If the antitrust verdict against Tyson stands and packers are prohibited from buying cattle with formulas, forward contracts and other mechanisms outside the spot cash market, ironically, the price at the center of the controversy could be the least affected and the least of producer concerns.
Before jumping into that, however, a few ground rules. Forget for a minute whether you're for or against the jury decision that found Tyson (actually IBP before Tyson bought them) guilty of a class-action lawsuit forged on the grounds of the Packers and Stockyards Act of 1921. In essence, plaintiffs argued and the jury agreed that the captive supplies IBP created through formulas and contracts allowed it to depress cash-market prices, thereby causing financial harm to anyone selling cattle to IBP on a cash basis.
Forget that Tyson has asked the judge in that trial to set the jury verdict aside, or the fact that both plaintiff and defendant in this case will likely appeal the judge's decision to a higher court.
Instead, assume the jury decision stands. Pretend that all packers are prohibited from procuring cattle by any other means than the spot cash market. Make believe the grass is greener on the other side of yesteryear and every head of cattle leaves the feedlot by means of a negotiated transaction. What happens to the fundamentals of supply and demand and their ever-present by-product of price? By all means, speculate. That's all the industry can do at this point.
Price Is What Price Will Be
Up front, in a free market, or something resembling it, price is determined by supply and demand, no matter the type of transaction mechanism used to clear the market.
“On average, I don't think it would have a super-negative impact on price or a positive one, either,” says Clem Ward, Oklahoma State University agricultural economist. “It would change the price for individuals at certain times, and it could change in either direction, but on average it shouldn't have much price impact.”
While there are no apples-to-apples comparisons, Ward bases his opinion on past experience. For one, mandatory price reporting that many in the industry believed would change prices significantly — and for the better — was basically neutral to price. That's if you don't count the bugs early in the system that meant lots of cattle were priced a lot less than they should have been.
Further back, at least where price volatility is concerned, Ward points out, “There was more volatility in prices when we were selling (negotiating) price pen by pen 25 years ago. If this court ruling means a return to that, and if that eliminates the 30-minute weekly marketing window, you may actually see more price volatility because fewer cattle will be trading for the same price at one time.”
Moreover, Ward points out, “One of the immediate implications is that we wouldn't have the obvious tie-ins between certain feedlots and packers. But, that wouldn't mean that buying patterns had necessarily changed.”
Just as cattle buyers purchase a producer's calves each year because they know the cattle and the risk involved, it seems reasonable to assume packers would continue doing business with the feedlots they have in the past.
Will eliminating the captive supplies fostered by promissory arrangements result in higher prices? Tim Schiefelbein, director of live cattle procurement for Swift and Co., points out, “If a packer has 40% of his needs accounted for in a week currently, that also means there are 40% fewer cattle available on show lists that he must be just as aggressive trying to buy to fill the remainder of his needs.”
Historic data gathered by organizations and individuals regarded as industry experts indicate that over the long haul, across the industry, on average, captive supplies have done little to impact price one way or the other. In a given region, in a given week, captive supplies may have a significant bearing on price.
Currently, Swift procures cattle through every buying mechanism under the sun — cash bids live and in the beef, negotiated-base grids, grids with a base determined by predefined formula, forward contracts and formulas. “The key is that with packers offering a variety of marketing methods, the market decides which methods are useful to producers and which ones aren't,” Schiefelbein says.
Without contracts and formulas, Schiefelbein says procurement costs increase. Whether or not that would impact price directly, he believes the reduced cost efficiency ultimately would make retail beef prices less competitive with other meat proteins. More than that, he worries about what the impact would be on branded beef programs and beef quality overall.
Where's The Beef — Quality?
“These branded programs are based on the supply of a specific product that we can supply to retailers year-round,” Schiefelbein explains. “When you're in the open market on that many (all negotiated) of your cattle, you can't be as a consistent with the product.”
For that matter, Schiefelbein believes vertically coordinated systems utilizing contracts and formulas, driving the move toward beef branding, have increased beef demand because of the economic incentives they provide.
“The entire industry has done an amazing job, from seedstock producers on up, increasing carcass quality and yield. If we're forced to remove the financial incentive there's no reason for producers to keep improving,” Schiefelbein says. “Alliances and formulas provide incentive and drive quality into the system.”
Bill Mies, vice president of national account sales for eMerge Interactive and a long-time trusted industry analyst, is concerned the shift could depress beef demand. He says that's because of what packers would be forced to do on the other side of the buying equation.
Mies explains that retailers, especially in food service, have come to rely on forward-contracting their beef purchases from packers from a quarter to a year in advance. They've done it largely to maintain price stability on their menus.
Unable to establish a base price for the future through contracts and formulas, Mies says, “My guess would be that packers would try not to forward contract any more beef than they had to, or any more than they already had contracted.”
Subsequently, if retailers are unable to lock in at least a base price over a specific period of time, he thinks it's logical that retailers would limit the number of beef items on their menus. Or perhaps They might remove beef items because of the price risk involved.
As for the potential impact on branded programs, Mies points out there may be more than one way to skin a steer. Perhaps, he suggests, producers could contract directly with retailers to provide their needs, and then contract with packers to harvest and fabricate the cattle for a set fee. That's if that is legal under the ruling, and with the understanding that, at least in the short term, both producers and retailers would be playing a game neither has any earthly idea how to play.
“I don't think this would eliminate branded beef supplies,” Ward says. “The same quality cattle are still coming to market. People know the gains that have been made with product development and supply chain coordination, so I don't think we would lose that, but it might make it more difficult to maintain the benefits.”
Uncertainty Increases Risk
One thing's for certain, if the legal decision stands and forward contracts are prohibited, cattle feeders will lose a risk-management tool that's been available to them for no out-of-pocket cost, Mies says. Instead, they would have to rely on futures and options contracts, which do cost money. Add to that the need for lots more folks to truly understand these markets, and the most lucrative investment could be in buying Maalox stock.
“It would certainly place more pressure on the feedlots to know what the market is at all times in order to negotiate,” Ward says. Since there is no recent record of all negotiated sales to use in analysis, Ward explains, “At least in the short term, it would probably add value to industry-wide market analysts and organizations such as Cattle-Fax and the state groups.”
Plus, the ruling calls into question similar mechanisms used by other segments of the industry.
“Will feedyards be prohibited from using forward contracts to line up cattle coming into the yard?” Mies wonders. You can argue the cattle feeding industry isn't as concentrated as the packers, but you can also argue it's just as concentrated relative to the number of suppliers funneling cattle to them.
If that sounds like carrying the speculation to ridiculous extremes, Mies points out there were plenty of producers who thought the very idea that the courts would dictate to them how they had to market their cattle to packers was a ridiculous extreme.
“It's one of those things where you have to be careful what you wish for,” Mies says. “One domino drops, another follows; I think this decision could have a lot of implications for the industry that few anticipated.”