When you get down to it, buying and selling cattle today, just like the last four decades, comes down to who is the best horse trader. But with the advent of e-trading and highly technical grids, marketing cattle in 2004 isn't your grandpa's version of a sale barn.
From the opening of the live-cattle contract at the Chicago Mercantile Exchange (CME) in 1964, to satellite television sales in the '80s, to grids based on carcass data today, there are dozens of methods of marketing cattle.
Any breed, size, grade or feeding method for any steer, heifer, cow or bull can be hedged, protected with options, cash forward contracted, basis contracted, e-traded, sold through specialized auctions or just “private treatied.”
With the bulging box of marketing tools available to ranchers, stocker operators and feeders, traders have any number of ways to protect their marketing risk and devote their time to producing the best possible gains, yields and grades, says Clement Ward, Oklahoma State University (OSU) livestock marketing specialist.
Jay O'Brien's operations in the Texas Panhandle include an Angus-cross herd, of which 90-95% are in a retained ownership program through the feedyard. He's experienced just about every marketing method available. He says marketing cattle today requires more discipline because of the many marketing alternatives.
“Flexibility is the most important thing,” O'Brien says, noting that many of his operation's cattle are grazed and fed to meet “natural beef” contracts that generate a solid premium.
“We are the closest we've been to a cattle marketing system that pays the producer the exact value of his cattle. But, overall, there are still many inefficiencies in the industry's marketing system,” he says.
Futures are born
It was Nov. 30, 1964, when the CME unveiled its new live-cattle contract. In Windy City fashion, a circus atmosphere on the trading floor featured CME president Everette Harris in cowboy boots and a Stetson hat, sharing the stage with a calf.
The animal symbolized the live commodity available for trading. And, even though many were successful with profits generated by futures trades, others would just as soon have done to the trading pit floor what the anxious calf did in all of the excitement.
Like any futures contract before or since, the live cattle offerings took off slowly. Open interest the first few years was low, topping just above 15,000 in 1968 and under 14,000 in 1970. By 1975, open interest numbers had climbed to 29,000+, and grew to 45,000 in 1980.
In 1985, open interest reached 59,000 and hovered in that range for a decade. In 2000, open interest topped 129,000. In late July 2004, open interest for live-cattle contracts stood at 117,000.
“I used a lot of futures trades in the '70s,” O'Brien says. “I recovered from the break in 1973 by basis-trading yearlings. After that, my main program was to operate as a “contrarian,” fading the market after a 15-20% move.”
CME Feeder Cattle Futures opened for trade in 1971. Unlike the live-cattle contract, it never drew huge open interest numbers, perhaps due to the wide range of calf and yearling sizes, yield grades and other factors.
Open interest totaled less than 200 in 1971, and had climbed to only 1,275 by 1975. By 1980, the figure was at about 8,600, and grew to 11,200 in 1985, 17,100 in 1990, 16,300 in 1995 and totaled 20,200 in 2000. Feeder cattle open interest was at 20,000 in late July this year.
During the past five years, changes were made to boost interest in the feeder contract. Current contract specs are for 50,000 lbs. times the CME Feeder Cattle Index per lb. for 700- to 849-lb. Medium and Large Frame #1 feeder steers.
Those numbers are closer to the types of cattle going to feedyards, but are out of line for calves sold as stockers. CME attempted a stocker cattle contract in the 1990s, but lacked the open interest to keep it going.
The live and feeder cattle futures contracts offered a means of protecting market risk. They still do, and many larger feeding companies make sure every pen is “hedged.”
Of course, there are stories in all cattle circles about how margin calls have turned many against using futures. The phrase, “I won't send another dime to those @&#X#s in Chicago,” has been expressed many ways.
Still, there are countless incidents where the hedging of fed or feeder cattle prevented huge losses after price breaks, like those in the early '70s, late '80s, and following the BSE scare at the end of 2003.
Options offer more choices
Options on futures helped ease some of the fear of using “the board” to manage risk. After opening in late 1984, open interest grew from about 8,600 that year to 97,000+ in 2000. It was at about 20,000 this July.
Feeder cattle options arrived in 1987. Open interest started at about 1,500 and finished the year 2000 at 20,000+. Open interest was about 16,000 this July.
OSU's Ward says that even though they have been below futures numbers, options trading is an alternative that offers producers and feeders protection against an all-out wreck while still being open to the upside.
“The whole concept of options, being able to set a floor and still have some upside potential, is an excellent concept,” he says. “It has offered a number of people opportunities to benefit from futures market changes without having so much invested.
“Most research says that straight hedges for everything just isn't the way to go. The question is, when do you use hedges and when do you look for something else? Options gave producers flexibility to look at a variety of things,” he says.
O'Brien points out that care is needed in using options. High volatility, especially in today's market, can prevent the return expected from an options strategy.
“The ability to buy put options have given those who need to protect their risk a good product,” he says. “But, for those who ‘write’ or sell put or call options, the volatility can cause excessive losses. A lot of people have been badly burned. There are a lot of different options strategies, and some of them can be scary.”
Forward contracting calves to stocker operators or ultimately to the feedyard has been another frugal method of locking in a specific price in a risk management program. Futures and options have often been used to cover forward contracts.
Ever since custom cattle feeding emerged in a giant way in the 1960s, feedyards have worked to “partner” with ranchers or other feeders to attract their cattle to specific yards. Knowing they would share the profits with a feedyard gave ranchers added confidence in how their cattle would be treated in a retained ownership program.
“Cussed and discussed” is a good characterization for the “formula” method Cactus Feeders, Inc., uses to market fed cattle to Tyson Fresh Meats, formerly IBP. Paul Engler, founder and chairman of Cactus, the nation's largest cattle feeding company, says formula pricing has been good for Cactus.
“We are in about our 18th year in our arrangement with Tyson,” he says. “Formula pricing has met the test of time.”
Developed in the 1980s, formula pricing was likely the industry's first large value-based marketing program. The objective was for a feedyard to provide high-quality beef to the packer, which then provided financial incentives to generate a true value for each animal fed. That true value is something many producers and feeders feel is missing in the final closeout.
“I understand and am fully aware of the criticism of formula and captive supply,” Engler says. “The industry will always have an argument dealing with negotiated sales to get a true market. But, remember, if you're on a formula arrangement, you're just as aggressive in trying to get the most for your cattle as the guy selling on a cash basis.”
The formula program was born out of a need to force packers to pay for higher quality. One of Engler's customers was feeding an excellent set of cattle penned adjacent to some rough Mexican Corrientes. When it was time to sell his higher quality steers, Engler told him the price. The feeder then asked what the Corrientes sold for.
“I was embarrassed to tell him,” Engler says. “The price was close to his cattle because they had been packaged together for the packer. That situation helped to establish the formula pricing method.”
O'Brien says the formula “hasn't been completely positive for the industry” because such locked-in supplies drag down cash and other grid prices. Ward says the formula has “both helped and hurt” the industry.
“It enables people who use it to focus on things other than the base price. They can manage the cattle to make them work best for a grid formula. A disadvantage is that it takes a number of people out of the cash market and perhaps gives packers more leverage to bid down the cash market,” he says.
Like them or not, cattle marketed through grids make up nearly 50% of the total supply, according to Grid-Max, www.grid-max.net, a program helping producers determine the best grid for their cattle. Breed association alliances, Tyson, Excel, National, Laura's Lean Beef, Consolidated Beef Producers and U.S. Premium Beef are among the grids attracting more and more producers. Grids have emerged steadily the past decade.
The benefit of receiving carcass data on every animal is helping producers improve the genetics and quality of their beef.
“Grids are a step toward helping the industry establish a competitive bidding system that we've always lacked,” O'Brien says. “With grids, you get dinked for your screw-ups, but you learn what needs to be fixed. We need competitively bid grids.”
Because of its rural roots, agriculture was one of the first industries to take advantage of satellite television programming, and eventually, high-speed Internet. It was only natural that cattle traders used those space-age tools to buy and sell animals.
The birth of video cattle sales came in Amarillo, TX, with the Amarillo Livestock Video Auction. It sent camera crews to ranches, where consigned cattle were videotaped for a later showing to potential buyers at several locations.
The new technology opened many eyes. In 1987, the space-age exchange merged with a Brush, CO, sale barn to form Superior Livestock Auction (www.superiorlivestock.com).
Paul Branch, Superior's business manager based in the old Fort Worth, TX, stockyards, says 330,000 head were sold that first year. This year, the firm expects to sell 1.56 million head.
“We had reached a plateau at 1.2 to 1.3 million head in 2001,” Branch says. “Fewer customers had the old C-band, large-dish satellite systems. Dish Network and Direct TV, with their smaller, digital-functioned disks were quickly emerging all over rural areas. We switched our operation to the digital networks two years ago, and our numbers increased to more than 1.5 million head marketed.”
Meanwhile, Western Video Market (www.wvmcattle.com), which started in 1989 in Cottonwood, CA, now markets about 600,000 cattle in 13 western states.
“We're still auction people,” says Andy Peek, whose father, Ellington, was a co-founder. “The video sale just offers the cattle to several hundred buyers or more, instead of just a few. It's a tremendous advantage for both buyer and seller.”
Besides selling over television airwaves, Western Video sales are held simultaneously on the Internet. Superior Stampede, a merger between the Fort Worth operation and an Internet sales company in Visalia, CA, is another Internet cattle exchange.
Branch says exposure to cattle offered over Superior and other satellite sales has been “astronomical.” The fact that ranchers are increasingly buying into preconditioning programs is apparent in sale numbers.
“We started having value-added sales in 1994, when we introduced a ‘vac’ program where calves underwent a strict vaccination program on the ranch,” he says. “This year, 85% of the calves we're selling have some kind of preconditioning shots in them.
“We've shown sellers they can get more for preconditioned calves. We've shown buyers that sellers will precondition calves if there's a premium for them,” he adds.
There are specialized sales for certified natural cattle — those free of antibiotics and growth promotants. Purebred sales are also popular on the dish and over the Internet.
“Value-added sales have been huge,” Branch says.
E-trading, which took off in the mid and late '90s, has enabled individual producers or feeders to make direct orders for futures, options and numerous combinations of both. Since then, tens of thousands of cattle have been e-traded. CME has an e-trading link, and many other entities also offer it.
There's also e-trading for marketing accounting and any other related services. E-trades of corn, hay and other feedstuffs also tie in with cattle trades.
Meanwhile, auction markets are striving to keep up with the times by going online, and offering sales for preconditioned or other cattle specific types The sale barn may not look different than four decades ago, but at any successful sale these days, there's someone with computer savvy crunching data that gets information to buyers and sellers more quickly and accurately.
Direct selling started the revolution. Sale barns actually had their place in trading cattle long before there was electricity, much less Microsoft Office. Sellers had an idea what the market was.
Not so at the feedyard, Engler says. He believes the biggest marketing breakthrough of roughly the last half-century occurred in the 1950s. It was direct marketing.
“I can remember very well back in Nebraska when we shipped all our fed cattle to central markets — Omaha, Chicago, Kansas City and other areas,” Engler says. “You were at the mercy of the buyer once you got to the markets. You would rarely see a situation where it would pay you to take the cattle back home.”
In those days, about 95% of fed cattle were sold that way, he says.
“When we went from central markets to direct selling, we took a major step in improving our market efficiency. People had an opportunity to know what they were going to get paid before cattle left the farm or feedyard,” he says.
So what's next?
Undoubtedly, there will be further marketing innovations. If a pen of steers — made up of seemingly perfect Angus or other breeds — can still face a half dozen or more sorts, there will continue to be new methods developed to identify the animal's value.
There will likely be more marketing cooperatives, avenues that enable smaller producers to pool their calves for more bargaining power.
“The Internet, like any technology, may well evolve to a level above where it is today,” Ward says. “We need something that would enhance all these marketing tools available to us.
“We're still striving to obtain a true objective measure for carcass attributes. People said 30 years ago that objective measurement was just around the corner. We're getting close, but we still have the human judgment in packing plants, and they're not strictly using the objective measurement yet,” he says.
Larry Stalcup is a freelance writer on cattle production and marketing topics. He is based in Amarillo, TX.