With day after day of high cash prices, few producers were thinking about hedging to cover the risk on four- and five-weight calves in late spring. Why would they, with $125 to $130/cwt. guaranteed at about every sale barn?
Still, with the possibilities of another case of bovine spongiform encephalopathy (BSE) turning up in the U.S., and corn prices climbing ever higher, some sort of price protection may be needed, says Ron Plain, University of Missouri (UM) agricultural economist.
Yet, even if producers wanted to hedge calves, there isn't a “stocker calf” contract that's a true match for calf size and numbers. The Chicago Mercantile Exchange tried a stocker contract in the late 1990s. It failed due to lack of interest.
The closest hedging tool available is the CME Feeder Cattle contract, with specs of 50,000 lbs. times the CME Feeder Cattle Index per pound for 700- to 849-lb. Medium and Large Frame No. 1 feeder steers. That's a little higher than freshly weaned calves. And, the live-cattle contract is even further apart — 40,000 lbs. of 55% Choice, 45% Select-grade finished live steers.
“Hedging a calf crop can be tough,” says Charlie Sellers, who runs a light calf and stocker operation along with an order buying service out of Amarillo and Hamlin, TX. “With the basis involved, about the only way to hedge them is by using the feeder cattle contract and figuring in your extra basis to the futures price.”
The basis between the feeder contract and 400- to 500-lb. steer averages varies from region to region. What may be a +12¢ to +15¢ basis in October for Texas or Oklahoma may be +5¢ in the Pacific Northwest. The numbers are narrower as calf weights increase, and wider for the peewees.
“The main thing is to know the basis,” says Steve Amosson, Texas A&M University (TAMU) agricultural economist. “There can be large variations, depending on the time of the year.”
For instance, the Texas Panhandle basis for a five-weight steer in April averages about +27¢, compared to the 12¢ in October, according to figures from the Livestock Marketing Information Center and Oklahoma State University.
“The basis challenge is enormous,” Plain says. “It's more erratic in some areas. So you can't offset as much risk with a hedge as you would like.”
Even with the strong market in mid-spring, there were opportunities to hedge calves that would be ready for wheat pasture or grass this fall.
“The October '04 feeder contract was trading at about $1/cwt. in early May,” Sellers says. “For calves that would be at 500 lbs. for selling in October, there was an opportunity to hedge them at the $1, then figure in your 10-15¢ basis (in the Texas Panhandle) for that time of year.”
That, he says would provide a floor price of about $1.15. That's lower than some of the prices we saw for 400- to 500-lb. steers in the spring, he adds, but it should still provide a reasonable price in this volatile cattle market.
Sellers doesn't claim to be a regular hedger. But he used the mentioned October feeder contract to hedge calves that will be sold this fall at 700 lbs.
“I paid $125/cwt. for 450-lb. steers in early May to run on grass about 150 days,” he says. “At a probable gain of 1.7 lbs./day, those calves should be at 700 lbs.”
Sellers says his cost of gain should be about 30¢ on the grass, which would give him a breakeven of $93. Instead of looking for a forward contract immediately, he says he decided to hedge them because of a good profit opportunity, and the continuing threat of summer drought. He sold October futures at $98.30, which gave him “a little window of profit at about $5 cwt.”
Another way to backdoor hedge calves is by using a 1½ to 1 ratio.
“Some use the 1½ times way of hedging because the volatility of the price of 500- to 600-lb. calves is much greater than the volatility of the feeder cattle contract,” Plain, the UM economist says. “Some will even use two feeder cattle contracts to offset the movement of 500-lb. calf prices.”
Plain says feeder cattle options are additional hedging tools for producers, but the cost of premiums are often out of reach.
“It's rare to find a cow-calf producer willing to go out much over $2/cwt. for an options premium. You might have to buy an out of the money put option to hold the costs down,” he says.
Just Not Enough Weight
One hedging roadblock for many producers is the size of the feeder cattle contract. For just one contract, that 50,000-lb. spec translates to about 100 calves. That often applies only to larger producers.
There continue to be situations for producers to pool calves, such as premium weaned-calf sales, to help meet a demand for quality calves. But for many producers, numbers speak for themselves.
Because of the feeder contract's size, many in the industry thought producers would welcome a stocker contract. In 1998, CME started the contract for Medium No. 1 and Medium and Large No. 1, 500- to 599-lb. feeder steers.
One contract equaled 25,000 lbs., or 40-50 calves. CME estimated 800,000 producers nationwide could use the new stocker contract to manage economic risks of downside price movements. There were large networks of Extension/CME-sponsored stocker contract seminars to educate producers nationwide. But the contract never took off. Open interest was sometimes in the single digits.
Some said the 500- to 599-lb. weight range fit well for Midwest operations, but was too high for producers farther south. The contract was lifted after only about two years.
Forward Contract Genetics
Sellers counts on forward contracts more than hedges to generate a reasonable floor price for calves or feeders. That includes both plainer cattle that must be straightened out, and calves that undergo a regimented preconditioning and backgrounding program with early weaning and a detailed vaccination program.
“A good preconditioning program that includes vaccinations usually produces a $50/head advantage,” Sellers says.
Ted McCollum, Texas A&M University beef cattle specialist, says the various methods of forward contracting can give producers the advantages of hedging without actually using the board.
“Contracts can be on a flat price, or a basis contract can be worked out in which the seller can set the basis against the feeder cattle contract price,” he says.
In another marketing scheme, commingled, premium, weaned-calf sales, like those held at Jordan Cattle Company in San Saba, TX, are helping generate the added value producers expect from their good genetics and feedyard-ready calves.
“We have developed the concept of a process-verified and pre-conditioned stocker and feeder sale that combines the best producer management practices with an innovative marketing program for small, mid-size and large producers,” says Ken Jordan, co-owner.
Premium calves are weaned, backgrounded for 45 days prior to the sale, vaccinated, eartagged, castrated and sometimes branded before being brought to the sale barn for auction. Once at the sale barn, the cattle are fitted with an electronic ear tag, sorted and commingled with other calves of similar weight, sex, breeding and background.
“This allows buyers to purchase calves in uniform lots, and allows the sellers to receive higher prices for their calves based on the pen average vs. individual animals,” Jordan says. The calves can also be identified and monitored through slaughter. The premium for these types of calves is $5-$7/cwt. over the average sale price.
McCollum says data from numerous sources, including 10 years of TAMU Ranch to Rail feed-out program data, show preconditioned calves' added value. In the widest variation, on average, calves that didn't get sick were worth $15.50/cwt. more at purchase compared to calves that got sick.
McCollum says that realistically translates to about $5-$8/cwt. when the $15.50 is adjusted for average morbidity rates for incoming calves.
“Other data, like that from the Superior Video Auction sale (in Fort Worth, TX), shows at least a $3.50 premium advantage for preconditioned calves,” he says.
Even though cattle prices bounced back strongly after the finding of BSE last December, producers need to think twice about counting only on cash sales for calves, Plain says.
“The risk out there is enormous,” he says. “I'm not optimistic that history will show that two will be the grand total of BSE cases [in North America]. Producers should look at ways of protecting their risk.”
To learn more about your region's basis for all weights of calves, contact your local Extension livestock marketing economist or go to the Livestock Marketing Information Center Web site at www.lmic.info.
Larry Stalcup is a freelance writer based in Amarillo, TX.