Price Discovery Issues for Fed Cattle: What s the Future of the Cash Market or How Thin Is Too Thin?

Transcription

1 Price Discovery Issues for Fed Cattle: What s the Future of the Cash Market or How Thin Is Too Thin? Stephen R. Koontz Professor & extension economist Department of Agricultural & Resource Economics Colorado State University Stephen.Koontz@ColoState.Edu November, 214 Objectives What is going on in terms of the use of US fed cattle markets? What is thinning cash trade and what s the problem? Research results in the context of the NCBA project specific to US. Contrast with business practices in Canada. Talk through recommendations for the NCBA. Recommendations for price reporting in Canada. Percent 8% 7% 6% 5% 4% 3% 2% 1% % STEERS/HEIFERS SOLD BY TRANSACTION National Definitions is the cash market there is bid and ask may be live weight or carcass weight or grid but there is price discovery. is the price is discovered elsewhere may be plant average price or a USDA AMS regional price or a downstream price or a futures price but there is no price discovery. The terms of the formulas may be negotiated but prices are not. contracts are transactions with >14 days before delivery. Packer owned are 1% packer own cattle. AMAs (Alternative Marketing Arrangements) and not Captive Supplies. 1

2 Percent 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % STEERS/HEIFERS SOLD BY TRANSACTION Texas, Oklahoma & New Mexico Percent 1% 8% 6% 4% 2% % STEERS/HEIFERS SOLD BY TRANSACTION Kansas Percent 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % STEERS/HEIFERS SOLD BY TRANSACTION Nebraska Percent 5% 45% 4% 35% 3% 25% 2% 15% 1% 5% % HOGS SOLD BY TRANSACTION National Purchases Other Market Swine or Pork Mkt Other Purchase Packer Sold Packer Owned 2

3 Percent 7% 6% TOTAL CATTLE SOLD BY TRANSACTION Monthly Fed Cattle Marketings in Canada 5% 4% 3% 2% 1% % Data Source: CANFAX Annual Survey Incentives to be on a formula? Cattle management pens are marketed when they need to be marketed. Feedlot management personnel, mills, & systems. Capacity utilization low-9s for formula enterprises & high-7s & low-8s for cash market enterprises. Financing, partial ownership, & profit-sharing. One of the most expensive people in the feedyard enterprise is figuring how to get cattle to make money & is not trying to get more money out of the packer. A Comment or Idea on Markets Markets that become too expensive to use will not be used & will become less important. Higher volumes, predictable volumes, & lower costs. Fewer personnel. Predictable program cattle volumes. 3

4 What s Next? The livestock industry wants price information... To use as base prices for formula transactions. To provide basis information in forward contracts. So that there is benchmarking information in evaluating profitability & returns to investment. But that industry wants to be able to not use those markets and to not have to do the work of price discovery. So negotiated cash trade of fed cattle is next. It will remain small, will shrink further, and will concentrate in some regions... And negotiated cash trade of beef has the same problem. And this makes problems live cattle for futures contracts. Example of Public Good Suppose a group of cow-calf producers do not have enough of their own land to graze all their animals but have access to common land. What happens to that common property? It will be over-grazed or over used. Same outcome occurs for open-access fisheries. Public goods are overused because each individual does not pay their specific full individual cost. There is no market solution to the problem. Solution requires collective action usually through government but an association of interested parties can work with authority to say who uses, provides & pays for the public good. How many of you read the Daily Livestock Report? How many of you pay for it? Price Discovery is a Public Good Cash market participants invest resources to negotiate & discover cash market prices. operations save that investment & make use of the prices discovered by the cash market participants. It is exactly the tragedy of the commons. operations use the outcome of the investment by cash market operations without paying. Research and group action are needed. This is not an it depends economist answer. There are questions the answer we don t know. Objective information is needed to support the making of good decisions. There will not be a market solution and my evidence is hogs, dairy, fruits & vegetables 4

5 What is cash market information worth? What is having a reported cash market price worth? What is cash volume information worth? What are grid prices (premiums/discounts) worth? What would you be willing to pay to get them? What would you be willing to be paid to do that work? If the answers are close to nothing well then there s your cash market. So How Thin Is Too Thin? Confidence & Pricing Error More transactions are needed for better price discovery high probability of less pricing error. Trade-off between number & confidence/error. If you want to be 99% sure then it s a lot more than if 95% is acceptable. If you want to have <$.5 error then it s a lot more than if <$2.5 is acceptable. Impact on price levels? Do formula volumes weaken cash prices? Impact on price volatility? Do formula volumes increase volatility in the cash market? So How Thin Is Too Thin? Make use of a statistical tool: Chebychev s Inequality Prob{-c (X n µ) c} 1 (σ 2 /nc 2 ) Prob is the probability (need to choose) c is the error in price (need to choose) X n is the mean reported price (measure) µ is the underlying market price (unknown) σ 2 is the variance of reported price (measure) n is the number of trades So How Thin Is Too Thin? So there are 3 variables. Choosing any 2 gives us the 3 rd : 1. c is the pricing error How well? 2. Prob is the probability How often? 3. n is the number of trades How many trades? In what follows: Given the error & probability then what s the volume? Given the volume & probability then what s the error? Solve for n = (σ 2 /{1 Prob}c 2 ) so given X n, σ 2, c & Prob 5

6 $14 $12 $1 $8 $6 $4 $2 $ Texas, OK & NM Cash Prices & Volume 1, 9, 8, 7, 6, 5, 4, 3, 2, 1, 6 Head ( Cash Trade) Price Volume Transactions: to achieve <$1/cwt pricing error with 95% certainty 4, 3,5 3, 2,5 2, 1,5 1, 5 Estimated Transactions Jul-13 Jan-2 Jul-2 Jan-3 Jul-3 Jan-4 Jul-4 Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 $3. $2.5 $2. $1.5 $1. $.5 $. Pricing Error at 95% & 99% Needed Confidence Needed Actual Jan-2 Jul-2 Jan-3 Jul-3 Jan-4 Jul-4 Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 95% Pricing Error 99% Pricing Error $14 Colorado Cash Prices & Volume 1, $12 9, 8, Head ( Cash Trade) $1 7, 6, $8 5, $6 4, $4 3, $2 2, 1, $ Price Volume

7 $14 $12 $1 $8 $6 $4 $2 $ Kansas Cash Prices & Volume 1, 9, 8, 7, 6, 5, 4, 3, 2, 1, 7 Head ( Cash Trade) Price Volume Transactions: to achieve <$1/cwt pricing error with 95% certainty 4, 3,5 3, 2,5 2, 1,5 1, 5 Estimated Transactions Jan-2 Jul-2 Jan-3 Jul-3 Jan-4 Jul-4 Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 $14 $12 $1 $8 $6 $4 $2 $ Nebraska Cash Prices & Volume 1, 9, 8, 7, 6, 5, 4, 3, 2, 1, Needed Actual Head ( Cash Trade) Price Volume Transactions: to achieve <$1/cwt pricing error with 95% certainty 4, 3,5 3, 2,5 2, 1,5 1, 5 Needed Actual Estimated Transactions

8 So How Thin Is Too Thin? Alberta Cash Prices & Volume For Nebraska & likely generalizes to other regions: Suspect impacts on price at the negotiated volume being 5-1% of total. Currently, at 2-5% or 3-4%. All other southern & western regions will see problems beforehand. Texas/Oklahoma/New Mexico there now. Kansas there next. Colorado been there for some time. Midwest regional markets are thickest and will be center of negotiated cash market price discovery? Nebraska & (less so) Iowa/Southern Minnesota. Estimated Transactions Transactions: to achieve <$1/cwt pricing error with 95% certainty 4, 3,5 3, 2,5 2, 1,5 1, 5 Jan-2 Jul-2 Jan-3 Jul-3 Jan-4 Jul-4 Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Perspective on Canadian Fed Cattle Trade Shift from negotiated cash to negotiated forward markets as opposed to formula. Steady 7% cash and forward trade. Price discovery happening in the forward market. Report the bid/ask. Report the flat-price forward contracts. Report the basis contracts. And there remains unique price discovery in the cash market relative to the US market Caution: reporting the forward market will impact the current cash market Needed Actual 8

9 What are solutions to the Tragedy of the Commons? Do nothing and live with it Government intervention & mandates. Privatize the public good. Collective action by interested individuals. Search for, develop & invest in new technology. Develop new information to mitigate risks. Employ market-makers. Quantity controls & with tradable rights. (This is not my list. These are what economists & other scientists that face these problems have developed since the 196s. There are nothing but hard choices. And 2 Nobel prizes in Economic Science.) And all work & don t work or have pros & cons. Final Comment on Markets Free markets are not free. Markets require & consume resources for use, maintenance, & development. We all want the information that comes from markets but we also want the option to not use them. Make market function & survival the result of an industrylevel decision & not something that just happens. Will need to take group action & do something specific to maintain & protect the negotiated cash fed cattle market. Need to remember the Public Good aspect of price discovery and information in general. Contact & Link Information Stephen.Koontz@ColoState.Edu 9