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 http://webdoc.agsci.colostate.edu/koontz Des Moines, IA December, 2013 Percent 80% 70% 60% 50% 40% 30% 20% 10% 0% 7/21/08 10/20/08 1/19/09 STEERS/HEIFERS SOLD BY TRANSACTION National Weekly Data Source: USDA-AMS Compiled by: Livestock Marketing Information Center 4/20/09 7/20/09 10/19/09 1/18/10 4/19/10 7/19/10 10/18/10 1/17/11 4/18/11 7/18/11 10/17/11 1/16/12 4/16/12 7/16/12 10/15/12 1/14/13 4/15/13 7/15/13 10/14/13 Grid Formula Forward Contract Series of charts with weekly data & history back to 7/2008. 1
Definitions is the cash market there is bid and ask may be live weight or carcass weight or grid but there is price discovery. Formula 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. Forward contracts are transactions with >14 days before delivery. Packer owned are 100% packer own cattle. AMAs (Alternative Marketing Arrangements) and not Captive Supplies. Percent 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 7/21/08 10/20/08 1/19/09 STEERS/HEIFERS SOLD BY TRANSACTION Texas, Oklahoma & New Mexico Weekly Data Source: USDA-AMS Compiled by: Livestock Marketing Information Center 4/20/09 7/20/09 10/19/09 1/18/10 4/19/10 7/19/10 10/18/10 1/17/11 4/18/11 7/18/11 10/17/11 1/16/12 4/16/12 7/16/12 10/15/12 1/14/13 4/15/13 7/15/13 10/14/13 Grid Formula Forward Contract 2
Percent 80% 70% 60% 50% 40% 30% 20% 10% 0% STEERS/HEIFERS SOLD BY TRANSACTION Kansas Weekly Data Source: USDA-AMS Compiled by: Livestock Marketing Information Center 7/21/08 10/20/08 1/19/09 4/20/09 7/20/09 10/19/09 1/18/10 4/19/10 7/19/10 10/18/10 1/17/11 4/18/11 7/18/11 10/17/11 1/16/12 4/16/12 7/16/12 10/15/12 1/14/13 4/15/13 7/15/13 10/14/13 Grid Formula Forward Contract Percent 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 7/21/08 10/20/08 1/19/09 STEERS/HEIFERS SOLD BY TRANSACTION Nebraska Weekly Data Source: USDA-AMS Compiled by: Livestock Marketing Information Center 4/20/09 7/20/09 10/19/09 1/18/10 4/19/10 7/19/10 10/18/10 1/17/11 4/18/11 7/18/11 10/17/11 1/16/12 4/16/12 7/16/12 10/15/12 1/14/13 4/15/13 7/15/13 10/14/13 Grid Formula Forward Contract 3
Percent 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% HOGS SOLD BY TRANSACTION National, Weekly Data Source: USDA-AMS Compiled by: Livestock Marketing Information Center 7/21/08 10/20/08 1/19/09 4/20/09 7/20/09 10/19/09 1/18/10 4/19/10 7/19/10 10/18/10 1/17/11 4/18/11 7/18/11 10/17/11 1/16/12 4/16/12 7/16/12 10/15/12 1/14/13 4/15/13 7/15/13 10/14/13 Purchases Other Market Formula Swine or Pork Mkt Formula Other Purchase Packer Sold Packer Owned Percent 70% TOTAL CATTLE SOLD BY TRANSACTION Monthly 60% 50% 40% 30% 20% 10% Grid Formula Forward Contract 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Data Source: USDA-AMS Compiled by: Livestock Marketing Information Center Monthly data & beginning 4/2001. 4
CATTLE SOLD ON A LIVE BASIS Monthly Percent 100% 90% 80% 70% 60% 50% 40% Grid Formula 30% 20% Forward Contract 10% 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Data Source: USDA-AMS Compiled by: Livestock Marketing Information Center Percent 80% CATTLE SOLD ON A DRESSED BASIS Monthly 70% 60% 50% 40% 30% 20% 10% Grid Formula Forward Contract 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Data Source: USDA-AMS Compiled by: Livestock Marketing Information Center 5
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-90s for formula enterprises & high-70s & low-80s 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. Higher volumes, predictable volumes, & lower costs. Fewer personnel. Predictable program cattle volumes. A Comment or Idea on Markets Markets that become too expensive to use will not be used & will become less important. 6
Is this next? 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. 7
Price Discovery is a Public Good Cash market participants invest resources to negotiate & discover cash market prices. Formula operations save that investment & make use of the prices discovered by the cash market participants. It is exactly the grazing example it is the tragedy of the commons. Formula operations use the outcome of the investment by cash market operations without paying. Research is needed. This is not an it depends economist 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 Price Discovery Study: What will we learn? Is there evidence of a problem at current levels? Formula volumes impact price levels & variability? Can price reporting be improved using MPR information? For example, are there differences across marketing methods? If no can reporting be combined? What is the impact of the OMB confidentiality requirements? Will we have no price reporting for regions with two packers? What does the industry think & what to do next? Interviews. How thin do they think is too thin? What will they do next? 8
Price Discovery Study: What have we learned? Cash markets are not used because they are too disorderly Internalizing the problem: Profit sharing downstream integrating with packer. Integrating upstream securing calves based on forward contract or hedged fed cattle valuations. AMAs are used to avoid some risks in the cash market. Large operations said, I can t risk not having a significant number of animals sold at the end of the week Small operations said, I can t risk not having the packer show up and bid any given week 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 Solve for n = (σ 2 /{1 Prob}c 2 ) so given X n, σ 2, c & Prob 9
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? $140 Texas, OK & NM Cash Prices & Volume 100,000 $120 90,000 80,000 Cash Price ($/cwt live weight) $100 $80 $60 $40 $20 70,000 60,000 50,000 40,000 30,000 20,000 10,000 Head ( Cash Trade) $0 0 Price Volume 10
Transactions: to achieve <$1/cwt pricing error with 95% certainty 4,000 3,500 3,000 Estimated Transactions 2,500 2,000 1,500 1,000 500 0 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Needed Actual $3.00 Pricing Error at 95% & 99% Needed Confidence $2.50 Cash Price ($/cwt live weight) $2.00 $1.50 $1.00 $0.50 $0.00 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 95% Pricing Error 99% Pricing Error 11
$140 Colorado Cash Prices & Volume 100,000 $120 90,000 80,000 Cash Price ($/cwt live weight) $100 $80 $60 $40 $20 70,000 60,000 50,000 40,000 30,000 20,000 10,000 Head ( Cash Trade) $0 0 Price Volume Transactions: to achieve <$1/cwt pricing error with 95% certainty 4,000 3,500 3,000 Estimated Transactions 2,500 2,000 1,500 1,000 500 0 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Needed Actual 12
$140 Nebraska Cash Prices & Volume 100,000 $120 90,000 80,000 Cash Price ($/cwt live weight) $100 $80 $60 $40 $20 70,000 60,000 50,000 40,000 30,000 20,000 10,000 Head ( Cash Trade) $0 0 Price Volume Transactions: to achieve <$1/cwt pricing error with 95% certainty 4,000 3,500 3,000 Estimated Transactions 2,500 2,000 1,500 1,000 500 0 Needed Actual 13
$140 Iowa & S. MN Cash Prices & Volume 100,000 $120 90,000 80,000 Cash Price ($/cwt live weight) $100 $80 $60 $40 $20 70,000 60,000 50,000 40,000 30,000 20,000 10,000 Head ( Cash Trade) $0 0 Price Volume Transactions: to achieve <$1/cwt pricing error with 95% certainty 4,000 3,500 3,000 Estimated Transactions 2,500 2,000 1,500 1,000 500 0 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Needed Actual 14
So How Thin Is Too Thin? For Nebraska & likely generalizes to other regions: Suspect impacts on price at the negotiated volume being 5-10% of total. Currently, at 20-50% or 30-40%. All other southern & western regions will see problems beforehand. Texas/Oklahoma/New Mexico there now. Kansas there next. Colorado been there for some time. Midwest regional markets are thickest and will be center of negotiated cash market price discovery? Nebraska & Iowa/Southern Minnesota Interview Questions How much pricing error is acceptable & what proportion of the time? Will help answer how thin is too thin? What are formulas worth ($/hd)? What are reported cash prices worth? Local regional cash market ($/hd)? What is the cost to replace that information? A group of regional cash markets ($/hd)? How many & cost to replace information? National cash market price ($/hd)? Replace? All these questions address the value of the cash market & its information. 15
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. Quantity controls & with tradable rights. (This is not my list. These are what economists & other scientists that face these problems have developed since the 1960s. There are nothing but hard choices because these are difficult issues. And 2 Nobel prizes.) And all work & don t work or have pros & cons. Specific Proposals Do nothing inevitable commodity industry growth & change. Quit opposing Johnson Amendment-type proposals with prohibition or limitations or introduce our own. Informal meetings with informal agreements. Look for & invest in technology to develop markets. Develop new information to address risks. Organize a market for price discovery issue permits (or requirements) & allow trade in those permits. 16
Interview Questions Is voluntary group-action sufficient & will you participate? What are your new-technology ideas? Electronic markets? Downstream market prices? Production contracts? B2B more-automated exchanges? Integration of ownership? Would you support collection and reporting of more detailed marketings and purchases? Would you support a market for tradable cash permits/requirements? How does new technology work? The new technology is with respect to the cash market it replaces or reduces the cost of using the cash market. What tools/technology replace the cash market but still result in a reportable negotiated cash price? Production contracts? Vertical integration B2B? What tools/technology reduce the cost of using the cash market? Electronic exchanges automated bid/ask automated scheduling? Vertical coordination B2B? 17
How does new information work? New information must mitigate the risk that is causing movement away from the cash market. The Cattle on Feed report is not enough and the information from private sources like Cattle Fax is not enough. Need: Information on weekly expected future marketings. Information on weekly expected future purchases. Where s the imbalance? Market and purchase around the problems. How does the tradable permit market work? Choose a volume for the cash market, e.g., 10%. Issue permits to the largest cattle feeders & stop with some designated modest size. Formula feeders will want to sell (pay to get rid of) permits & cash feeders will want to purchase (be compensated). And there will be a cash fed cattle market. The permit market will provide information as to how much price discovery is wanted/needed. High priced permits implies the % was too large. Low priced permits implies the % was too small. But there are issues with regions Can the market be closed? 18
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. Need to remember the Public Good aspect of price discovery. Contact & Link Information Stephen.Koontz@ColoState.Edu http://webdoc.agsci.colostate.edu/koontz/ 19