Dillon Feuz: Forward contracting feeder cattle | TSLN.com

Dillon Feuz: Forward contracting feeder cattle

This time of year I usually get a few phone calls from producers asking if I think it is a good time to forward contract their calves or yearlings. Sometimes the question is even more direct in that they have a contract offer and they want to know if it is a good offer; of course by a good offer, what they really want to know is will the price in the fall be higher or lower than their offer.

Some years cattle buyers are very active this time of year and there are many opportunities to forward contract. In other years, you cannot find an order buyer anywhere near a cattle ranch and they certainly won’t be found loitering around the coffee shop for you to corner them and try and get a deal out of them.

Most of the satellite video auction companies offer fairly regular sales from now until late in the fall. These sales can be for immediate sale, but most sales this time of year are for delivery later in the fall, so this is essentially a forward contract.

In responding to the question “Is it a good time to forward contract?,” let me give a few general guidelines about forward contracting and I will also look at the last 10 years to give a perspective on how prices have moved from summer to fall. Responding to the question about how good a specific offer is, is much more difficult. Every operation has their own costs, a differing amount of debt and even different attitudes concerning the amount of risk they are comfortable dealing with. But, I will give a few general guidelines to perhaps help you evaluate an offer you might have received.

What are the advantages of forward contracting? Perhaps first and foremost is the elimination of price risk. Once that forward contract is signed, as a producer you know longer have to worry about the market. If prices drop, you are protected. If prices rise, you cannot benefit from that but hopefully your contract price was at a profitable level, and as the saying goes, you will never go broke earning a profit. With price risk removed, your managerial time is freed up to concentrate on production issues and not be caught up in worrying about the market or trying to establish buyers for your cattle. There may also be some opportunities with forward contracts to receive price premiums for managing your cattle in certain manners to qualify for specific market targets. This can also be rewarding to you if you feel that you are getting paid for specific production practices that you are following.

There are some disadvantages to forward contracts as well. As mentioned above, if the market rallies between the time you sign the contract and when you actually deliver the cattle, you do not participate in this rally. Furthermore, while price risk is eliminated with a forward contract, production risk is not limited. Presumably, the contract is for a certain weight and number of calves or yearlings. What happens if the calves are heavier or lighter than is called for in the contract? What happens if you have unusually high death loss and cannot deliver the number of calves specified? Many contracts are written to lower the price per pound if the cattle are heavier than expected, but generally if they are lighter, the seller just loses out. Be mindful of this as you estimate your cattle weights and as you negotiate price slides for heavier and perhaps lighter cattle.

I don’t really have the data on forward contracts to know if historically they have resulted in higher or lower net prices than selling later in the fall on the cash market. From theory, we would actually expect the price to be a little lower from forward contracts because you are paying someone else to take on your price risk. If we use the CME Feeder Cattle futures as a proxy for forward contracts and recognize that often those individuals writing forward contracts are utilizing the futures for a price guide, then we can compare historical futures over time. Specifically, I looked at the change in the monthly average price of the September and November Feeder Cattle contracts from July to September or November.

Most yearlings coming off of grass are probably being sold in August or September, so that is why I used the September contract. Over the last 10 years the monthly average value in September was $1.58 per hundredweight higher than it was in July. This follows what theory suggests; you get a slightly lower price on average from forward contracting yearlings in July versus selling them in September on the cash market. In three of the last 10 years, the price declined from July to September and in those years you would have been better off to forward contract.

Many calves are weaned and sold in late October or November, so I used the November Feeder Cattle contract to represent these calf sales. Over the last 10 years the monthly average price in November on the futures has been $2.36 lower than the November contract was trading in July. This is counter to the theory, in that you could eliminate price risk on calves and actually do it for a higher price. In only four of the last 10 years was the November Feeder Cattle contract higher in November than it was in July.

As I mentioned previously, I am only using the futures as a proxy for forward contracts and I am not accounting for basis variability. However, just looking at this simple analysis, it would appear that there is likely a greater incentive to forward contract calves than there is to forward contract yearlings.

One manner of determining if an offer is a “good” offer is to compare that price to the futures price adjusted for your local basis (basis equals local cash minus futures). For example, if you will be selling 550-pound steer calves and you know that historically your local cash price is $5 per hundredweight higher than the November Feeder Futures in November and the current November futures price is $135, than you would expect around $140 for your calves in the fall. Any forward contract price above that value could be considered very good. If it was close to that price, it is probably a good offer and if it is substantially below that price, then it may not be that good of an offer. But, ultimately, that depends upon your own cost of production, your own tolerance for risk, and your own expectations for where the market is headed.

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