Is There A Pricing Edge?

Captive supplies have been a major concern and a divisive issue in the beef industry for two decades. Issues related to captive supplies contributed to producer support for mandatory price reporting (MPR), which requires packers to report their livestock purchases to USDA. The resulting Livestock Mandatory Reporting Act began in April 2001. One immediate effect of MPR was to create new data series

Captive supplies have been a major concern and a divisive issue in the beef industry for two decades. Issues related to captive supplies contributed to producer support for mandatory price reporting (MPR), which requires packers to report their livestock purchases to USDA. The resulting Livestock Mandatory Reporting Act began in April 2001.

One immediate effect of MPR was to create new data series on prices and quantities of fed-cattle procurement, some of which pertain to captive supplies. Data compiled by Oklahoma State University agricultural economist Clem Ward over the first three years of MPR provides insight into packer procurement and pricing methods.

Debate over livestock procurement practices came to a head in Pickett v. IBP. An Alabama jury found that cattle feeders selling on the open market lost $40/animal — totaling $1.28 billion from 1994-1999. The jury attributed the losses to IBP's (now Tyson Foods) manipulation of the markets due to the use of captive supply in violation of the Packers and Stockyards Act. The trial court judge subsequently overturned the jury's verdict, but not its finding about the impact of captive supplies on cattle markets.

Last month the 11th U.S. Circuit Court of Appeals affirmed the judge's action, but went on to say that the plaintiffs did not present any evidence from which “a reasonable jury” could conclude that Tyson lacked pro-competitive justifications in its purchasing agreements.

Captive supplies are usually considered slaughter livestock committed to a specific meatpacker two weeks or more in advance of slaughter. The three most common captive supply procurement methods are:

  • marketing/purchasing agreements,
  • forward contracts, and
  • packer ownership/feeding.

Moreover, “sweetheart deals” between select feeders and some packers have long been thought to unfairly harm smaller or “independant” cattle feeders.

Until recently, however, there was limited marketing data and information on how packers procured fed cattle and how their buying practices hindered the process of price discovery.

“A common element of procurement methods is that packers have a portion of their slaughter needs purchased two weeks to several months prior to the livestock being slaughtered,” Ward says. “A key issue is whether captive supplies can be used as leverage by packers to pay lower prices for fed cattle purchased in the cash market.”

Knowing the extent of each of the marketing or procurement methods is important, but more important is a comparison of prices among those methods.

Before MPR

Prior to 2001, official data on captive supplies came from USDA Grain Inspection, Packers and Stockyards Administration (GIPSA). In 1988, GIPSA began requiring packers to report monthly procurement of fed cattle by captive supply methods. In 1994, USDA Agricultural Marketing Service began reporting data on non-cash market shipments of fed cattle.

This series, called additional movement, became a proxy regarding the extent of captive supplies.

Although it included shipments of cattle that constituted captive supplies, Ward says it also included shipments of cattle priced by methods not defined as captive supplies. These would include cattle priced on a grid but not part of a marketing agreement or contract.

GIPSA data show annual average captive supplies ranged from 17.5% to 24.9% of fed cattle slaughter for the four largest beef packers between 1988 and 1998. Marketing agreements and forward contracts accounted for 13.7-19.3%; and packer feeding, 3.2-5.6% during that period.

For 1999-2001, total captive supplies for the four largest packers as defined by GIPSA were 32.4-42.9%. Marketing agreements and forward contracts increased to 24-32%, while packer feeding increased to 8.4-10.9%. GIPSA cautions that the audited figures for 1999-2001 are not comparable to previous year figures.

After MPR

Is there more information available on the volume of captive supplies since MPR?

“Yes,” Ward says. “MPR provides additional data with which to study the contentious issue of captive supplies and their market impacts.”

Also, he adds, more price information by procurement method is available since MPR was established. This availability enables tracking prices by procurement method and making comparisons that were not previously possible.

In studying pricing data over the three-year period since MRP was initiated, Ward has found:

  • Negotiated pricing on average accounted for 46.1% of fed cattle marketing (Figure 1). Generally, negotiated pricing can be interpreted as cash market pricing, though grid base prices are also determined by negotiation.

  • Formula pricing averaged 43.3% of fed cattle procurement and was the most used method in 2001 and 2002, declining sharply to 34% in 2003. Cattle feeders who responded to a 2002 survey indicate most formula price arrangements are tied to the cash market — either a quoted market price or a plant average price.

  • Packer ownership of livestock, one of the most discussed components of captive supplies and a frequent target for legislative reform, accounted for 7.1% of total fed cattle procurement.

  • Forward contracting, which consists mostly of basis contracts between packers and cattle feeders, averaged 3.5% of packers' procurement. Most forward contracts for fed cattle are basis contracts.

MPR has provided some information from weekly data on captive supplies that wasn't available previously and is much more timely than GIPSA's monthly or annual reports. Ward cautions that the data on captive supplies using MPR doesn't exactly match the definition GIPSA has used for captive supplies.

Level of captive supplies

For any given week, data after MPR show the percentage of negotiated pricing was as low as 24.5% and as high as 76.9%. Formula pricing also varied from week to week, ranging from 22.1% to 64.8%.

For the other two procurement methods, there was considerable week-to-week variation, but the variation was of a much smaller magnitude. The range for forward contracts was 0.2-9.4%, and the range for packer-owned cattle was 2.6-13.6% of total fed-cattle procurement.

Week-to-week variation in negotiated trades and formula-priced trades is extensive, both on a percentage basis and in absolute volume traded.

“At times over the three years, formula pricing exceeded negotiated trades; at other times, the reverse occurred,” Ward says. “The exact reason for the variation or apparent tradeoff between these two pricing methods isn't clear.”

The extent of packer feeding was reasonably stable over the three years, in most weeks 5-10% of total procurement, but exceeding 10% on occasion in 2003.

So, under MPR, what is known about the extent of captive supplies? Some might argue captive supplies constitute the sum of formula pricing, forward contracting and packer-owned procurement by packers.

“For forward contracting and packer ownership, this argument is seemingly clear, though there could be exceptions,” Ward explains. “For formula pricing, the argument is much less clear.”

Many formula-priced trades are associated with supply contracts or marketing agreements. Many of those agreements allow feeders to determine the delivery date for fed cattle one to three weeks prior to harvest, either alone or in conjunction with the participating packer.

But, let's assume this set of three procurement methods comprise captive supplies. They effectively establish a near-maximum extent of captive supplies from the weekly MPR data. Combining data reported earlier, captive supplies accounted for 56.1% of fed-cattle procurement in 2001, 59% in 2002, and 46.1% in 2003.

“Although the level of captive supplies no doubt concerns some,” Ward points out, “there's no apparent upward trend in the percentage based on the first three years of MPR data.”

Pricing/price comparisons

Additional information is available since MPR began for negotiated pricing, formula pricing, and forward contract pricing of fed cattle (Figure 2). Price comparisons are on a dressed-weight basis, and the five-region weighted average price includes prices for all grades of fed cattle purchased from several major cattle-feeding areas — Texas-Oklahoma, Kansas, Nebraska, Colorado and Iowa-Southern Minnesota.

“It could be argued the five-region weighted average price is the most comprehensive and representative of market conditions in the cash market,” Ward says. “We use the five-region weighted average steer price as the base or standard for comparing prices reported by procurement methods.”

  • Negotiated prices for the three years together averaged 14¢/cwt. above the five-region weighted average price (Figure 3). On an annual basis, negotiated prices averaged as little as 4¢/cwt. higher than the five-region average in 2002 to as much as 29¢/cwt. in 2001.

  • Formula prices averaged higher than other pricing methods or the five-region average in some years and lower in others. For the three-year average, formula prices were $1.43/cwt. higher than the average for forward contracts, and 7¢/cwt. higher than average negotiated prices.

  • Forward contract prices varied the most relative to other pricing methods. They were 6¢-91¢/cwt. higher than comparison prices in 2001. However, in 2003, forward contract prices were $6.02/cwt. below negotiated prices and $5.31/cwt. below formula prices. This large price difference is likely related to the nature of pricing basis contracts.

Price data aren't reported for packer-owned cattle, as those cattle are transferred internally from one business area of the company (cattle feeding) to another (slaughter-fabrication).

So what about sweetheart deals between packers and feedlots?

Ward contends, given the reported annual average prices, that although sweetheart deals may exist, there's no significant advantage, on average, with formula prices relative to other procurement methods or the five-region weighted average price.

No distinguishable difference

Comparing each of the price series for pricing methods to the broader weighted average price is important to identify similarities and differences.

“In a comparison of weekly weighted average dressed steer prices vs. negotiated prices for the three years since MPR began,” Ward explains, “there appears to be no distinguishable difference between prices.”

Many MPR supporters presumed a favorable relationship of formula prices existed relative to negotiated prices. Comparing formula prices and forward contract prices with reported negotiated prices, there is a noticeable difference in many weeks (Figure 3).

But, do those who formula price receive preferential prices?

“The answer appears to be ‘yes’ sometimes and ‘no’ sometimes,” Ward says. “Recall that the price difference on average between negotiated and formula prices was just a few cents per cwt. and favored formula prices two of the three years.”

A partial explanation may be that negotiated prices tend to be lower than formula prices on a declining market. Conversely, formula prices tend to trail negotiated prices on a rising market. Many base prices in grids are formula prices tied to last week's cash market — either a reported cash market price quote or the average cost of fed cattle at the packer's plant where the cattle will be harvested.

Therefore, a closer relationship is expected between this week's formula prices and last week's negotiated prices, compared with this week's negotiated prices and this week's formula prices.

In comparing forward-contract prices with negotiated prices, Ward reminds that forward-contract prices deviate sharply from negotiated prices in some weeks.

“With basis contracts, packers bid a futures market basis in the month fed cattle are expected to be harvested, and cattle feeders can pick the fed cattle price anytime before delivery of the cattle,” he says. “Thus, cattle feeders determine when the futures market contract price has peaked for the expiration month just after the cattle will be harvested.”

As a result, this week's reported forward contract prices may or may not be closely aligned with this week's negotiated prices.

Ward offers summary observations:

  • In general, prices for the three procurement methods track each other relatively closely. Each is representative of broad market conditions but not of what migh affect prices within and between weeks. But, less reliance should be placed on forward-contract prices as an indicator of current market conditions compared with either negotiated or formula prices.

  • No single pricing method has been consistently higher or lower than any other. This seems especially important, given the concerns regarding captive supply prices versus cash market prices.

“Neither of the two pricing methods typically associated with captive supplies is consistently above cash market prices,” Ward concludes. “However, there appears to be differences associated with rising or declining prices that could be important in choosing one marketing method over another.”

WORC says captive supplies suppress all prices

The Western Organization of Resource Councils (WORC) began addressing the issue of captive supplies nearly 15 years ago. In an effort to “restore competition to the livestock market” the Billings, MT-based WORC has offered a proposal requiring:

  • A fixed base price on contracts and marketing agreements.

  • Contracts be traded in open, public markets. “No more secret deals.”

This proposal is the basis for the Captive Supply Reform Act, S. 960, introduced in the 109th Congress by Wyoming Sen. Mike Enzi. S. 960 would amend the Packers and Stockyards Act of 1921 to prohibit certain forward contracting practices.

WORC maintains captive supplies hold down all cattle prices in all forms of contracts. Because formula prices are tied to the cash price, all prices — both formula and negotiated — are driven down due to the high levels of captive supplies, WORC says.

“In his research, Clem Ward (see article above) indicates formula contracts, forward contracts and open negotiated contracts all provide approximately the same price for producers,” says Skip Waters, Moorcroft, WY, former WORC chair and a member of WORC's livestock committee. “Through current contracting methods, the packers are able to line up enough supply through formula contracts to affect the cash price, driving it down.”

WORC says Ward's finding sheds even more light on the need for the Captive Supply Reform Act.

“When all contracts are made in an open public market, no one form of contracting will have the ability to hold cattle prices captive,” Waters says, He adds that while Mandatory Price Reporting (MPR) was recognized at the time of its passage as a method to shed light on the issue of captive supplies, it's just one piece of the puzzle.

“Because there's no price associated with packer-owned cattle, the true effects of packer-owned cattle — just one form of captive supplies — on the overall cattle markets isn't revealed with price reporting alone,” Waters explains. “MPR did give us one important piece of information — a more accurate count of other forms of captive supplies such as formula contracts and other forward contracts.”

With Ward reporting that around 50% of fed cattle are captive supplies, WORC says these actual numbers are much higher than either USDA or packers reported prior to MPR.

“It's also interesting to note that Ward found captive supply levels lower since the Canadian border closed,” Waters continues. “That may be because Canadian cattle imported for slaughter were a disproportionately high percentage of captive cattle.”

Or, he adds, because with the limited supply of live fed cattle, more U.S. cattle producers were able to get a fair price in the open cash market and didn't feel compelled to enter into formula agreements.

“It does appear that with lower overall captive supply levels available to packers, cattle prices have increased,” Waters says.

For more information on S. 960, go to: