Cattle MMP: Perceived Benefits Of Border Closure Outdistanced By Economic Shortfalls

Seasonality stormed the market in late-March. Purchasing competition was fierce at month’s end among packers which helped to drive prices higher. It derived from the need to prevent inventory stock-outs and ensure fulfillment of seasonally increasing retail beef orders. A win for feeders as it generated an additional $5-7 in the northern dressed market with sales occurring at $152-3. Southern feeders proved reluctant traders; agreements were delayed until Friday at $92-3 – off several dollars from the previous day’s trade in the north but still several dollars better than the previous week. April’s first week of business subsequently saw both sides biding time. That wait-and-see mentality postponed trade for both regions until Friday. The outcome proved disappointing for cattle feeders as prices were well below asking prices earlier in the week ($95). The market settled largely at $90.

Despite lower prices last week, March was friendly to the market and, as mentioned, stems directly from seasonally improved wholesale demand. The light-Choice cutout began March by reversing a downward slide of nearly $7.50 during the last half of February. And along the way the light-Choice cutout also established new highs for 2005, much of which has been driven by surging middle meat prices. Mid-March’s Choice box price neared $157 with the past several weeks seeing values wavering between $152-5. The surge in demand has also inflated the Choice-Select spread to over $10 versus a $2-3 differential at the beginning of March.

Even with improved beef interest packers seemingly can’t catch a break. March’s ending week saw both stronger live values and softening boxed beef prices; as such, packers found themselves on the wrong side of the margin equation from both the buy and the sell. Packers managed to return the favor last week; feedyards were pinned down while the wholesale market found some renewed support. Even still it wasn’t enough to bail out the packer – the week’s operating margin still proved negative. That’s an ongoing burden: my estimates place average packer margin losses for the year at $28/head. That fact has played upon the beef complex; most notably, federally inspected slaughter for March averaged 26,000 head fewer per week than 2004.

Feeder cattle prices continue to be nothing short of phenomenal! Yearling prices began January well above last year’s level. Moreover, following a contra-seasonal pattern similar to 2003 and 2004, feeders have worked even higher as the year has progressed with sizeable advancement during the past five weeks. Meanwhile, March’s fed market averaged nearly $92. That surge has allowed feedyards some reprieve from negative closeouts; for the time being closeouts are generally breakeven-or-better. Comparatively, last month’s market of $87-8 placed closeouts at $50-60/head in the hole. Improved profitability has subsequently been allocated to the swap and supporting the feeder market. Looking forward, though, expensive replacements could create a period of prolonged negative breakevens, especially if the fed market disappoints as we transition into summer.

The late-spring / early-summer period is always critical for the market; May and June often dictate market tone for the ensuing months. The feeding sector’s ability to work through relatively large supplies of calf feds and subsequent questions of currentness regularly weigh on market psychology during this time of year. 2005 is no different. However, this year also possesses several other factors of critical importance – the heart of which surrounds consumer behavior. The unanswerable question at this point: how will rising fuel prices affect purchasing behavior during beef’s peak demand season? Moreover, the long-term outlook relative to rising oil prices, discretionary income and consumer attitudes is also concerning. The Gallup News Service (March 29) explains:

…there has been a sharp increase in the percentage of investors who feel today’s higher energy prices are likely to be permanent. In March, more than three in four investors say they believe that the rise in gas prices is a permanent change and not just a temporary fluctuation – up from 56% in May 2004. This change in perspective suggests that many consumers may begin adjusting their buying preferences, as well as their overall spending, with an eye toward a long-term decrease in the level of their disposable income.

That scenario does not bode well for beef demand. From a supply perspective it also hampers efforts to minimize production costs.

That being said, market uncertainty is amplified by current litigation surrounding Canadian trade. And until the issue is resolved and trade normality is reestablished, opportunity costs will continue to mount for the U.S. beef complex. Perceived benefits of border closure are largely outdistanced by industry-wide economic shortfalls. Over the short run, trade barriers may benefit the commercial cow/calf sector; over the long run, though, absence of international trade proves to be detrimental for the industry. Clearly, the past several years have proven to be very profitable for those who run commercial cows and ongoing border closure helps to extend that event. However, that strategy is not sustainable and self-defeating. The remainder of the industry, much of which includes “U.S. cattle producers”, finds itself challenged by the current business environment (see MMP: 12/10/04). Moreover, the current week-to-week operating environment makes long-term business plans difficult to facilitate - financial pro formas are impossible to develop with any confidence.

Given those realities, R-CALF’s injunction limiting Canadian trade is troubling. The organization’s leadership touts itself as representing “thousands of U.S. cattle producers on domestic and international trade and marketing issues [while being] dedicated to ensuring the continued profitability and viability of the U.S. cattle industry.” An effort to limit trade, though, relinquishes their commitment to common good. Hence, the mission statement is disingenuous: single-segment, geographically-centric, scientifically-unfounded policy directly opposes the stated priority of supporting the viability of the industry as a whole.

Economic freedom is a critical foundation of prosperity. Voluntary exchange and the absence of unsubstantiated restrictions enable all participants to be better off. With reference to international trade, authors Gwartney, Lawson and Clark explain (The Independent Review, Spring, 2005):

In our modern world of high technology and low costs for communication and transportation, freedom of exchange across national boundaries is a key ingredient of economic freedom…Of course, exchange is a positive-sum activity: both trading partners gain, and the pursuit of the gain provides the motivation for the exchange. Thus, freedom to trade internationally also contributes substantially to our modern living standards.

The irony is that R-CALF’s current stance on foreign trade is inherently conflicted. The association opposes forward contracts and inter-segment marketing agreements preferring for its members to maintain status quo - doing business within an adversarial and fragmented operating environment. Yet their current litigation increases uncertainty and delays onset of reduced market volatility (MMP: Jan ‘05). Maintaining trade disruption and prolonging the heightened level of operating risk will serve to only accelerate movement away from segmentation in favor of increased synchronization within the industry (MMP: Feb ’05).

R-CALF, and its cohort OCM (Organization for competitive Markets), remain tediously focused on packer-producer inequity and desire to fold that concern into every issue. That mantra, though, is tired and inept. R-CALF and OCM, to maintain relevance, would be well served to broaden their perspective while becoming more objective relative to shifts in commerce. The food retailing business has undergone tremendous transformation causing change throughout the entire beef complex; much of which includes increased synchronization and consolidation at all levels. That’s not unique. March’s Harvard Business Review cogently illustrates that reality, present in many industries including food production, is inevitable and requires adaptive, competitive strategies.

You’ve heard the term oligopoly – a market with a small number of sellers. An oligopsony may be less familiar – that’s a market with few buyers…But what happens when a company is in both an oligopoly and an oligopsony? It’s an increasingly common situation [in all industries], and one for which [author Steve Hannaford has] coined the term oligonomy…The most notorious oligonomy player is Wal-Mart. Economists have traditionally focused on the power of oligopolies to set high prices, whether through collusion or silent agreement. Most [mergers and acquisitions] of the past decade have aimed at building oligonomies, which are well protected from the extremes of business cycles since they can adjust costs as well as prices…As industries from steel to hotels to toys concentrate further, most businesses will at some point feel the hot breath of an oligonomy on their necks. How they deal with that threat will determine whether they survive.

The industry remains distracted by the dark cloud of R-CALF’s injunction. And meanwhile, the U.S. beef industry’s competitive advantage is increasingly threatened by foreign infrastructure investments (Canada and Australia), competing protein sources (pork and chicken) and the current economic environment (inflationary pressures and rising interest rates). Continuation of gains realized over the past decade mandates the beef industry maintain customer focus with ensuing energy dedicated to creativity, market growth and alignment of industry-wide incentives. Protectionism undermines that endeavor. Fear of transition and/or competition cannot serve as an excuse for, nor rationalize, narrow-minded, incremental thinking which proves regressive.