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So what’s all the fuss over price discovery?

More robust price discovery does not guarantee higher prices.

The clock is ticking on the agreement coming out of the Cattle Industry Summer Meeting over how the beef business will address and ultimately deal with price discovery. In the meantime, have we really delved into what price discovery is and more importantly, what it isn’t?

Here’s what it isn’t: More robust price discovery does not guarantee higher prices.

Here’s what it is: Price discovery is the process of negotiation, of buyers and sellers knocking heads until a trade is made, which is an important part of price determination.

READ: Beef producers hammer out compromise on addressing price discovery

By finding ways to make price discovery more robust for fed cattle, we’re ultimately helping ensure better price determination. And price determination is what writes the numbers on the check. Price determination is a function of supply and demand. Supply and demand determine which side—buyer or seller—has the most leverage and the stronger negotiating position.

If the seller has the leverage, the price is apt to go up. If it’s the buyer’s turn, the price is apt to go down.

So yes, price discovery is important. But price discovery in and of itself is not the answer to what many folks think ails the cattle market.

“I think a lot of this debate has as much or more to do with price transparency than the lack of price discovery,” Don Close, senior protein analyst with Rabo AgriFinance, tells me.

Related: True West Beef plans new packing plant

That’s because, in a lot of cases, price transparency—visibility of where that price came from—is hard to achieve. “If you take all the various transaction types, some of them are reported on a live basis and some are reported on a dressed basis…it’s not really easy to find what the flat price is,” he says.

It’s not necessarily a lack of cash transactions, although that’s important. It’s the uniformity, or lack thereof, between the various transaction types, Close says. “Part of the problem is the siloing of prices by type.”

Now let’s circle back to price discovery and why it’s important. Feedyards in the Southern Plains have almost exclusively gone to various alternative marketing arrangements (AMAs) while northern feedlots sell more cattle on the cash market. Price discovery is an expensive exercise and there are economic incentives for cattle feeders to market fed cattle under some sort of arrangement with the packer.

READ: Fire fight--negoitated cash trade and price discovery

“You’ve got to find a buyer, you’ve got to negotiate with that buyer, all that stuff,” Close says. That costs time and money.

“If you’re doing a formula trade, you’re puling on that exercise being done by others, but you’re not enduring the expense to directly contribute. And I think part of this riff is the dissatisfaction from the camp that is shouldering the expensive price discovery. They think the formula guys are free-riding off their labor.”

Hard to argue against that. That’s why, when looking at ways to make price discovery more robust, the solution needs to be inclusive.

Then there’s this question: Given the changes in how fed cattle are marketed, is the fed cattle cash market the best place for price discovery to take place?

Short answer: No. At some point, the beef business will have to move from a strictly cash basis to some sort of formula that includes the wholesale market. Work is underway to look at that. Stay tuned.

In the meantime, what should cow-calf producers do?

“I think there are two answers to that,” Close says. “The first one is I think they need to be implementing VAC-45 and an early wean program. They need to be in some kind of marketing agreement where they are producing calves for a specific end point and not being dependent on the commodity market.”

The real answer, however, lies in limited slaughter capacity, which gives the buyer more leverage in fed cattle price discovery. In the current environment, Close says the beef business has two choices. We can reduce the cow herd and the total cattle population, or we can build more plants. “But the crux of this whole thing is currently, there is not enough slaughter capacity for the number of cattle we have on hand.”

That will change. The announcement of the True West Beef plant in Jerome, Idaho, is the first of more to come. So eventually, that imbalance will level out.

In the meantime, the market will do what the market has always done—ration supply and demand. “This whole imbalance between supply and slaughter capacity, the market is brutally honest in conveying that economic message. But it’s never an easy pill to swallow,” Close says.

“The market is not broken. The market is working perfectly well. We don’t like the message, but the market is working.”
 

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