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Understanding feeder cattle price structure

Market Update with Jerry Klassen: Comparing prices for custom feeders and a finishing feedlot

The feeder cattle futures have traded in a narrow range since early November but we’ve seen severe swings in the western Canadian feeder cattle basis. This has made it difficult for the cow-calf operator and backgrounding operator to project a forward price for summer and fall.

I’ve also received inquiries in regards to the price of grassers. Producers are asking what is a fair price for grass cattle this spring based on the fall 2019 yearling market. So it is a good time to review the economics for backgrounding operators and for producers shopping for grassers this spring.

Much of the U.S. Midwest and the U.S. Southern Plains have received above-normal precipitation. The market has potential to be quite firm due to favourable pasture conditions. This could cause prices to move to high relative to the yearling and fed cattle markets for the appropriate timeframe.

In the example 1 (below), I’ve conducted a sensitivity analysis for 525-pound steer purchased in February. This animal will come on the yearling market in August assuming growth of 2.2 pounds per day with cost-per-pound gain of $1.13. This is the going rate for feeder cattle in a custom feedlot in southern Alberta. This exercise can be a useful tool to determining the appropriate purchase price for a 525-pound steer.

As noted in articles from last year, the average basis in Manitoba for 850-pound steers was C$20 under the appropriate feeder cattle futures. At the time of writing this article, the August feeder cattle futures closed at US$150 and the exchange rate was 76 U.S. cents. The expected forward price for August for an 850-pound steer is C$177 ($150 divided by 0.76 minus $20). In the example, one can see buying 525-pound steers for an average price of $230 results in a breakeven of $185, which is $8 above the expected forward price.

It’s also important to put yourself into the shoes of the finishing operator who will be buying these yearlings in July and August. In example 2 (below), I’ve conducted a sensitivity analysis for the finishing feedlot operator buying 850-pound steers at $176 and at $185. The steer is fed to 1,400 pounds and the cost per pound gain is $1.17. This includes all costs including feed, yardage, processing etc.

For the fed cattle, basis levels are more readily available because packing plants are constantly contracting cattle in the forward positions. In this example, the December live cattle futures closed at $117.62 and the Canadian dollar for December is also at 76 U.S. cents. Using a basis of C$6, the expected forward price for the December fed cattle is $149.

A backgrounding operator can clearly see that a price of $185 is a bit rich for yearlings. However, even using the purchase price of $176 results in a potential loss of $56 per head. However, the lower purchase price of $176 clearly has a better risk-reward profile even though there is a small loss. A feedlot may be able to push efficiencies or bring down the cost structure so that economics reveals a small profit. In any case, backing up to our first example, paying $230 for grassers or backgrounding calves is too high. One would probably need to buy the 525-pound steers around $210 so that a profit could be seen throughout the production chain.

By conducting a sensitivity analysis and using the expected forward price, producers can have a good idea of the price level to purchase grassers or backgrounding calves. When the backgrounding operator put themselves in the shoes of the finishing feedlot, they can also work back the economics to discover reasonable purchase price for yearlings and calves.

About the author

Columnist

Jerry Klassen manages the Canadian office of Swiss-based grain trader GAP  SA Grains and Produits Ltd., and is president and founder of Resilient Capital specializing in proprietary commodity futures trading and market analysis. Jerry consults with feedlots on risk management and writes a weekly cattle market commentary. He can be reached at 204 504 8339.

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