Factors Behind The Recent Cattle Market Downturn
By: Dr. Kenny Burdine, Livestock Marketing Specialist, University of Kentucky
There continues to be a great deal of discussion surrounding the current cattle market and specifically why prices dropped so much over the course of 2015 and 2016. It is one of the most common questions I am asked when I travel the state and it has been written about in farm and popular press. There is a lot of frustration among those in the industry and also a great deal of misinformation circulating. My motivation for writing this is simply to provide some objective information and answer some questions that are out there. There are multiple factors behind the price drop from 2014 to the present and I will walk through many of these factors as I answer a series of common questions that I have been asked. I have discussed many of these things in extension programs and other articles, but I am hoping this discussion will pull much of this together.
How much has beef production increased since 2014?
According to USDA-ERS, 2016 beef production was up about 4% from 2014. Part of this is due to the cowherd expanding during 2014 and 2015. A larger cowherd means a larger calf crop and a larger calf crop means larger beef production over time. Since this cowherd has continued to grow, we will likely continue to see beef production increases over the next couple of years. Production levels have also been impacted by increasing harvest weights, which are partially explained by lower feed prices. Harvest weights reached a peak in fall 2015, but have continued to be historically high since then.
How about production levels of competing meats?
The primary meats consumed in the US are chicken, beef, and pork. Prices were strong for each of these species during 2014 and all three expanded. But, production can increase much quicker in the poultry and pork sectors, which meant that poultry and pork production rose first. According to USDA, broiler production rose 5.5% from 2014 to 2016 and pork production rose by over 9%. Increased production of competing meats tends to put pressure on wholesale beef prices as there is more competition at the wholesale level.
How about the balance of imports and exports?
Beef imports dropped sharply in 2015, but increased in 2016. Comparing 2014 to 2016, beef exports are down about 2%. Imports followed the opposite pattern, increasing in 2015, but decreasing in 2016. Over the course of the last two years, imports increased about 2%. Much of this tracked the strength of the US dollar.
Another common way to look at meat supply is to combine production with trade. Production levels, plus imports, minus exports, yield a measurement of how much total meat is really available for each US consumer. USDA-ERS refers to this as “per capita disappearance”. Per capita disappearance of beef increased by 2.4% from 2014 to 2016. Even more telling, total red meat and poultry disappearance per capita increased by more than 6% from 2014 to 2016. In short, there was quite a bit more meat that had to work through the system in 2016 than there was in 2014.
How much are cattle prices actually down from 2014?
While this seems like a simple question, it really depends on what level in the system we are talking about and the specific time-frame we consider. For example, weaned calf prices in Kentucky were down a little over 50% from December 2014 to December 2016. Heavy feeders in KY were down about 43% over that two-year period and fed cattle prices, using the USDA 5-market weighted average price, were down about 30% over that same 24-month period. It is common for the percent change to be greater at the calf level because the value per head is smaller. For example, if there is a shock in the system that results in a $100 decrease in values per head, this $100 is a greater percentage of calf values than of fed cattle values. This is probably best explained by working through some examples.
The $100 change in value discussed above will be passed through the marketing chain. By this I mean that packers won’t be able to pay as much for fed cattle, feedlots won’t be able to pay as much for feeder cattle, and backgrounders and stocker operators won’t be able to pay as much for calves. If a 1,400 lb slaughter steer is selling for $1.20 per lb, that steer is worth $1,680. If the value of this fed steer drops to $1,580, that was a decrease of about 6%. If this decrease in the value of fed cattle is expected to persist, this will reduce the price for feeders. If 800 lbs steers were selling for $1.30 per lb, or $1,040 per head, their value is likely to be reduced to $940. Because this feeder steer is less valuable than the fed steer, the $100 decrease in value is nearly a 10% change. Finally, perhaps 500 lb steer calves are selling for $1.40 per lb, or $700 per head. A $100 decrease in the value of this calf would be a decrease of more than 14%.
How long has it been since we have seen prices this low?
I have probably heard more misinformation here than anywhere. Looking back at Kentucky prices for both calves and feeders, we saw similar price levels during 2010 as were seen in 2016. And, the same holds true for fed cattle prices at the national level. I have read multiple times that this is the worst cattle market in decades, but the price data simply does not support this assertion. Things changed quickly, but we are by no means in uncharted water. In fact, current price levels are a lot closer to “normal” that the price levels that were seen in 2014 and 2105.
Are packer margins higher now than usual?
This is the most controversial question I get asked and also the most difficult to answer. First, I do not fully understand the cost structure for packers, so I can’t estimate their profit. There is data on boxed beef prices, beef byproduct values, and fed cattle prices, and these can be used to estimate a gross margin at the packer level. Gross margin does not include additional costs of facilities, equipment, labor, utilities, etc., but it can be used to gauge likely changes in profit. While this approach has limitations, I will do my best to provide some perspective here.
Figure 1 is my attempt to track an estimated monthly gross margin for beef packers from January 2010 to February 2017. To estimate revenues per head, I start with the average live weight for steers in each month as reported by USDA, convert that to carcass weight, and multiply it by boxed beef and drop prices, both of which are calculated on a carcass weight basis. Then, to estimate purchase price for fed cattle, I multiply the live weight by the 5-area weighted average slaughter steer price. The difference between these two estimates is considered an estimated packer gross margin per head and is plotted below. Again, this is an estimated gross margin and does not include an estimate of any costs beyond what is paid for fed cattle. Clearly, this does not perfectly describe trends in packer profitability due to contracting, formula pricing, timing, and other limitations, but I do think the trends over time may shed some light on this question.
Figure 1 shows that there is a great deal of variation in the packer margin that I have estimated over time. It appeared to move in a range of $0 to $200 per head from early in the year 2000 through the first half of 2015. But, this margin does appear to increase significantly from mid-2015 to the end of 2016 and this did coincide with a sharp decrease in fed cattle prices. I’m sure contracting explains some of this, but this still suggests that margins on the spot market were higher during this time period. Also, note the sharp drop in this estimated margin for the first two months of 2017 as fed cattle prices increased.
It may also help to put this in perspective by discussing the magnitude and potential impact on calf values. Again, for simplicity, let’s assume that packer margins were $100 higher than normal during 2016. If packers eventually bid that $100 back into fed cattle prices as they compete against each other to purchase cattle, and if that full $100 were passed back to the feeder cattle level, this would amount to something close to $20 per cwt on 500 lb calves and $12.50 per cwt on 800 lb feeders. Clearly, this is an oversimplification, but it does illustrate the potential impact on cattle prices and also demonstrates that, while packer margins may partially explain the recent drop in cattle prices, this is only one of several factors that have been at play. Further, I would add that we have a better chance of seeing cattle prices increase if entities downstream are profitable. If packers are more profitable now, it is likely that overtime they will bid some of these profits back into cattle prices as they compete against one another purchasing cattle.
The purpose of this article was to review some of the many factors that have impacted cattle prices over the last few years. We saw prices reach record highs and saw them drop about as swiftly as they rose. Many have said that there is no way the fundamentals of the market have changed so much that calf prices should have dropped by 50% over 24 months. While this is true, it is equally hard to explain why prices reached the high levels that we saw in 2014 and 2015. I believe that it was a very unique set of circumstances that lead to what we saw during that time period and I simply can’t forecast a return to those levels. Regardless, good managers look forward rather than backward. So, it’s time to focus on the next few years, rather than the last few.