May 14, 2020
There are reasons the negotiated cash market has thinned and alternative marketing arrangements (AMA) have flourished.
That’s among the many results of research into the ailing cash market for fed cattle. Beyond the Mandatory Price Reporting (MPR) information and the USDA-RTI study, there are the attendant interviews with cattlemen and packers: all research involving Stephen Koontz, ag economics professor at Colorado State University.
Koontz’s interviews with feeders over cash marketing problems pinpoint less control over shipping date, clearing pens for incoming cattle and feed costs for extra days. These considerations and others have operational efficiency costs.
Then there are risks, like cost and performance losses from cattle not shipped at the optimal time for grading and yield, cited by both small and large feeders. The larger operations could not risk having large portions of their showlist not marketed on time. For small operations, it was not getting good bids in time.
Packers also had complaints about timing. AMA cattle provided more predictable flows of cattle and more communication between feeders and packers than cash deals.
Inefficiency means higher costs
But most of the AMAs, whether formula, forward contracts or branded beef, rely on a cash market price in their pricing equation, not just the supply and demand of AMA cattle.
Markets and market information can be considered a public good and that is one reason the government collects and disseminates market information. While the public pays for that information through taxes and user fees, the other means of marketing, like AMAs, do not pay anything.
Those who use the cash markets invest time and resources to establish prices. Everyone else “free rides” on the efforts of the cash traders, Koontz points out, including downstream and upstream segments.
Koontz said achieving the economically optimal level of a public good in competitive markets requires group action and some market intervention. Often, it is associations of individuals who reach the conclusion they must act because doing nothing is not a solution.
Koontz put together a series of potential options, ranging from voluntary steps individuals could take to more structured initiatives that mandate behavior and include economic incentives. The intermediate ones suggest new information provisions and changing business practices. Several options could be tried at once.
But, Koontz said, the steps must take into account the costs and risks inherent in cash trading and provide incentives or offsets.
The order of the suggestions goes from least effective and most flexible to most effective and least flexible. The following are highlights from Koontz' 15-page pre-publication write-up titled Price Discovery Policy Recommendations that he shared with BEEF:
Forum: Koontz’s first suggestion—not so much a first step in a series as a new approach for research and resolve—was the creation of a specific forum in which AMA participants would discuss regional and national cash markets. Trends, behaviors and perceptions need airing before they become big problems.
This would be a natural extension of association work and could help prevent litigation and legislation. Some of this has been happening within associations but needs engagement across usual association lines.
These discussions need to be transparent and open. This approach requires goodwill, creates no direct economic incentives for cash marketing, allows the most freedom for operations but opens up more possible avenues of action.
Basis trading: This would entail shifting cattle pricing to a basis market, much as grain is traded now. Basis—cash price minus futures price—has not been a particularly favored route for cattle feeders in the past. Likely, only the thinness of the cash market is leading to reconsideration now.
The futures contract would require considerable study and likely revisions to make this work. The contract is owned by the CME, not the industry. This approach may or may not help bolster the cash market. While some may consider it an improvement on the current too-thin market now, the concept might not carry long-term support.
There would also likely be issues with how USDA-AMS reports cattle trades compared with how grain trades are reported. Basis trades with short-term delivery would likely be reported as forward contracts in cattle, whereas the grain markets would consider that a cash trade. Basis trading for cattle would be better reported as cash trades.
New trading and reporting technology: Boxed beef price reporting in the ‘80s and MPR in 2001 were the last upgrades in cattle pricing. Our monitoring equipment—computers and cell phones—is new but they are reporting roughly the same level of pricing as 1983.
Feeder cattle use video, satellite and electronic auctions but fed cattle have lagged behind. Much of the fed cattle transaction involves an in-person, visual evaluation of the cattle and follow-up phone calls and haggling. Electronic trading is not much in the picture.
MPR data is after-the-fact, derived from packer databases. The bid/ask procedure is unknown, and depth of the market is only available from state association or national services. This somewhat mysterious process is frustrating to many feeders.
While lots of electronic data is available on stock and futures markets, fed cattle markets have not followed suit. This would provide information and transparency useful to depth in the cash market. Koontz suggests that “numerous cattle feeding enterprises may be able to place a relatively small number of cattle in the cash market and elicit high-quality price discovery.” This approach features flexibility and industry control.
Question: Will more transparent trading attract more interest to the cash market?
Institutional practices: Koontz defines institutions as the rules and customs associated with trading fed cattle. That includes such customs as packers bidding on cattle first, feeders following up with offers, packers arriving first bid first, the high bidder is “on the cattle,” a subsequent bid must be advanced a certain amount, a specific order to follow-up bids and in some regions, there is a seven-day pickup.
There are other less pervasive customs, like “right of first refusal.” The packer with that right only has to match a new offer.
A lot of cattle are put on the grid for premiums and discounts and have a formula base price. Keeping those premiums and discounts and bidding the base price on a Choice, Yield Grade 3 could also be formalized.
National agreement on some of these “institutions” could improve the functioning of the cash market and cut risk.
New institutions could be added, like harvesting cash cattle early in the week or at least scheduling ahead of AMA cattle. Or a rule about no delays in scheduling cash cattle without compensation. Such steps could lessen cash cattle risks. Many perceive AMA cattle getting preferential treatment.
This approach can be set and controlled by the industry—packers and feeders figuring out what works for both.
Standard business practices: Institutional practices noted above are voluntary agreements between packers and feeders. Another step with more teeth would be to create an entity to formalize and enforce standard business practices for cash transactions and trade reporting rules.
Koontz suggested that housing and staffing such an entity could be a natural function of the national cattle industry’s organization, NCBA. He noted the grain trade has such an entity, a committee of the National Grain and Feed Association and association membership constitutes acceptance of the rules they set.
There are rule sets for grain trade, feed trade, barge trade, barge freight and rail freight. Payment, freight, quality and delivery timing rules are spelled out without dictating terms of trade or creating leverage for any party.
Buyers and sellers of fed cattle would have to be involved and rules set by committee vote. Koontz said many cattle feeders interviewed, especially frequent cash market users, indicated something like this was needed.
New marketing information: Two risks limiting cash market participation are, for bigger feeders, not getting the showlist sold in a given week and for packers, not getting sufficient volume bought in a given week.
Information beyond the Cattle on Feed report could solve problems for both parties. What is needed is knowledge of anticipated marketings and purchase needs by region.
Koontz suggests aggregating, over all cattle feeding enterprises, expected regional marketings for the upcoming 8-12 weeks. Packers would provide expected regional cattle buys for the next 8-12 weeks.
Imbalances between supply and demand could thus be obvious for everyone and adjustments to avoid bad spots could be made. AMAs already provide some of this information between feeders and packers, so schedules mesh better and efficiencies happen.
Koontz points out that this information is what the industry already tries to estimate anyway.
Market makers: A tool already used by the major stock exchanges, a market maker’s job is to always be in the marketplace and provide liquidity. The cattle industry would need to fund a market maker or provide fed cattle for trading in the cash market.
Market makers are compensated, either directly, through commissions or through buy/sell market opportunities. The cash market would gain some thickness and stability and would benefit from more certain price discovery. Funding could come from the industry or, perhaps, from a government source as contributing to the public good of preserving a cash market.
Permits or certificates: This system would require all cattle feeding operations over a certain size to obtain permits to trade a specified percentage of the total fed cattle in the cash market. Operations that exclusively market through AMAs could transfer their permits to other operations that extensively use the cash market.
The transfers could be worth 50 cents or $1 or whatever the industry decides is fair compensation to get a cash market and the cash market feeders would get the transfer fee. For example, Koontz said if 90% of the cattle traded through AMAs, at a $.50 per head transfer fee, the 10% cash market traders would get $4.50 per head for supporting and using the cash market. If the AMA feeders feel the cash market is getting too thin, they could pay $2.00 for each transfer and cash market feeders would get $18.00 per head.
This would be an industry-regulated mandate, but it directly supports a cash market more reflective of value for price discovery.
Legislation: Legislative ideas in the past have tended to take away the advantages AMAs have for cost reduction, efficiency enhancement and demand improvement through better quality. It takes away cattlemen’s freedom to operate and innovate and revising mandates is difficult. What percentage of cash trade would be required is an estimate and could vary by region.
Many believe we must improve the reliability of the cash markets to accomplish price discovery. This list of prescriptions by an expert familiar with the industry and who knows how markets in other commodities and assets work, the data from the MPR reports and the RTI study, is a starting point the industry should not ignore.
Steve Dittmer is a longtime beef industry commentator and executive vice president of the Agribusiness Freedom Foundation. The opinions of the author are not necessarily those of beefmagazine.com or Farm Progress.
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