– Dr. Kenny Burdine and Dr. Greg Halich, University of Kentucky Department of Agricultural Economics
The last couple of years have been nothing short of a roller coaster ride for beef cattle producers. We saw prices rise to record levels and then fall as sharply as we have ever seen. A combination of factors such as cattle inventory, production of competing meats, increasing slaughter weights, and international trade were all at play in the market. At the same time, producers were making management decisions in a rapidly changing environment. If the old adage is right and history repeats itself, it’s worth taking a look back to reflect on some things that can be learned.
1) If Calf Prices Seem too Good to be True, They Probably Are
There is a long time adage by agricultural economists that the cure to high prices is high prices. The implication is that producers respond to high prices by increasing production, which then brings down prices. As basic as this may seem, it is easy to get caught up in the euphoria of historically high calf prices and try to find reasons why it is different this time. Perhaps it may have been different in terms of how high prices rose, but it was no different in terms of how producers responded to high profits and how quickly these prices came crashing back down. Don’t expect prices that seem too good to be true to last, they never do.
2) The Cattle Cycle Isn’t Dead
Over the last 10 years, many “experts” stated that the cattle cycle is dead or no longer exists. We have never agreed with this logic, and feel part of that reason is that we may define the cattle cycle differently that most people. To us, the cattle cycle is primarily about cow-calf operators responding to profits by expanding their cow herds and the time lag between this decision and the associated supply impact. Two major external events in the last half-dozen years impacted the current cattle cycle, and changed its dynamics. First, historically high grain prices from 2008-2013 caused significant conversion of pasture and hay-ground to row crops. This conversion was occurring during the liquation phase of the last cattle cycle and thus caused cow numbers to drop quicker than what we would have normally seen in this phase. Second, during a portion of this same time period, 2011-2013, a major drought hit a large section of the Southern Plains and forced a massive liquidation in the cow herd, further dropping cow numbers during the liquidation phase. This was in an area that made up roughly 25% of our entire U.S. beef cow herd at the time.
The combined effect was that cow numbers continued to drop during a time period when they normally would have been expected to start increasing. By 2012, calf prices (and cow-calf profits) were likely high enough to justify heifer retention. However, the combination of severe drought and pasture conversion led to cow-herd liquidation at a time when calf prices would have suggested expansion. As weather improved and cow profits soared in 2014 and 2015, expansion took a firm foothold. This cow herd is currently growing, and doing so at a swift pace as beef cow numbers are up over 4% over the last two years. While it is true that many other factors impact cattle prices than the size of the cow-herd, we are not yet ready to bid farewell to the notion of the cattle cycle.
3) Expansion Isn’t Just About Heifers
Traditional cattle cycle mentality is that expansion comes from heifer retention and this is true from a long-term perspective. However, the age of the cow herd cannot be ignored in the short-run. A factor that drove beef cow numbers so low from 2011-2013 was extremely high cow slaughter. Most of this came from the Southern Plains as they dealt with widespread severe drought. When increased moisture was overlaid with strong calf prices in 2014 and 2015, most of the initial increase in cow inventory came from reduced beef cow slaughter. The overall age of the herd was younger, fewer cows were near the end of their productive lives, and profit was there. It made logical sense to cull fewer cows during these two years and this worked to jump-start the expansion phase of this cycle.
4) The Impact of Competing Meats
In the US, beef, chicken, and pork are the primary consumer meats and 2014 was a banner year for profitability in all three. So, it is no surprise that expansion occurred in all of these markets. However, the pace at which growth can occur in these markets is different. Due to shorter gestation periods and younger age at harvest, pork and poultry producers can increase production much faster than beef producers. It is likely that 2016 will be the first year that we actually see increased beef production (boxed beef), while significant increases have already been seen in the pork and poultry markets. Since these proteins compete in the meat case, beef prices were pressured in late 2015 from increased pork and poultry supplies before beef supply increased significantly.
5) Exports are a Double-Edged Sword
There is no doubt that increased exports have a positive impact on price, holding everything else constant. Increased exports reduce domestic consumer supply, which drives prices upward at home. However, over time we respond to these higher price levels with increased production. Then, as shocks occur in international markets that lead to decreased exports, all that extra supply is left on the domestic market, and prices fall. Last year, 2015, was a good example of how this can play out. Exports were down drastically due to increased price levels, a stronger US dollar, and weakening economies for some of our trading partners. The decrease in exports piled onto an already decreasing market, with the net effect being a price implosion. This is not to say that we should stop exporting beef. We just need to be aware that exports can cut both ways.
6) Learn to Manage Price Risk
Few people predicted cattle prices would increase as quickly as they did during 2014 or decrease as quickly as they did in 2015/2016. These price swings represented hundreds of dollars in cattle revenue and meant the difference between profit and loss for many stocker/backgrounders. They also represented over $300 in value per calf for cow-calf operators. Many producers, especially those in the first few years farming, simply can’t self-insure this type of market risk. Cattle producers who could have self-insured against the normal volatility of a typical cattle cycle need to learn to manage today’s price risk and volatility through futures markets, LRP insurance, forward contracts, or any other means available. This will mean that in some years money will be left on the table, but other years it will avoid huge losses that could destroy the financial well-being of the operation. For more information on using the futures market as a tool to manage price risk in feeder cattle see the following publication: http://www.uky.edu/Ag/AgEcon/pubs/ext2013-0128.pdf.
7) Don’t Take a Short-Term Perspective on Long-Term Decisions
While we don’t think many people expected calf prices to stay in the $2.50 per lb range forever, most of us were surprised how sharply prices came down in 2015. The folks hit hardest by this drop will be the ones who made decisions in the last couple years as though calf prices were going to stay at $2.50 for years to come. As was discussed in lesson #1, if there is one certainty about agricultural markets it is that abnormally large profits won’t exist for long. Supply will increase until profits reach more normal levels. Long term investments in land, breeding stock, equipment, facilities, etc. need to be made from a long term perspective. It appears that a lot of producers made investments over the last couple of years based on the assumption that those incredibly high prices were here to stay.
Possibly the most extreme example of this is bred heifer prices. Given reasonable cow maintenance costs, weaning weights, and weaning rates over the life of the heifer, calf prices would have needed to stay above $2 per lb for 5-8 years to justify the prices that were being paid for bred heifers. This was the focus of an article in the November 2015 issue of Cow Country News and a decision aid created to help determine what can be paid for bred heifer given the users assumptions and cost estimates. It can be found at the following link: http://www.uky.edu/Ag/AgEcon/pubs/BredHeifer.xlsx.
These examples aren’t just limited to breeding stock. Similarly, it is easy to justify purchasing a new piece of equipment during a year of abnormally high profits on the basis that you can avoid paying taxes by using a Section 179 depreciation allowance. But also understand that decision will impact your long-run profitability negatively if it is a piece of equipment you could really do without.
While there is no simple success recipe for cattle producers to follow, we felt the last couple years provided an excellent opportunity to reflect on what we saw and what we can learn. While it is impossible to know if, and when, we might see markets like we saw in 2014 and 2015, it would be naïve on our part to assume that we would never see something like that again. Many of the “lessons learned” we discussed in this article apply to all cattle cycles, but the extreme market swings of the last year or two amplified their importance. We’ve heard it said before that challenging times show who the better managers are and we believe this will play out in the next few years. The producers who made wise decisions over the last couple years will be the ones who are in the best position moving forward with lower prices. Hopefully, by reflecting on some things learned during this time period, we will be less likely to make some of the same mistakes the next time it comes around.