In an iGrow article last week, I discussed record high feeder cattle prices as well as the lack of profits for current feedlot placements. While current price levels offer little or no profit opportunity for buyers of feeder cattle, those same prices could result in record or near record profits for cow-calf producers this year. The Livestock Marketing Information Center projects returns over cash costs (including pasture rent) to be near $350/head for an “average” cow-calf operation in 2014. If realized, that would be sharply higher than the $123/head return in 2013 and the previous record high of $150/head in 2004. Of course, many production and marketing risks could quickly reduce those projected returns, as they did in 2012 and 2013. Drought could reduce pasture and range productivity, thereby raising grazing costs and forage and hay demand. And, although the corn growing season appears to be off to an average start so far this year, should weather problems develop that significantly lower the national corn yield, higher corn prices will force feeder cattle prices lower.
As cow-calf producers are turning pairs out to summer pasture right now, it is appropriate to start considering marketing plans for those calves. Last year, the price for 500-599 lb steer calves in South Dakota was about $191/cwt during October. At this point, the prospects for a large corn crop and increasingly tight calf supplies indicates prices this fall could be 10-15% higher than last year, which would put steer calf prices close to $215/cwt this fall. October 2014 CME feeder cattle futures are currently trading near $198/cwt. Historically, the basis for 500-599 lb steer calves in South Dakota in October is close to +$20/cwt. So, a futures-based price forecast adjusted for local basis would also suggest prices in the mid- to upper $210s this fall. Although reports of forward contracted feeder cattle sales for fall delivery are limited yet, it appears that buyers are willing to bid much higher than the $215-220/cwt for 500-599 lb steers. Some regional reports have steer calves in the $240s/cwt for October delivery.
With that background, it is useful to consider the advantages and disadvantages for three of the more common hedging alternatives:
Cash Forward Contract. Forward contracts lock in a cash price (both futures price level and basis) and typically require delivery at a specific future time (possibly a range of dates). By locking in both price level and basis, risk of lower prices and weaker basis is eliminated. However, the cow-calf producer wouldn’t be able to take advantage of higher prices or stronger basis if they occurred at delivery time. Typically, cash forward contracted feeder cattle are sold using a price slide, where the dollars per hundredweight price is adjusted lower if the cattle’s weight exceeds the estimated base weight. Cash forward contracts for feeder cattle can be executed either through direct negotiation between the seller (i.e., cow-calf producer) and buyer (i.e., feedlot) or using video/Internet based sales. In some cases, the seller may need to have load lots available to sell. An additional consideration this year is the requirement to deliver at a certain time. If drought conditions worsen, calves may not grow to their projected base weight by the delivery period or the producer may need to wean calves early to save late summer forage. In the latter case, the producer might need pens to background the calves until the delivery period if the buyer is unable/unwilling to take the calves early.