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Even with High Price Projections, Managing Price Risk is a Must

By Larry Stalcup

Barring any global "wrecks," all signs point to profits for cow-calf or stocker operators. With the enormous capital requirements needed to maintain good breeding stock or get a quality calf crop or yearlings to market, careful risk management should be in your operating plan. And if you're still trying to get back on your feet after the drought, extra steps may be needed.

CattleFax marketing analysts project prices for 550-pound steers to average $175 per hundred pounds. That's not a misprint. Strong domestic and especially strong foreign demand, along with a cattle supply that is still limited, "leave cow-calf and stocker operators carrying a big stick," says Troy Applehans, CattleFax analyst in Denver.

Producers across the Southwest should have good opportunities to enjoy strong profits, adds Paul Gutierrez, New Mexico State University Extension economist in Las Cruces. But that's where marketing around the drought will cause greater concern about risk management, he says.

"With beef demand likely outpacing supplies for the foreseeable future, cow-calf producers have unprecedented opportunities amid high production costs and continued market volatility," he says. However, for producers still in drought or on the edge of drought conditions, the ability to take advantage of flourishing markets could be limited if they must first worry about restocking herds. To "fit cattle market conditions better," Texas, New Mexico and Oklahoma producers who were forced to liquidate part of their herds should consider spreading out their rebuilding, Gutierrez says. "They should consider a more patient recovery strategy of rebuilding cow herds over a 2- or 4-year period," he says. "This may be beneficial to promote optimal recovery and healing of pastures. Slower herd rebuilding could leave some additional forage available. That opens the door for other options to complement cow-calf production."

That could include buying calves to run as stockers to capitalize on high markets for feeder cattle in the short term. Aswith calves, feeder markets are projected high, with an average price for the year pegged at $150 per hundred pounds by CattleFax.

In further discussing the projected $175-per-hundred-pounds price average for calves, Good says that price will produce nearly $157 more per head this year compared to 2011, and that calf prices will vary by 15 percent this year, with the annual high/low in the $162 to $182 range.

All of those price projections come with a virtual guarantee of strong price volatility, so risk management through the use of forward contracts, futures or options to lock in a strong price is advised.

Know your breakeven
Determining the cost of getting a calf or yearling ready to market is the first step in putting together a marketing plan that fits your operation. With the many feed and animal health product cost variables, breakevens can be difficult to determine. There are various types of software and spreadsheet programs to help measure input costs and determine a breakeven price.

In buying inputs or marketing cattle, "try not to be in the spot market," Applehans says. "Don't shoot at a moving target." As an example, he says producers can use seasonal markets to lock in a stronger price. "The advantage for ‘selling' calves in July for an October delivery is about $4 per hundred pounds," he says. "You should also use your local basis (difference between the cash price and futures price) to secure a good price."

"Seasonal pricing works 8 out of every 10 years," Applehans says. He adds that producers or stocker operators can likely add to their profit potential be keeping calves on grass longer before selling them as feeders.

"If you [bought] calves in April, you likely can add good value by putting on 200 pounds after hedging the feeder futures market," he says. "With these higher corn prices, summer grazing is very competitive. It's the cheapest gain out there."

Traditionally, 550-pound calves see a seasonal high value in about April. The seasonal high for 750-pound yearlings is in August and September, when feedyard demand is strong, says Applehans.

Get the down payment
Forward contracting calves for a better price than you expect to see when they're ready to deliver is normally a smart move. But because of what the industry has seen in recent years with defaults on cattle sales, producers should know their buyers are reputable.

"Even then, if you forward contract, get the down payment," Applehans stresses, noting that there have been cases in which buyers have backed out on the contract price if the market has declined.

Gutierrez says feedyards will likely want the heavier cattle. "Facing higher ration costs, feedlots have an incentive to purchase heavier feeder animals and reduce feed use at the feedlot level," he says.

Mike Murphy, another CattleFax analyst, says ranchers who are considering retained ownership to take advantage of their proven genetics or who seek longer-range profits face added marketing risks and volatility. Some of that risk can be eased by partnering with the feedyard that may be willing take ownership of a portion of the cattle and be responsible for purchasing an equal portion of the ration costs.

Murphy adds that retailers have had an impact on prices paid to cattle producers. For example, the move by Walmart to sell mainly Choice quality grade beef has helped increase prices for higher quality grade cattle. "The Choice to Select spread (the difference between Choice and Select beef prices) was about $3 per hundred pounds in 2006," Murphy says. "It was $7 or higher in 2011."

He says Walmart made the move to Choice after surveys found that lower-quality cuts were not producing strong beef sales. He adds that Walmart is "giving it a full year" to determine if it will stick with the Choice beef strategy.

Situations that help boost beef prices can be offset in an afternoon if a report of E. coli or other consumer scare causes prices to plunge. Thus the need for risk management will remain strong, whetheryou're a cow-calf producer with less than a 100 cows or several thousand cows.

"There will be changes to the number of producers, the number of feedyards, where cattle are located, the cost of cattle, the value of gain and the swings between price cycle highs and lows," Gutierrez says "For the astute producer, those changes mean opportunities. Know your cost of production at every turn."

Applehans adds, "Be ready to follow through and act on profit opportunities when trends change."

"Even with High Price Projections, Managing Price Risk is a Must" is a web exclusive from the June issue of The Cattleman magazine.