Drought and demand will dictate the direction of U.S. cattle and beef markets this year. The impact of the first, on herd size and producer costs, is already largely known. So how beef demand holds up against higher consumer beef prices is the big wildcard for 2013.

Americans’ ability to pay more for beef will largely determine prices for calves, feeder and live cattle. This ability also involves consumers in other countries, as U.S. beef will continue to be some of the most expensive in global markets.

The U.S. beef industry must feel it is in constant crisis mode. From the battle against E. coli O157:H7 starting in 1993 to the first BSE case in the U.S. in 2003, the industry has faced and overcome severe animal health issues. It’s had to adjust to costly new government regulations and endure national and social media attacks that nearly eliminated a legitimate beef product last year.

Drought is a challenge

Now the industry faces a challenge as far-reaching as BSE. The 2010-2011 drought centered in Texas and Oklahoma, and last year’s much more widespread drought, impacted cow-calf producers’ ability to expand their herds. In fact, the national herd on Jan. 1 will be below 90 million head for the first time since the early 1950s. The result is an industry significantly smaller than 17 years ago. It’s startling to realize that the U.S. has lost 14.5 million cattle since 1996. Yet the herd might continue to shrink until 2015.

A Closer Look: Southwest Drought Elicits Dust Bowl Comparisons

This prospect has significant consequences for everyone in the beef chain, from producers to processors to companies that supply products to the industry. The deepest impact, though, will be on consumers. A shrinking supply of domestically produced beef will force retail and foodservice prices higher, and it will likely force end users to be more dependent on imported beef.

USDA’s latest forecasts for available beef supplies (production plus imports minus exports) in 2013 are 54.8 lbs./person, down 2 lbs. from 2012, and down 4.8 lbs. from 2010. Per-capita supplies of pork and chicken will also be down in 2013 from 2012, USDA says.

But the declines are smaller than for beef, which means Americans will continue to eat more pork and chicken and less beef. This has nothing to do with preference; it’s simply a matter of the available supplies of each protein.

The impact of the drought caught the national media’s attention last summer and stories zeroed in on food prices. But the drought’s impact isn’t likely to fully hit consumers until 2013.

The drought will raise the year’s grocery bill for a family of four by $351.12, according to projections by the Food Institute (FI). That’s an increase of about $6.75/week, slightly higher than the 2.5%-3.5% estimated by USDA. Higher grocery bills will be most notable in the meat section where a family of four can expect to pay $44 more in 2013 than in 2012, FI says. USDA forecasts that the retail price of beef will be 5% higher in 2013 than 2012.

Such price advances might seem modest, but they must be put in context. Many Americans are struggling to pay more for beef as the U.S. economy remains weak and unemployment high, economists say. This struggle began in 2008 at the height of the recession and its effects on the beef industry remain to this day.

More than half of all beef is now consumed in some form of ground beef, as it is the only affordable beef item for many Americans. This trend will continue. Both wholesale and retail beef prices were at record levels most of 2012 and beef became less competitive with pork and chicken. This showed up in grocery store sales and is likely to be the trend in 2013, analysts say.

Scramble for cattle

The scramble for all classes of cattle will intensify into 2014 because the herd shows no signs of stabilizing until then. Total cattle numbers have declined 14 of the past 17 years, from 103.5 million head on Jan. 1, 1996, to an expected 89 million head on Jan. 1, 2013. That’s down 2% in the past year.

Analysts wonder if net heifer retention will occur even this year. Increased production costs and lower-than-expected calf and feeder prices eroded cow-calf margins in 2012 and producers will be wary of expanding their herds until their pastures are much-recovered. If net retention does occur, more cattle will not start showing up for feeding and processing until late in 2015.

The beef industry has adjusted to the loss of millions of cattle in several ways, notably by improving productivity per animal and better red meat yields. Cattle feeders are feeding to record heavy weights and are selling more cattle on a carcass basis to offset higher feed costs. Carcasses will get heavier again in 2013 but they’re unlikely to achieve the year-on-year increases seen in 2012, analysts say.

A Closer Look: Carcass Weight Reaches Record Level

More beef from fewer animals won’t, however, compensate for fewer head to be fed or harvested. This will exacerbate the 35% over-capacity in the cattle feeding industry. Several factors have already forced thousands of small farmer-feeders out of the feeding business. They were mostly in the Corn Belt where, ironically, the number of cattle on feed in larger feedlots has increased. That’s because of their proximity to cheaper corn and dried distillers’ grains, compared to Southern Plains feedlots.

Southern lots face two regional supply setbacks this year. Excep-tional drought in Mexico forced as many as 1.4 million young cattle to come north in 2012. This helped some feedlots keep their pens full. But Mexican feeder imports might decline by 700,000 head or more this year. In addition, Texas and Oklahoma lost 948,000 beef cows in 2011, largely due to drought. Conversely, Nebraska’s beef cow numbers increased by 112,000 head.

This means fewer calves down south and more up north, with 2012’s national calf crop likely to be down at least 800,000 head. This and the migration to more cattle finishing up north suggest that northern cattle feeding operations might be better positioned the next two years – than those down south – to weather the challenge of finding cattle to fill their pens.

Feedlot operations on the Southern Plains have already begun to adjust to shrinking numbers, though most of these adjustments have not been made public. Pratt Feeders in Kansas, for example, the industry’s 20th largest feeding company, announced in early November it was mothballing a 20,000-head feedlot in Hays, KS. This author subsequently learned that Cactus Feeders, the second largest feeding company, repurposed a 30,000-head feedlot in Syracuse, KS, last summer from a finishing yard to what Cactus calls “for supply chain management.”

Anecdotal evidence suggests other feedlots have stopped finishing cattle and are backgrounding everything from calves to bred heifers to cows. Others continue to explore such options to allow them to keep operating.

But the options are limited, analysts say, because the cattle aren’t there, nor are the cattle feeding margins. This suggests less, not more, opportunity to be a “middle man” operator. That’s likely to be true throughout the U.S. cattle production sector for the next two years.

Steve Kay is Editor of Cattle Buyers Weekly. His column “Meat Matters” appears in each monthly issue of BEEF.