A “Crush” Can Help Counter Cattle Market VolatilityA “Crush” Can Help Counter Cattle Market Volatility
With the potential for extreme market volatility in the new year, cattle feeders should consider employing the ultimate risk management strategy – the crush.
January 23, 2013
After months of losses, cattle feeders may be able to pencil out some profit in early or mid-2013. But without some risk management on the input and output side, those profits may evaporate quicker than a drought-depleted stock pond.
Shane Ellis, Iowa State University Extension livestock marketing economist, says cattle feeders are pinching themselves and asking, “What, we can actually break even, or make a slim profit, by feeding cattle?” For those who’ve seen losses for so long, the opportunity to break even seems like Christmas all over again.
Cattle feeders large and small, and economists and analysts, have been trying to figure out the market. For those weathering high feed and feeder cattle prices, and drought, it’s been circle-the-wagons time.
For the past six months, corn has been $7/bu. or higher, and pushing $8 or more in some cases. Yearlings in the 750-lb. range have gone from about $150 cwt., down to about $140 in early December, then back up to $150+ within two weeks. And fed prices have swung from $135+/cwt., down to $125, then back up to $135+. There’s no telling where prices on all three commodities will be over the next few months.
Duane Lenz, a CattleFax analyst in Denver, says hedging should be part of any large-scale cattle transaction. “If you can hedge and make a little money, you need to do it because of the volatility,” he says, suggesting futures, options or forward contracting. “Watch the market. If it gets a little over-bought, you need to use price protection because of the volatility.”
Randy Blach, CattleFax executive director, has projected small profit margins for part of the year during seasonal trends of higher markets. “But there will likely be more than a $300/head range in prices in 2013 due to price volatility,” he says. “Risk management is critical.”
Is it crush time?
Ellis says the ultimate risk management strategy may be needed to weather volatility – the cattle feeding crush. Basically, the crush is being short; or selling live cattle futures, and being long; or buying feeder cattle and corn futures. You’re basically locking in all three facets of the feeding process.
The Iowa Beef Center maintains a Yearling to Finish Crush Margin table. Every Wednesday, data on corn, feeder cattle and fed cattle prices are entered into the table. With that information, it projects crush margins for when cattle are finished and sold.
“For cattle placed on feed in December or January, the margin table showed about a $50/head profit for finishing in May or June,” Ellis says. “That was for Iowa area cattle, but it should translate into some profit potential for the Southern Plains as well (all depending on the local basis).”
The crush margin is the return remaining from cattle sales after accounting for the feeder steer and corn used. The crush margin is based on: live cattle at 1,250 lbs., feeder cattle at 750 lbs., and about 50 bu. of corn/steer.
Crush numbers change constantly. But in early December and into January, they provided closeouts in the black for cattle finishing in May or June, Ellis says.
Here’s how the crush margin table read: November feeder cattle bought at $146, April live cattle sold at $134, and December corn bought at $7.55. That put the feeder cattle cost at $1,095 ($146 cwt. x 750 lbs.) and corn cost at $377 ($7.55 x 50 bu.). Cost of inputs is $1,472 (cost of gain is locked in $1.32 lb.)
So $1,472 is the breakeven price, plus an estimated $150 in animal health, labor and other expenses. The 1,250-lb. finished steer is locked in at a sale price of $1,675 (based off $134/cwt.) The crush margin is about $200, or the difference between the sale price and cost of feeders and corn. That equals about a $50 profit, less the $150 in added expense.
However, based on live cattle, feeder cattle and corn futures prices in late 2012, the crush margins start thinning for cattle closing out from July on. Seasonal price ranges will likely take place.
“Once you get past the April-June period, you can get back into another hole,” Ellis says. “It’s not that fed-cattle prices aren’t looking good; they’re still in the high $120s. But the price of corn will probably be about $7. It’s hard to make that pencil out.”
The margin chart had the June margin at $196 for cattle to be placed in January, based on feeders at $148, live cattle at $132 and corn at $6.91. That spelled about $45-$50/head profit ($196 crush margin less the $150 expense). But the July margin was at about $140, August about $122, September about $115 and October about $100 – all below the breakeven level.
(Remember, all three commodity prices are extremely volatile and can change by the minute. So the crush margin can change at any time, and likely will.)
What about call options?
Calls can help offset higher input prices. “Sometimes it’s hard to lock in a high corn price,” Ellis says. “Cattle feeders may use the opportunity to take out call options. That will keep corn from going too high and they can take advantage of a likely lower feeder cattle price.”
By buying a call, the price is protected if the price runs up. For example, with March corn futures at $6.85, the at-the-money strike price has about a 25-30¢/bu. premium. If volatility causes the price to surge toward $8, the value of the option will also increase, which can offset much of the cost to you, Ellis says.
“If the corn price goes down, you’re only out the cost of the premium, which will be offset by the lower corn price,” he says.
He adds that feeder cattle calls can also help cover high prices. “If you pay $145/cwt. for feeders and feel the market still has upside potential, you can buy the call and take advantage of a higher price. That can help offset their high cost to start with, and possibly add to a finished cattle profit margin.”
Stan Bevers, Texas AgriLife Ex-tension economist in Vernon, TX, says successful commercial feeders are likely using sound risk management that can help their customers who retain ownership.
“If I’m feeding my own calves, I’m hoping the feedlot manager or risk management manager will point out risk management strategies needed for my feeding period,” he says.
He says if commercial feeders aren’t using a crush, “they’re certainly looking at the figures and seeing what it looks like for future cattle prices.”
Ellis says options premiums “are expensive,” but still provide a method of managing risk. “Risk management is really important,” he says. “It’s so volatile out there. You never know what’s going to happen with the next crop of corn. If there’s another dry year, carryover stocks will be even lower. And higher prices could follow.”
He says Livestock Risk Protection insurance is another risk management tool. “But when you take out those policies, you’re locked in. With options, you can get out of them any time you want,” he says.
Larry Stalcup is an Amarillo, TX-based freelance writer.
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