Basis shift looming as changes in Feeder Cattle futures take effect

October 19, 2016

5 Min Read
Basis shift looming as changes in Feeder Cattle futures take effect
<p>Changes in feeder cattle basis will change the market. Getty Images/John Moore</p>

“Beginning with the November contract, Feeder Cattle futures will settle against an animal that is an average of 50 pounds heavier,” says Glynn Tonsor, agricultural economist at Kansas State University (KSU). “You need to account for it when considering use of historic basis relationships.”

Weight parameters for CME feeder cattle contracts and the CME Feeder Cattle Index used to settle them will increase 50 pounds on both ends of the range—from 650-849 pounds to 700-899 pounds—starting with the November contract.

As such, Feeder Cattle futures will likely decline, reflecting the heavier cattle.

“Expect to see Feeder Cattle futures lower than they have been in the past (because of the basis change), but let’s not be alarmed by it. It doesn’t mean that the cattle markets are going down the tubes,” says Brett Crosby, president of Custom Ag Solutions (CAS) in Cowley, Wyo., which produces and maintains the website (BBC), in partnership with KSU. BBC is a free public site that provides an array of decision-support tools for producers.

The change in the weight range will cause the basis to grow wider, negating the use of historic feeder cattle basis information, such as using an historic three-year average in forecasting price.

The basis equation is: basis = local cash sales price – futures price.

Working with the folks at CAS, Tonsor says it appears basis will widen an average of about $3. That’s based on re-constructed BBC models and applying the change to all transactions in the massive BBC database for the years 2011-2015.

Tonsor provided an example at this fall’s KSU Beef Stocker Field Day to illustrate how the change affects futures-based price projections.

Estimated cash sale price = futures price + basis.

Prior to the change, using Salina, Kan., as the market location (local basis $8.81) and November Feeder Cattle futures at the time ($130.00), the implied November price forecast was $138.81 per cwt. Accounting for the new specifications, calculates the local basis to be $11.99, making for a forecast price of $141.99.

“When you forward-contract cattle and use Feeder Cattle futures, recognize that the change in basis needs to be incorporated,” Crosby says.

For a while, Tonsor says you can add $3 to your historic basis and get close to the mark. As time goes on, though, this crude calibration gets dicier. Ultimately, he recommends using in order to account for it more accurately.

Plans call for having the BBC models completely updated by the end of November. To my knowledge, it is the only publicly available source currently in the midst of updating its pricing models to account for the basis change.

Time considerations

There are other reasons to take a look at For instance, the site provides a daily-updated Stocker Cattle Price Index nationally and regionally. There are lots of decision-support tools, too, including easy calculation of value of gain (VOG).

In simple terms, VOG is the difference between the gross selling price and purchase price of the animal, divided by the number of pounds added between purchase and sale. Some folks simply look at the current cash value of both the buy-weight and sell-weight and then calculate VOG.

For instance, Tonsor explains if the cash price of a steer weighing 521 pounds in Kansas in mid-September was $160.43 per cwt ($835.84 gross) and a steer weighing 761 pounds the same day brought $136.36 ($1,037.70 gross) the cash-based approach says the implied VOG for 240 pounds of gain is 84 cents per pound.

“I think it’s dangerous to just look at the cash market and say those pounds are worth X amount of money today, when it takes three months or six months to put them on,” Tonsor says. “I can’t put 200 pounds on before I leave the auction market. There’s a temporal component that needs to be considered.”

With the futures-based approach in the example above, you’d use the same cash price when considering the 5-weight steer for purchase, but you’d look at the basis-adjusted futures price nearest the expected time of marketing. For the example above, the basis-adjusted April Feeder Cattle contract was $127.45 ($969.89 gross). That makes the implied futures-based VOG 56 cents.

Neither approach will be dead-on correct, but Tonsor says the futures-based approach is more accurate more of the time.

“Although both approaches (cash and futures-based) are highly sensitive to changes in the market, the magnitude of error is greater with the cash approach,” Tonsor says. When comparing the two approaches in models, he adds, “67% of the time, basis-adjusted futures-implied value of gain forecasts are more accurate, not just the frequency of accuracy but the level of accuracy.” The latter comment is based on examining current cash market VOG and futures-based, basis-adjusted VOG for 1995 through 2015.

So, even if producers don’t use futures to hedge, Tonsor emphasizes there is value in using them to forecast prices.

VOG as a management tool

Crosby, who ranches in Wyoming, points to changes he made in his operation based on studying VOG.

“It’s obviously easier to calve in northern Wyoming in April and May, but that animal will come out of the feedlot in August to September, as opposed to the higher value months of April, May and June,” Crosby explains.

VOG climbs with the weight of fall calves because the heavier ones are more likely to be placed and fed for those months when fed cattle possess significantly more value.

“So, VOG is important to us to decide if it’s worth doing something to bring in a heavier calf,” Crosby says.

In his case, besides calving earlier, Crosby built facilities that enable him to wean earlier and background calves in order to add more weight to them than their mothers could.

“Your environment chooses the size of your cow,” Crosby says. “I can’t run a bigger cow, but I can change her calving date.”

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