Dillon Feuz: Drought-driven changes in feedlot cost of gain and feeder cattle prices

Dillon Feuz
for Tri-State Livestock News

How can feeder cattle prices decline more than $20 per hundredweight in five weeks when fed cattle prices remained unchanged? Answer: when projected feedlot costs per hundredweight of gain increase more than $25 during that same time period.

The worst drought to hit much of the U.S. in 50 years is certainly impacting the markets for grain and livestock. Let’s briefly review what has occurred since May and then discuss strategies that might be used to deal with the current situation.

In May 2012 a record number of corn acres had just been planted. Experts were predicting record or near record corn yields and therefore a record U.S. corn crop. December Corn Futures were trading between $5.00 and $5.40 per bushel while the near-by May contract was trading around $6.25 per bushel. Total cost of gain in a feedlot was about $100 per hundredweight of gain in May and the expectations were that with cheaper corn in the fall, feedlot cost of gain would also decrease in the fall.

There seems to always be optimism in the spring feeder cattle markets and this past spring was no exception. Feeder cattle supplies were tighter than they had been in 50 years; beef was selling at record prices with fed cattle prices expected to set a record for the year. December Live Cattle were trading for about $127 per hundredweight and April 2013 Live Cattle were trading at $130 per hundredweight in May.

As a result of this optimism and market fundamentals, 550-pound steers were selling for $190 per hundredweight in Nebraska with the expectation that fall prices could be at $180 per hundredweight for steer calves. Heavier 750-pound steers were selling at $160 per hundredweight in May with an expectation of prices increasing to $165 per hundredweight by fall.

I know hindsight is always 20-20. Therefore I am always reluctant to tell you what you should have done. You obviously already know. Those of you who did get your calves contracted for this fall and those of you who did forward contract for some fall corn in May or early June are obviously in a much better situation than those who didn’t. So, what happened?

It stopped raining. Climate experts now say much of the U.S. is in the worst drought in 50 years. Expectations for a record corn crop in 2012 evaporated at the same rate as soil moisture did. December Corn prices started to move higher and with each week’s crop progress report coming in more negative than the prior week’s report, there seemed to be no stopping the rally in corn prices. Omaha cash corn prices have increased from around $6.25 per bushel in May to near $8.00 per bushel on July 25. The December Corn futures increased from $5.20 per bushel to $7.80 per bushel in mid-July.

Rather than feedlot cost of gains decreasing from spring into fall, they have increased from $100 to $120 per hundredweight of gain. Current fed cattle prices this past week were $113 per hundredweight That means that at present corn and cattle prices, it is costing more to put a pound on then that pound can be sold for. If this condition persists into the fall, then there will be even more downward pressure on feeder cattle prices.

As of mid-July, October Feeder Cattle futures had declined from over $160 to just over $140 per hundredweight That would imply fall 550-pound steers in Nebraska should sell for about $160 per hundredweight compared to the earlier expectations of $180 per hundredweight. Heavier 750-pound steers will likely sell in October at around $145 per hundredweight compared to the earlier expectation of $165 per hundredweight

At the present time, deferred Live Cattle futures have not declined; December Live Cattle were at $127 in May and remain at $127 in mid-July. April 2013 Live Cattle were at $130 in May and now have increased to $132 per hundredweight. It is these expectations for where fed cattle prices will be this fall and into next spring that are keeping feeder cattle prices at their present levels.

This past week, I remind you that fed cattle only sold for $113 per hundredweight. If fall fed cattle prices do not rally to the expected level, and if corn remains near $8 per bushel, there will be greater price pressure on feeder cattle prices. Those prices could decline another $20 per hundredweight from present levels.

I am not predicting this decline. Fed cattle prices should rally from these summer lows. However, I am pointing out that there is still more downside price risk in the feeder cattle market. If the fed cattle market rally falls short of expectations, at least some further decline in feeder cattle prices will occur.

What actions should you take given the current conditions in the market place? If you currently own calves or yearlings, I would suggest that you still look very closely at any forward pricing alternatives. For those needing to buy corn, I am not sure what I would recommend. The experts I read don’t hold out much hope that the corn crop will get any better. However, it may not get any worse at this point either.

Do I think corn prices could still go higher? Yes, I think that is a possibility. Could corn prices decline? Yes, I also think that is a possibility. Looking at December Corn Option prices on July 26, more money is being bet that prices will move higher than lower. Contracting for corn at $8.00 per bushel does not sound very appealing, but it may turn out to be.

One final comment: I am never one who looks to government to solve anything; they rarely do. It is an election year. I would anticipate some crop disaster money flowing into some hard hit states, or perhaps some key voting states (my cynicism comes through). That is all well and good. I doubt feedlots, hog producers, dairies, or cow-calf producers will see much from the government in the form of disaster relief from high feed prices and yet the economic impact on these operations may be as great as on the corn farmer who has lost some yield potential.