Transcript No Slide Title

Cattle Risk
Management
GEOFF BENSON, PhD
Extension Economist
Dept of Agricultural and Resource
Economics
North Carolina State University
Agenda
 Introduction
 Price forecasting
 Price risk management
Hedging with cattle futures
USDA-RMA LRP Program
Cattle futures options
Setting price targets & pulling the
trigger
 Summary
GEOFF BENSON, ARE, NCSU
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Risk
 RISK -- the chance of loss or an
unfavorable outcome or event


Anticipated or unexpected
Known probability or uncertain
 RISK EXPOSURE -- The amount of a
loss, if it occurs
 The financial consequences for the
business: cash flow, profit, solvency
GEOFF BENSON, ARE, NCSU
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Sources of Risk







Weather & other natural phenomena
 Local variation in rain, temperature, etc.
 Regional, national, global weather
 Extreme (tornadoes, hurricanes, floods,
etc.)
“Technology” and competitiveness
Changes in your customers’ ability or
willingness to buy your product
Societies attitudes & preferences
Government and other institutions rule
changes
Individual human behavior
Random accidents
GEOFF BENSON, ARE, NCSU
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Managing Risk
 What are the most important risks
your farm business is exposed to?
 How vulnerable is your farm
business to these risks (exposure)?
 What cost-effective strategies are
available to manage price risk?
 What is your attitude to risk?
 Do you have the time, knowledge
and risk management skills?
GEOFF BENSON, ARE, NCSU
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Risk Management
 Management strategies include:
Reducing the chance of an event
The
management ability, knowledge and
effectiveness of the producer is the key
Reducing the impact if an event occurs
Buying insurance
Self-insurance, which comes in many
forms including carrying inventories,
diversification, maintaining financial
reserves, borrowing, off-farm income
GEOFF BENSON, ARE, NCSU
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Cost:Benefit
 All risk management strategies
involve costs, in money or time
 Effectiveness varies among
alternatives
 Financial benefits & costs
 Time, new knowledge and skills
Evaluate trade-offs
GEOFF BENSON, ARE, NCSU
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Agenda
 Introduction
 Price forecasting
 Price risk management
Hedging with cattle futures
USDA-RMA LRP Program
Cattle futures options
Setting price targets & pulling the
trigger
 Summary
GEOFF BENSON, ARE, NCSU
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Price Forecasting
 Helpful for making marketing
and business decisions
 The futures market provides
an industry consensus on
prices as far as one year out
 Takes account of known
information
 Changes daily as new
information becomes available
GEOFF BENSON, ARE, NCSU
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Cattle Futures
 The CME Group trades two types of cattle
futures – data at www.cmegroup.com
 Live (or finished or fat) cattle futures -40,000 pound lots of 55% Choice, 45%
Select, Yield Grade 3 steers, physically
delivered: Feb, Apr, Jun, Aug, Oct, Dec.
 Feeder cattle futures are for 50,000 pound
lots of 650-849 pound L&M 1&2 steers,
cash settled: Jan, Mar, Apr, May, Aug,
Sept, Oct, Nov.
GEOFF BENSON, ARE, NCSU
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Price Forecasting
 Use “nearby” futures contract price
for intended sale month
 BUT
This is not the NC price
“Basis” = futures price – local cash
market price for similar cattle
If basis is predictable, then we can
use the futures market to project local
North Carolina prices and use this to
make business decisions
GEOFF BENSON, ARE, NCSU
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Price Forecasting, cont.
 The cattle futures contract may not
match the cattle you have to sell –need
to adjust the futures price
 What market premiums & discounts
affect the value of your cattle?
 Weight
 Sex
 Frame
 Muscle
 Breed
 Other, e.g., market channel, truckload
GEOFF BENSON, ARE, NCSU
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Price Worksheet
ITEM
$
FUTURES PRICE, SALE MONTH
Basis
Weight adjustment (+ or -)
Sex (heifer) adjustment (+ or -)
Frame adjustment , if not M or L (-)
Muscling, if not 1 or 2 (-)
Breed or color adjustment (+ or -)
Other, e.g., special sale, lot size (+ or -)
Estimated price for your cattle
GEOFF BENSON, ARE, NCSU
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Feeder Cattle Futures, $/100 lb, 3/26/09
GEOFF BENSON, ARE, NCSU
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Historic Basis
 The most useful comparison is the
published NC weekly auction (cash or
spot) prices for a particular week or
month relative to the cattle futures price
for the “nearby” month
 Note
 NC Auction prices are reported weekly in 50
or 100 lb./head increments for small lots
 CME feeder cattle futures contract is for
650-849 lb. M&L1&2 steers in truckload lots
 Contract months are Jan, Mar, Apr, May,
Aug, Sept, Oct, & Nov.
GEOFF BENSON, ARE, NCSU
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NC Basis, Avg. 1990-2000
J
F M A M
J
J
A
S
O
N
D
0
-2
$ per cwt.
-4
-6
-8
-10
-12
Asheville
Siler City
Smithfield
-14
GEOFF BENSON, ARE, NCSU
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NC Basis, 1990-2000
 Negative (transportation cost)
 Varies by market, west to east
 Seasonal:
Smaller discount in spring, high
demand for cattle for summer grazing
Larger negative differences in fall as
cattle are sold as grass runs out
 Historic data on line at:
http://www2.ncsu.edu/unity/lockers/
project/arepublication/AREno32.pdf
GEOFF BENSON, ARE, NCSU
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“Quality” Differences
 What are the characteristics of your
cattle and how do they affect the
price (value)?
Weight
Sex
Frame
Muscle
Breed
Other, e.g., market channel, truckload
GEOFF BENSON, ARE, NCSU
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Price Differences, NC Graded
Sales, M1 Steers, 1991-2001
.
Fall
Spring
Weight, lb.
Calf
Stocker
400-499 + 11.5¢/lb. + 22¢/lb.
500-599
+ 7¢
+ 19¢
600-699
+ 4¢
+ 8¢
700-799
Base
Base
GEOFF BENSON, ARE, NCSU
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Price Differences, Graded Sales,
M1 Heifers v. Steers, 1990-2001
Weight, lb.
400-499
Fall
Spring
-12¢/lb. -15¢/lb.
500-599
-8.5¢
-14¢
600-699
-8¢
-12¢
700-799
-6.5¢
-6¢
GEOFF BENSON, ARE, NCSU
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Price Differences, Graded Sales,
500-599 lb. Steers, 1990-2001
Grade
Fall
Spring
M1
Base
Base
S1
-11¢/lb.
-16.5¢/lb.
-6¢
-9.5¢
LMS2
GEOFF BENSON, ARE, NCSU
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Selected Breeds










Angus
Braford
Brahman
Brangus
Braunveih
Charolais
Chianina
Devon
Galloway
Gelbveih










Hereford
Holstein (dairy)
Jersey (dairy)
Limousin
Longhorn
Maine Anjou
Nellore
Piedmontese
Pinzgaur
Polled Hereford
 Red Poll
 Sahiwal
 Salers
 Santa Gertrudis
 Shorthorn (dual)
 Simmental
 South Devon
 Tarentais
 Zebu
+ Crosses &
Composites
GEOFF BENSON, ARE, NCSU
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Price Differences, Graded Sales,
500-599 lb. M1 Steers, 1991-2001
Breed
Black
B&W
Exotic X
Hereford
Str. Cont.
Brahman
Fall
Spring
Base
Base
+ 0.5¢/lb. + 0.5¢/lb.
- 6¢
- 6¢
- 10¢
- 2.5¢
- 12¢
- 13.5¢
-13.5¢
-7.5¢
GEOFF BENSON, ARE, NCSU
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Marketing Options
 Regular auction = Base
 Graded sale
 Special programs, e.g.,
Southeast Pride, preconditioned sales
 Direct farm sale (several
options)
 Retained ownership
GEOFF BENSON, ARE, NCSU
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Marketing Options
 Farm situation determines
opportunities and cost:
Size of herd
Number
of cattle for sale
Uniformity of cattle
Market Premium offered
Marketing Cost
Risk
GEOFF BENSON, ARE, NCSU
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Price Worksheet
ITEM
$
FUTURES PRICE, SALE MONTH
Basis
Weight adjustment (+ or -)
Sex (heifer) adjustment (+ or -)
Frame adjustment , if not M or L (-)
Muscling, if not 1 or 2 (-)
Breed or color adjustment (+ or -)
Other, e.g., special sale, lot size (+ or -)
Estimated price for your cattle
GEOFF BENSON, ARE, NCSU
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QUESTIONS OR COMMENTS
ON PRICE FORECASTING?
GEOFF BENSON, ARE, NCSU
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Hedging Price Risk
 Basics of futures & options
 Hedging with futures examples
 USDAs Livestock Risk
Protection (LRP) Program
 Hedging with Options
 Is hedging for you?
How much do you have at risk?
Risk management strategies
GEOFF BENSON, ARE, NCSU
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Futures Contracts
 Sell a Feeder Cattle contract for a
specific month at a specific price -Locks in a price!
 “Off-set” your position in the futures
market
By letting the contract expire
By buying back an identical contract (at
or near the expiry date)
 At the expiry date the futures price =
the cash market (spot) price
GEOFF BENSON, ARE, NCSU
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Futures Contracts
 Set up a trading account with a
brokerage
 Pay a small commission to the
broker for the transaction
 You may get margin calls to ensure
you can cover your position -Deposit cash in your trading
account when the futures price
moves above the price you locked in
GEOFF BENSON, ARE, NCSU
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Hedging: Example 1
Item
1.Sell an October
contract in April
2.Future price in Oct
3. Your Gain or Loss
4.Cash Price in Oct
5.Net Proceeds
Market Market
Falls
Rises
$100
$85
$15
$85
$100
$100
$110
-$10
$110
$100
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Hedging: Example 2, Part 1
Item
1. Sell October
contract in April
2. Local basis
3. Expected local
cash price
Market Market
Falls
Rises
$100
-$5
$100
-$5
$95
$95
GEOFF BENSON, ARE, NCSU
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Hedging: Ex 2, Part 2
Item
5. Future price in Oct
6. Gain or Loss
7. NC Oct Cash Price
8.Net Proceeds
9. Actual Basis
Market Market
Falls
Rises
$85
$110
$15
-$10
$80
$105
$95
$95
$5
$5
GEOFF BENSON, ARE, NCSU
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Hedging: Example 3
Item
Sold Oct. futures
5.Future price in Oct
6.Gain or Loss
7. NC Oct. Cash Price
8.Net Proceeds
9. Actual Basis
Market Market
Falls
Rises
$100
$85
$15
$82
$97
$3
$100
$110
-$10
$101
$91
$9
GEOFF BENSON, ARE, NCSU
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USDA’s LRP Program
 Price risk insurance, pay a premium
 Can cover each year up to
2,000 head of feeder cattle of up to 900 lb.
– two weight categories, steers or heifers,
3 breeds – Brahman, Dairy, “all other”
4,000 head of 1,000 to 1,400 lb fed cattle
 Coverage can range from 70% to 100%
of estimated ending value*
 More flexible and more direct pricing
than hedging with futures
GEOFF BENSON, ARE, NCSU
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Example 1, Nash Co, 3/30/09
ITEM
STEERS
STEERS
Number of head
20
20
Sale weight, cwt.
5.5
5.5
Coverage price per cwt.
$92.39
$94.59
Coverage level
.8669
.8875
Insured value
$10,163
$10,405
Premium rate
0.014252
0.018142
Premium cost
$126
$164
GEOFF BENSON, ARE, NCSU
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Example 2, Nash Co, 3/30/09
ITEM
HEIFERS
HEIFERS
Number of head
20
20
Sale weight, cwt.
5.5
5.5
Coverage price per cwt.
$83.99
$85.99
Coverage level
.8669
.8875
Insured value
$9,239
$9,455
Premium rate
0.014252
0.018142
Premium cost
$115
$150
GEOFF BENSON, ARE, NCSU
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Information on LRP
 Fact Sheets are available on line at
http://www.rma.usda.gov/livestock/
 Examples of contracts are at
http://www3.rma.usda.gov/apps/livestock_rep
orts/main.aspx
 A premium calculator is available at
http://www.rma.usda.gov/tools/premcalc.html
 A list of LRP insurance providers is at
http://www3.rma.usda.gov/tools/agents/compa
nies/2008/north_carolinaLPI.cfm. All are from
out-of-state
GEOFF BENSON, ARE, NCSU
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Options
 The right (but not the obligation) to
buy or sell a futures contract.
Puts a floor under the price but
not a ceiling – you get the upside
 A “put”= right to sell & allows the
producer to hedge
 A “call”= right to buy & allows the
buyer (e.g., the feedlot operator) to
hedge
GEOFF BENSON, ARE, NCSU
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Options
 An option is for a specific futures
contract and a specific price
 The agreed upon futures contract price
is called the strike price
 The cost of an option is called a
premium
 Premiums are established by public
outcry pit trading and by electronic
trading, similar to the way futures
prices are established
GEOFF BENSON, ARE, NCSU
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Options
 There is a range of strike prices for
each futures contract
 Premiums have 2 components:
Time value -- pay more for options on far
off contracts, shrinks as the expiry date
approaches
Intrinsic value -- related to the
relationship between the strike and
current price of the futures contract
GEOFF BENSON, ARE, NCSU
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Options
 In-the-money -- Underlying futures
price is favorable compared to the
strike price
 Out-of-the-money -- Futures price
is unfavorable vs. strike price
 At the money
 Options automatically settle for
cash at the time the underlying
futures contract expires
GEOFF BENSON, ARE, NCSU
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Feeder Cattle Options Premiums,
May Contract, $/cwt., 3/25/09
ITEM
PRICE
NET
Futures contract price
$95.375
$95.375*
Put Option at $92.00
$1.80
$90.20
Put Option at $94.00
$2.50
$91.50
Put Option at $96.00
$3.35
$92.65
Put Option at $98.00
$4.425
$93.575
Put Option at $100.00
$5.95
$94.05
*No brokers fee or cost of margin calls included
GEOFF BENSON, ARE, NCSU
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QUESTIONS OR COMMENTS
ON HEDGING?
GEOFF BENSON, ARE, NCSU
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Is Hedging for You?
 Things to consider
Size of your cattle operation
Financial importance of your
cattle operation
Ability to handle price risk
Attitude to risk & expectations
about hedging
GEOFF BENSON, ARE, NCSU
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Farm Structure, 2007 Census
US
NC
963,669
19,229
818,992
14,895
626,775
13,178
-- 50-99 cows
102,217
1,169
-- 100-499 cows
80,816
525
-- 500+ cows
9,184
23
All farms with
beef cattle
Farms with
beef cows
-- 1-49 cows
GEOFF BENSON, ARE, NCSU
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Why Do You Have Cattle?
OR
FUN
OR
MONEY?
GEOFF BENSON, ARE, NCSU
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Hedging
 It is not for everyone
 Very small producers
 Busy producers
 Producers for whom beef cattle are a
sideline

All risk management strategies involve
costs and effectiveness varies among
alternatives
 Financial benefits & costs
 Time, new knowledge and skills
Evaluate trade-offs in your situation
GEOFF BENSON, ARE, NCSU
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Hedging
 How much do you have at risk?
Number of head
Possible change in price
Total financial losses
Impact of those losses on farm and
family finances
 Example,
I truckload of feeder cattle = 50,000
pounds (~65 head)
A $10 per cwt. price drop = - $5,000
GEOFF BENSON, ARE, NCSU
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Price Risk Management Strategies
 Ride it out – “self-insure”
Draw on savings or borrow
Restructure debt payments
Adjust expenses, especially
maintenance & new investments
Add off-farm income or cut family
living expenses
 Prevent unacceptably low prices
with futures contracts, options,
LRP – “buy insurance”
GEOFF BENSON, ARE, NCSU
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Hedging
 Attitude & Expectations
Futures, options & LRP are tools to
manage downside price risk and
prevent or moderate the financial
problems lower prices would cause
It is unrealistic to expect that using
futures and options will increase your
average or long run profit but using
them may help keep you in business!
Using them may help you sleep better!
GEOFF BENSON, ARE, NCSU
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Attitude to Risk
 Attitude to risk affects an
individual’s decision in a given risk
situation
Are you risk averse?
 Willing
pay to reduce risk (insurance)
 Willing to accept a somewhat lower
expected profit to avoid downside risk
Are you a “risk preferer” – NOT willing
to pay for risk reduction and possibly
accept lower average profit
GEOFF BENSON, ARE, NCSU
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Setting Hedging Price Targets
 A minimum profit
Full cost of production + margin
Break even
 Cash flow protection
Stocker purchase price
+ or - debt service
+ or - cash production costs
+ or - $$ for family living
GEOFF BENSON, ARE, NCSU
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Do you know your cost of production
& profit margin?
 Operating cost - Out of pocket
expenses, e.g. forage, other
feed, fertilizer, vet, repairs,
 Investment (fixed) costs—
Depreciation, interest, property
taxes & insurance (DITI)
 Opportunity cost – charge for
your time and equity capital
invested
GEOFF BENSON, ARE, NCSU
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MN Cow-calf Cost & Returns, 2007
Low
Profit
Avg.
Profit
High
Profit
Revenue
$394
$524
$710
Operating cost
$481
$437
$376
Margin over op. cost
-$87
$87
$334
Fixed & O/H cost
$149
$115
$79
Labor & Mgt charge
$83
$84
$102
Total cost
$713
$836
$556
Net Return
-$319
-$112
$154
Source: MN Farm Business Management
database
GEOFF BENSON, ARE, NCSU
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55
MN Stocker Cost & Returns, 2007
Low
Profit
Avg.
Profit
High
Profit
Revenue, net
$110
$207
$252
Operating cost
$200
$179
$149
Margin over op. cost
-$90
$28
$103
Fixed & O/H cost
$59
$25
$21
Labor & Mgt charge
$75
$19
$16
Total cost
$333
$223
$187
Net Return
-$223
-$16
$65
Source: MN Farm Business Management
database
GEOFF BENSON, ARE, NCSU
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NCSU beef & forage budgets
 Beef: cow-calf, backgrounding,
summer grazing, pasture finishing,
conventional finishing, preconditioning
 Forages: perennials, annuals, hay
making, silages
 Available on line at:
http://www.ag-econ.ncsu.edu/
extension/Ag_budgets.html
GEOFF BENSON, ARE, NCSU
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Costs in the Budgets
 Operating inputs -- fuel, fertilizer, chemicals,
labor, seed, interest
 Fixed costs -- depreciation, interest, taxes,
insurance on machinery and buildings
 Full labor and interest costs and charges
 Forage budgets
 Do not include storage, feeding or pasture
management costs
 Some include harvesting costs
 Include yield estimates and “unit costs”
 NO farm overhead cost
 NO land charges
GEOFF BENSON, ARE, NCSU
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Cash Flow
 Budgets include full economic costs
 For cash flow price targets, evaluate
the revenue needed to cover
Out of pocket production expenses,
including cattle purchases
+ or - Debt payments
+ or - Family living
 Remember, the purpose is to lock in
or set a floor price at an acceptable
level to insure against a financial
disaster
GEOFF BENSON, ARE, NCSU
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Pulling the Trigger
 Futures price volatility means pricing
opportunities come and go
 Futures prices respond to:
Market fundamentals, so track key
economic factors and understand their
impact on prices
 Supply
factors
 Demand factors
Technical trading driven by market
psychology, so following price moves and
interpreting trading patterns can help
GEOFF BENSON, ARE, NCSU
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Demand & Supply Factors
 Consumer Demand
General economy – income,
unemployment, exchange rates
Competition from other meats
Demographic changes – age, race, pop.
 Supply
Availability of cattle – stage of cycle
Feedlot costs
Transportation costs
Trade
GEOFF BENSON, ARE, NCSU
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US BEEF PRODUCTION & PRICES,
1976-2006
29,000
$100
27,000
$90
$70
23,000
$60
21,000
$50
19,000
17,000
BEEF PROD.
$40
FED CATTLE PRICE
$30
Price, $/100 lb.
$80
25,000
TREND IN FED CATTLE PRICE
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
$20
1978
15,000
1976
Production, mil. lb.
.
GEOFF BENSON, ARE, NCSU
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Cattle cycles
 Low prices force liquidation of breeding
stock, adding to beef supplies and
reducing prices further
 Reduced production leads to higher
prices encouraging heifer retention for
breeding, reducing beef supplies and
raising prices further
 Lags
 Decision making takes time
 15 months to raise a heifer to breeding age
 Seasonality in breeding & 9-month gestation
 14-18 month production period
GEOFF BENSON, ARE, NCSU
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Beef Product & $$ Flows
$ CONSUMER $
RETAILER
PROCESSOR
WHOLESALER
PACKER
FEEDLOT
COW-CALF
STOCKER
GEOFF BENSON, ARE, NCSU
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Price Volatility
 Unexpected changes in significant
supply & demand factors
 “Known unknowns”
Weather
 Crop
prices & feed costs
 Forage supplies & quality
 Cattle supplies
 “Unknown unknowns”
Disease outbreaks, e.g., BSE
Economic crises
GEOFF BENSON, ARE, NCSU
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Feeder Cattle October Contract
Price History
GEOFF BENSON, ARE, NCSU
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Hedging
 Takes time to learn to follow
market conditions
Marketing club?
Paper trading
Finding a market adviser and/or
broker you trust
 Takes confidence to learn when
to “pull the trigger”
GEOFF BENSON, ARE, NCSU
67
Summary
 All producers can use futures and
other price information to project
prices for their cattle as part of
marketing and business decisions
 Benefits of hedging
Protecting yourself from unfavorable
price movements that would cause you
serious financial problems
For the seller -- protection from price
drops
For the buyer – protection from price
increases
GEOFF BENSON, ARE, NCSU
68
Summary
 Several factors affect profits
For cow-calf
 Prices
& premiums related to selling
weight, frame, breed/color, season, choice
of market etc.
 Animal performance
 Cost of production
Base hedging decisions on feeder
cattle futures prices, adjusted for
basis, weight, other cattle
characteristics, and market choice
GEOFF BENSON, ARE, NCSU
69
Summary
 For Stockers, key factors:
 Purchase price
 Selling price
 Feed costs
 Average daily gain & change in body condition
 Use feeder cattle futures prices as the
basis for profit projections
 Base hedging decisions on feeder cattle
futures prices, adjusted for basis, weight,
other cattle characteristics, and market
choice
GEOFF BENSON, ARE, NCSU
70
Summary
 Price risk management tools include
futures, options and LRP
 Set price targets based on your own
cost of production or cash flow needs
 Track market conditions to time your
actions
 Producers need good financial records
to set price targets, and monitor
performance, costs & profit margins
 No $imple or ea$y an$wer$!!
GEOFF BENSON, ARE, NCSU
71
“If it’s easy, fun or can be done
from the seat of a tractor,
there ain’t no money in it”
Anonymous
Cowboy
GEOFF BENSON, ARE, NCSU
72
What Next?
 What more assistance do you want or
need, if any?
 Topics
 Price forecasting
 Hedging with futures
 USDA’s Livestock Risk Protection Program
 How would you like this help delivered?
 One-on-one with an adviser & broker
 Group meetings
 Materials, publications, etc.
GEOFF BENSON, ARE, NCSU
73
Geoff Benson
 Phone: (919) 515-5184
 Fax: (919) 515-6268
 E-mail: [email protected]
 Web page:
http://www.ag-econ.ncsu.edu/
faculty/benson/benson.html
GEOFF BENSON, ARE, NCSU
74