Source: Matthew A. Diersen, Professor, Department of Economics, South Dakota State University
Regardless of the cold, spring calving has started. While it is at the early stages, it is not too early to think about price protection for those calves. The high cash and futures prices have people talking about the value of calves to be sold this fall. A solid risk management tool for cow-calf producers to consider is Livestock Risk Protection, or LRP, on feeder cattle. There are adjustment factors that tailor LRP to calves (weighing less than 600 pounds), heifers, dairy and Brahman cattle. For some general background on LRP, see: http://www.rma.usda.gov/pubs/rme/lrp-feedercattle.pdf.
LRP is offered and sold by insurance agents, and is available in most cattle states. LRP only covers price risk, not production or mortality risks. Buying LRP is like buying put options. There are potential advantages using LRP. The first advantage is the ability to cover a small or an odd number of head. A standard feeder cattle futures or options contract is designed to cover 50,000 pounds of feeder-weight steers. Producers covering fewer pounds or with the equivalent of a half of a contract, may find that LRP is more cost-effective as it is sold on a per-head basis. The second advantage is the set of adjustment factors which effectively fix the floor-price basis for any class of cattle that you would otherwise cross-hedge against feeder cattle contracts.
A popular adjustment factor in South Dakota is the 110% adjustment for beef calves (classified as Steers Weight 1 and weighing less than 600 pounds). LRP on calves does two things: it protects against future feeder prices falling and it protects against basis levels falling. Higher new-crop corn prices and/or higher hay prices would pressure both aspects covered by LRP. For additional insights on using LRP for calves see: http://igrow.org/up/resources/02-2006-2013.pdf.
The calves must be born (alive) before coverage can be purchased. Currently the most deferred Steers Weight 1 coverage available has an end date of August 29, 2014. Thus, it is at the typical front end of the time period for selling calves in the fall. During the next several months, later end dates and more coverage levels typically become available. For comparison, there are feeder cattle futures trading into January of 2015, and even a few put options with the same expiration date.
LRP is tied to the futures prices. Coverage is purchased based on ending values (that mirror futures), coverage prices (that mirror strike prices) and a cost (that mirrors a put option premium). The end value is $193.08 per cwt, or about 110% of the August feeder cattle futures price from last week. A deductible bases the coverage off of $187.70 per cwt. Such coverage would cost $3.70 per cwt. before a 13% subsidy. After subtracting the non-subsidized portion of the premium, the floor price is $187.69 per cwt. The premium may look low because it is low. It reflects the lowest price volatility in a decade. At normal volatility levels, the premium right now would cost about $5.50 per cwt. The floor price may look high because it is high. 2013 was the only year on record with calf prices in South Dakota higher than that floor level.
The benefits of LRP come through in South Dakota and the use of LRP backs that up. In fiscal year 2013 there were 131,042 head covered by LRP feeder cover across the U.S. In South Dakota that year, there were 37,076 head covered; more than in any other state. So far in fiscal year 2014, which is two-thirds complete, there are 181,410 head covered in the U.S. and 47,864 head covered in South Dakota. Other states with significant volume covered are Oklahoma, Kansas, Missouri, North Dakota and Nebraska. Standard LRP on feeder-weight steers has likely been the source of much of the volume so far in 2014 as the per-head pricing benefit still applies. It will take few additional sales to push the total covered above the record set in 2011. Producers could use put options until a desired LRP level or end date becomes available.
Much of what I heard this past week regarded the high prices. Yes, people were amazed at the high prices paid for fed cattle (regardless of weights). However, several different groups of people commented on the high price of steak in restaurants, the high price of hamburger in grocery stores, and the high price of deli roast beef. What did these cost-conscious consumers have in common? They were all cattle producers marveling at how expensive beef is getting at the retail level. The more familiar cattle and grain prices are shown below.