Say all you want about historically high cattle prices, the longest sustained period of cow-calf profitability on record, robust consumer beef demand and the growing seasonal prospects for more grass and forage.
“We didn't expand the herd last year, we won't this year, and I don't believe we'll grow it to any degree for the next several years,” says Bill Helming of Bill Helming Consulting Services at Olathe, KS.
Net economics appear to be the growing reason.
“The financial health of the production sector is at greater risk than a year ago because cost of inputs has increased so dramatically and quickly,” says Nevil Speer, a Western Kentucky University livestock economist.
In fact, the Food and Agricultural Policy Research Institute (FAPRI) estimates feed costs (for all livestock) for this year will be up 22.4% compared to last, while net cow-calf returns are projected to decline 45.2% to $42.70/cow. Prospects deteriorate steeply from there. FAPRI pegs net cow-calf returns at $9.40/cow next year and then -$11.91 to -$47.92 until breakeven levels return in 2014.
Keep in mind, part of the FAPRI assumptions include more traditional cyclical cowherd expansion.
Ethanol's effects
“There's more uncertainty in the market. We haven't seen historic patterns of price seasonality for the past six or eight months,” Speer says. “I'm more uncomfortable than I have ever been running generic breakevens because of the weather effects and corn prices.”
Though no one knows with certainty, Helming believes it's rational to assume, with reasonable luck and barring poor growing conditions, there will be 12.1-12.5 billion bu. of corn produced this year (it was 10.5 billion bu. last year) from 89-90.5 million acres.
Helming says it's also reasonable to peg corn usage — livestock and poultry, ethanol, industrial use and export — at 12.3 to 12.5 billion bu. So, best-case scenario, already historically low corn stocks (carryover) will tread water.
“Potentially we could go into the 2008-09 crop with zero corn carryover,” Speer says.
With his underlying assumptions, Helming says the delivered price of corn to feedlots in the Central High Plains will likely average $3.80 to $4.30/bu. in 2007-2008.
“A lot of stars have to line up for that to happen. Anything short of these production estimates, and we could add $1-$2 more to the delivered corn price in the High Plains,” Helming says.
Like crude-oil prices, corn prices are more likely to move higher on average than otherwise. Incidentally, Helming expects energy costs — diesel, gasoline and natural gas — to remain relatively high for the next two to three years ($50-$70 crude). As such, he believes there will be more use of less energy-intense processes at the feedlot, such as using more high-moisture corn and dry-rolling corn rather than steam-flaking.
“As corn prices increase, it will become more about feedmill efficiency and what you can do with ration cost,” Speer says. Though winter weather slammed carcass weights for a time, he points out steer carcass weights are still running ahead of the five-year average.
“Clearly, ethanol production — good, bad or indifferent — is here and will grow, so corn prices will continue to be historically high for at least the next several years,” Helming says. “You can go back 50 years looking at the major ups and downs in corn prices. All of those periods were driven by supply. This time it's driven by demand as it relates to its relatively new and substantial use for ethanol production.”
So, there's no waiting for Mother Nature to improve yield next year and correct the situation.
How high corn helps
Though it may at first seem like a stretch, Helming points out the beef industry will suffer less than its competition since cattle can utilize forage and distillers grains, while pork and poultry can't.
“The increased availability of distillers grains will particularly benefit the yards closest to ethanol plants, and particularly those that can utilize wet distillers grains,” Helming says.
Since high grain prices historically reduce total red and white meat supplies, Helming explains that, too, is supportive of meat prices in general for 2007-2008.
“I think beef production in 2007 will be down about 1%,” Helming predicts. “More important, total net red and white meat supplies will be down 2.5-3%. We haven't seen that in a long time.” The net is defined as total domestic production of beef, pork and poultry, minus exports, plus imports.
Ironically, high corn prices can be friendly to cattle feeders, too, Helming says. Since the beef industry is still segregated, cattle feeders can dilute some risk spawned by higher input costs by paying less for cattle to feed. There's a limit, however, to how far cattle feeders and beef packers can lower the price floor in the face of today's excess capacity in both sectors.
The opposite holds true for cow-calf operations as reflected by the FAPRI figures shared earlier.
“My biggest concern is for cow-calf producers,” Speer emphasizes. “Ethanol is changing land values so quickly, and farmers are competing with cattle producers for hay and grazing acres.”
It's not that producers are necessarily tearing up hay fields and native grass pastures to plant corn, though that is happening in some parts of the country. It's more that producers are planting corn on less fertile, tillable ground where they may have planted another row crop in the past, and then planting the substituted crop on the ground previously used for hay and grass.
Economy, demand still strong
At least the industry is facing these challenges amid consumer spending strength.
“Overall, the U.S. economy should remain positive over the next year or two in terms of growth and consumer income,” Helming says. “Exports are improving, and I'm optimistic they'll continue to improve gradually. As incomes rise globally, I believe U.S. beef will get its share… Consumer demand for beef is at a critical point. It's positive, and I think it will remain positive.”
In fact, when Helming looks at consumer expenditures for beef and competing proteins (in current dollars) from 1999 to 2006, beef is the clear winner. During that period, he says consumer expenditures for beef increased 41%; pork expenditures increased 16%, and poultry 12%.
“That's not a direct proxy of demand, but it does show a positive consumer spending pattern. The demand curve itself has shifted to the right. During that same period of time, American consumers have been willing to pay more for more beef, more for the same amount of beef and more for less beef.”
This means the beef demand curve has become more inelastic; consumers have been willing to consume available beef supplies at higher prices. In other words, consumers are less sensitive to increased beef prices than in the past.
Based on the assumptions made here, Helming believes cow-calf producers will still be profitable this year (July 2006 though June 2007 — Period 1) and next (July 2007 through June 2008 — Period 2) but at a lower rate.
“Best as I can tell, it will be breakeven or a small profit in Period 1 for stocker operators, and probably a small loss in Period 2,” Helming says. “Clearly, cattle feeders posted a loss in Period 1. I believe they will post a small profit in the next period because they will pay less for replacement cattle, while beef cut-out values and fed cattle prices will remain relatively strong.”
Effect on industry structure
Perhaps the most significant wonderment spawned by ethanol-fueled corn prices is what rising costs and declining net profits may portend for industry structure.
“At what point do we begin to see more liquidation of cows?” Speer wonders.
If more cow liquidation occurs, with feedlots already struggling to maintain occupancy rates, Speer foresees another round of consolidation in that sector. The same logic applies to packers in general, especially on a regional basis.
“The principle of commodity production, like corn, is that it trades at basically the cost of production; it's a breakeven business,” Speer says. “Since the largest commodity operators have more opportunity to reduce production costs because of the economies of size, I think we could also see another round of liquidation among the smaller farming operations, too.”
In the meantime, Speer and Helming suggest the primary opportunity cow-calf operators have to manage the risk associated with high corn prices is by exploiting the widest price ranges in history for same-class, same-weight cattle. Calf and feeder buyers will likely continue paying more for what they want and less for what doesn't fit in order to reduce risk.
Likewise, retained ownership enables fixed-cost operations to dilute costs.
“There will be opportunities for cow-calf producers who have better than average, proven genetics to bring back significantly more per head, via retained ownership and working with selected parties,” Helming says.
“We keep thinking, ‘When the market straightens out…’ But it has never gotten back to what we think of as normal since BSE in 2003,” Speer says.
And chances are, it never will.
