On April 20, 2020, expiring May 2020 West Texas Intermediate crude futures settled at −$37.63 a barrel. This was the first time in history the price of U.S. oil turned negative. This was part quirk, part supply, and it was demand-driven. Futures contracts that required buyers to take delivery of oil in May 2020 were expiring the following day. Nobody wanted the oil because there was no place to store it. Demand for oil was collapsing. Refineries were unwilling to turn oil into gasoline and other products, because so few people were using it.
The meat market also has idiosyncrasies. On Feb. 22 of this year, the Choice boxed beef cutout was at a $2 per cwt discount to the Select cutout. This was the 19th time this daily inversion has happened since 2004, when USDA’s Agricultural Marketing Service (AMS) began reporting the data in its current form. This particular negative Choice-Select spread, however, was the largest over the period.
Individual prices for specific cuts ultimately drive cutout values and differences in the Choice-Select spread. On Feb.22, the Choice value for chuck, brisket and round traded at a notable $1.80, $2.21, and $6.00 discount, respectively, to the Select value. Choice quality-grade loins were discounted $1.98 to Select quality-grade loins, a stark contrast to typical pricing. The Choice rib primal was only at a small $2.67 premium to Select ribs. The load count of Select-grade beef cuts trading in the negotiated market was comparatively small that day. Retailers looking to get needs covered paid up for the limited supply.
Cutout represents carcass value
The boxed beef cutout represents the estimated gross value of a beef carcass based on prices paid for individual parts of the carcass. The seven primals are: rib, chuck, round, loin, brisket, short plate and flank. The primals are made up of various subprimals. USDA AMS calculates two closely monitored daily beef cutout values ― Choice and Select. They are published in the National Daily Boxed Beef Cutout and Boxed Beef Cuts–Negotiated Sales–Afternoon report (LM_XB403). USDA AMS also publishes a morning report.
A steak labeled USDA Choice means the beef came from a steer or heifer stamped “Choice” by an official USDA meat grader. Choice and Select are two of the four quality grades used by USDA. The degree of marbling (the white flecks of fat within the lean meat, often referred to as intramuscular fat) is the primary determination of quality grade. Maturity of the carcass is the other factor. Marbling is what gives beef its flavor, juiciness and tenderness. Carcasses that grade Select have less marbling than their Choice counterparts. Prime quality-grade beef has abundant marbling and is generally sold in restaurants.
The Choice-Select spread is important because roughly 85% of all graded beef is in one of these two quality grades. Anything that shifts the supply or demand for either Choice or Select beef can impact the Choice-Select spread.
Understanding Choice-Select seasonality
When cold weather is prevalent, consumers focus on roasting cuts and enjoying meals indoors. Winter weather generally keeps grills in hibernation. The chuck and round primals experience seasonal strength during the fall and winter. The brisket experiences its highest prices in the winter months. Often only small differences exist between Choice and Select values for the chuck and round. Regardless, if cuts from these two primals are Choice or Select, low-temperature cooking can achieve similar results. Cuts from the plate, or short plate, are used to make fajitas, pastrami, skirt steak and short ribs, and do not show any value differences between Choice and Select quality grades.
Differences in values of loins and ribs drive differences in the Choice-Select spread. The loin contributes 21.26% and the rib contributes 11.4% to the carcass yield. These are the most expensive primals. Cuts from these primals are naturally more tender, regardless of the degree of marbling, but Select grades may need to be monitored a little more closely and cooked a little less to keep them as tender as possible.
The Choice-Select spread is typically narrowest in the first quarter of the year. This can be summarized as Choice- and Select-graded beef being closer substitutes over the winter than during the rest of the year.
Volatility reflects imbalances
Since the first of the year, the Choice boxed beef market has produced seven week-to-week price changes exceeding $5 per cwt. The two which were positive were over $10. Five were negative and started in February, as boxed beef values were searching for a seasonal low. These price swings greatly influence the retail price of beef and consumer purchasing habits.
High fuel prices, rising food costs, falling stock values and higher interest rates have consumers suffering through tough times. The restaurant business is always vulnerable during times of tight budgets. Some consumers may opt to trade down to less expensive dining options. Beef has great versatility. There are plenty of options for every taste and budget. Some substitution among cuts may also be occurring.
Tighter Choice supply will widen spread
Choice-grade beef is entering a period of seasonal strength, while Select may find it difficult to keep pace. The result is a widening of the Choice-Select spread over the next couple of months. This might be more supply-driven than demand-driven.
Seasonality of cattle production impacts the Choice-Select spread. The share of cattle grading Choice typically declines during late spring and early summer. A tightening supply of Choice-grading cattle in the spring and summer reflects younger cattle being placed into feedlots in the fall. Placements of lightweight cattle are typically high in the fall, with seasonally large numbers of spring-born calves available. Lightweight placements require more days on feed, as a certain amount of weight gain is necessary to reach Choice quality grade.
In November 2021, placements of cattle weighing less than 700 pounds were up 7.1% compared to November 2020, while placements of cattle over 800 pounds were down 1.3%, according to USDA National Agricultural Statistics Service estimates for feedlots with capacity of more than 1,000 head. In December 2021, placements of feeders under 700 pounds were up 9.5% year over year, while placements over 800 pounds were up only 1.1%. Several factors accentuated the seasonal rise in lightweight placements. Drought in the western half of the United States limited winter background opportunities. Lower forage availability and high feed prices pushed heifers into feedlots, rather than to expand beef cow herds.
Submarkets offer options
Quality grades fall on a continuum. That is, submarkets can exist for different ranges of a quality grade. An upper two-thirds and lower one-third Choice market allows retailers to offer Choice beef in their meat case that would have previously graded Select plus. Through the first nine weeks of 2022, nearly 75% of fed cattle graded Choice, according to the USDA National Steer and Heifer Estimated Grading report (NW_LS196). Just under 31% were in the upper two-thirds Choice category. This is down from levels at the beginning of recent years.
The upper two-thirds-Choice threshold is more expensive to produce, relative to lower one-third Choice, which is reflected in the supply curve for each submarket. High feed costs may encourage cattle feeders to not target as much toward upper two-thirds Choice. That’s the marginal cost side. The marginal benefit is the lack of a discount, or premium value, that Choice provides when compared to Select. The Choice-Select spread, and upper two-thirds-Choice premiums are key pricing differentials.
Schulz is an Extension ag economist with Iowa State University.