market. That dropped to 60% by 2002. "And if we took a straw poll today I'd bet we'd find it was about (30%). The point is, price discovery is being impaired."

Packers voluntarily report their method of procurement in confidence to Canfax who publish an annual summary but Prentice finds this of little value other than a historical interest. What he and the other feeders at the ABP want to see is Canadian legislation similar to the U.S. Livestock Mandatory Report Act of 1999. "An open market and the discovery of price operates when there's perfect kowledge on both sides," Prentice says. "And we don't have that here now."

The idea of regulation didn't sit well with some of the rancher delegates to this meeting, such as Russel Picker of Bassano who represents the Western Stock Grower's Association on the ABP, "I don't think we should be legislating anything that interferes with commerce," he says. "It may make packers less inclined to work with us. Are we willing to tell the packers andeveryone else whether our cattle are contracted. We should have to disclose the other way too. It can't be a one-way street" " end of quote

[pandiana]

rsomer, maybe you can help me understand your last post. Have you abandoned the retained ownership idea and are counting on government support?

Through these posts, the problems are becoming a little clearer but the solutions just keep getting muddier.

What seems to be happening is the packers, with deep pockets and market power, can secure enough cattle to keep their costs down and profits up.

Suggestions to counter this are to retain ownership through to the packer/retail which would have the effect of top down distribution of profit.

The problem then becomes how does the producer - packer cooperative then go head-to-head with the multinational packer conglomerates? If we are marketing the same product, can we compete efficiently?

[rsomer]

While I agree with John Prentice's comments "An open market and the discovery of price operates when there's perfect kowledge on both sides", I would argue that in our situation the problem is more a lack of competition than a lack of knowledge.
Competition is the heart and soul of markets and efficiency. Without competition efforts to make Canadian beef markets more efficient by regulating disclosure of information will be fruitless.

[ValueChainFX]

There is just no way to go head to head with the big guys, but a meeting this week showed the unwillingness of the big processors to do a total trace system and information exchange! (go figure) Retails will now be pushing for this system and that means it will come soon. I believe the dead line to have a plan in place is some time in June this year. Going outside the standard commodity type product market will help us to establish some better longer term markets and experts can try as they may to make these areas grey, but unless we do something they can't we are going to have a lot of meat in the freezers.

[rsomer]

pandiana: you asked "rsomer, maybe you can help me understand your last post. Have you abandoned the retained ownership idea and are counting on government support?"
Although the producer owned packer idea offered one suggestion of how a producer could market his product and manage his risk, it was a long term solution that offered no immediate relief for anyone who has the misfortune to own market cattle after December 23.
A lot of calves are going to come onto the market within the next few months. Although when those calves went into the lot it was anticipated that the U.S. market would be open in the New Year, it now looks like that will not be the case. What happens to those calves?
In the absence of any competition between the Canadian packing plants, and there will be no competition until the U.S. border is opened to live cattle, what should be done?
Without competition there is no marketplace and no market. None at all. Yes retaining ownership of cattle until slaughter offers advantages and I would wish to see the industry move in that direction. But I would want to see competition in the marketplace before I do that. In the mid term that means wait until the U.S. border is open to live cattle before holding onto calves until slaughter. Long term the producers should seriously consider owning their own packing plants and marketing a branded beef product they own and control. But what about the short term.
The marketplace will not offer a short term solution because a market does not exist within Canada at the moment. Even if a few cattle are moving through the auction, ultimately there are only two buyers in this country. In the short term government is going be involved in whatever solution becomes available if Canadian producers are to continue to own cattle in this country in the future. The least invasive method for the government to do this is through direct producer payments. A more invasive method would be for the government to become the market for live cattle until such time as trade in live cattle resumes with the U.S. Doing nothing is not an option for the government. Retaining ownership of calves and for that matter cull cows indefinitely with no functioning competitive marketplace for those animals in sight is not an option for the producer.
I am suggesting we need short term, mid term and long term solutions. I am suggesting tinkering with the market by making the market more efficient or introducing a risk management tool such as basis options won’t work right now because there is no functioning market for live cattle in place and that therefore government intervention is necessary in the short term until the border opens to live cattle.

[kato]

At the present time, an open border is not in the best interests of the Canadian packers. (Read that to mean the Canadian divisions of American packers)

You can be sure these companies will be quietly lobbying for such things as no universal testing for cows by coming up with excuses we have all heard such as..too expensive...to time consuming. What it really means is "too much cutting into profits". At the moment they have no competition, no controls, and are still shipping boxed beef into a profitable American market.

In the short term, I think if American producers were in our position, their government would be stepping up and helping them out whatever way they could. Regardless of consequence. Our government needs to "just say no to bullies" and step in. There is more than the beef industry at stake here.

I wonder what would happen if just one independant Canadian packer, even a small one, found a way to test it's cattle (over 30 months). Brand it, certify it, and offer it up on the market. Stand back and see what happened. I bet it would get more attention than any lobbying ever could.

Testing is the best and quickest solution yet. There would not be a country in the world that could justify, legally shutting it's borders to Canadian beef. If a border is shut due to protectionism, then call it that...don't pretty it up by hiding behind "science".

It's also a precedent that's not wanted down south. (Leverage?)

[cowman]

While the solution in the short term might be a direct producer payment I wouldn't bet the farm on it happening. Or if it does happen it will mostly be a joke like the cull cow payment(which incidently I never recieved yet).
The Martin Liberals have pretty well stated they are broke and they have more pressing needs than paying a few broke farmers to stay in business.
The Alberta government says they are going to stand with their producers! Well when? So far who have they helped other than a few big feeders and the packing houses? And don't forget the teachers, doctors, nurses and government employees are all pleading poverty and the need for some more money.
In the next few months I expect we will see a meltdown if the border doesn't open. This could be the hardest year yet we've ever faced? I can imagine there will be a lot of tough discussions around the kitchen table this year? If we get another drought and the border isn't open by this fall I suspect price won't even be a factor. The mindset will be let me out of here!

[rsomer]

Cowman, I agree. I think when charliep asks us to think about longer term issues around price discovery/risk management there was an implicit assumption that the long term industry would look much as it does today. I suggested that the industry could be different with more retained ownership and producer owned packing plants. You suggest that if the border doesn’t open in the next few months there will be a meltdown in the industry. But there is no reason to believe the border will open any time soon. Failing substantial government intervention in the form of direct support for primary producers the meltdown will come in the form of a transfer of ownership of the Canadian cattle industry. The two Canadian packing plants will end up owning the majority of the Canadian beef herd at 40 cents on the dollar. The industry will become vertically integrated as I foresaw but it will be vertically integrated backward from the packing plant level instead of integrated forward from the producer level.
The future of the Canadian beef industry will be determined in the next few months by the politicians. It will be interesting to see what they decide is our future.

[charliep]

Thanks for the cooments. It is helping with thinking. My questions were more related to the commodity pricing versus moving up the value chain.

A couple of questions from the grain side and how they might apply. Some of the new specialty canola/****seeeds are offering long term contracts to grower for set prices (I think $10/bu in the case of high erucic acid ****seed for the industrial market) at levels above long term averages for canola. Another suggestion I have heard (can't say if it is good or bad) is for feeders to enter into longer term supply agreements (maybe 3 years) with grain farmers for feed barley at a set price (say $3/bu). The barley grower would have a profitable price. The user would have a stable supply of quality product.

Would the type of arrangements you talk about work similarly for cattle? Assuming a reasonably stable price at the retail level, separate out value up and down the supply chain. What would prevent cheaters from selling outside for cheaper? Impact imports? Other meat products impact (i.e. pork, chicken).

[cowman]

Charlie: I suspect this type of setup could very well be the future. Basically contracts for everything with some sort of adjustment provision. The thing that I don't like about that setup is you lose true price discovery and the packer/retailer has way to much power. This is basically what happened in the US chicken industry? Everything was contracted. Worked great until Lilydale and their like put the squeeze on both ends? Now Lilydale owns it all.
The cow/calf industry in western Canada is made up of a real mix of people. The majority are small producers who would probably be excluded from the contract process. Eventually they would be out but this does not necessarily mean this land would be kept in that type of production.
Over the next few years we will see a great shakedown in the cow/calf business, I believe. A lot of people are going to leave the industry never to return. The age of the average producer dictates this will happen no matter what, nevermind the complete lack of profit! It quite frankly just isn't worth doing anymore. There always will be a cow/calf industry but it will be very different in the future.

[ValueChainFX]

Cowman and charlie the future is ous to make! I was told that when I was a lot younger than now! I was also told you don't make the future by yourself! Both your talents (Cowman/charlie)can help make the future. Knowing what we all know now means we need to find a way to make it happen and try our best to make it fair and plug the loop holes that have allowed some of the more unfair things to happen! How we do this is going to be how we are judged in the future.

So how do we make it work? How do we include the small producers with the rest?

[rsomer]

I realized your questions were more related to the commodity pricing versus moving up the value chain. You also mentioned risk. But there are certain realities that cannot be ignored specifically relating to many weak sellers and one or very few strong buyers.
For instance the canola contracts....the ones I have seen typically attempt to persuade the producer to sign up for a premium price yet to get that price certain quality characteristics must be achieved. Whether the product delivered actually meets the quality characteristics is determined solely by the contracting company with no independent third party verification. Obviously not a very fair arrangement. But the producer has no recourse, it is the way the contract is written.
I understood that the feedlots that had cattle contracted to the packers before May 20 found the packers backed out of the deal when trouble hit which certainly raises concerns about how well these kinds of relationships work when there isn’t competition in the marketplace.
What has happened in Canada since May 20 and the closure of the U.S. border is that competition is reduced to a point where the two packers no longer compete creating a monosony where the efficient allocation of resources throughout the value chain doesn’t occur. Until the border opens to live cattle trade or until such time as Canada can increase its slaughter capacity and that capacity is owned by players who are in a position to compete for the sellers product there is no working marketplace for beef in this country. Unless real competition is regained and a marketplace begins to function again any solutions such as you suggest, contracts, supply agreements, or other methods designed to stabilize price or manage risk are bound to be unsuccessful. Competition must exist or all else fails.

[pandiana]

I have to wonder how we could ever expect 'real' competition between mice and elephants. The mice must regain the power of united numbers. Cooperatives or supply management!

[rsomer]

Exactly so. Supply management has worked for the dairy and chicken people. I think the new generation cooperatives have a place for the beef producer. People should not expect the new cooperatives to operate like the old Alberta Wheat Pool. New models and methods of structuring ownership will be developed that could provide ordinary farmers with ownership benefits and value added, vertically integrated opportunities that they could never realize on their own. These are real viable price/risk tools that are available to farmers right now.
Farmers totally underestimate how much market power they could potentially have by organizing, forming alliances and taking charge of their destiny. These kinds of cooperatives offer the only real opportunity to have effective competition with Cargill and Tyson Foods.
If farmers would pull together we could be elephants too.

[cowman]

rsomer:How would these new generation co-ops work in relation to a beef plant? Would it be possible to do that?
I know they have had new gen co-ops in the States but I thought they were mainly purchasing type co-ops? And I also heard some of them weren't doing too well?