AoR 94: Current Cattle Market Risks & Opportunities with Shannon Neibergs and Jack Field

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>> Welcome to the Art of Range, a podcast focused on rangelands and the people who manage them. I'm your host, Tip Hudson, range and livestock specialist with Washington State University Extension. The goal of this podcast is education and conservation through conversation. Find us online at artofrange.com.

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Welcome back to the Art of Range. We're continuing our series on ranch financial resiliency. And I have back on today a couple of repeat guests. Dr. Shannon Neibergs is with the Western Center for Risk Management. And Jack Field with CKP Insurance. Shannon and Jack, welcome back.

>> Great. Thanks for having us.

>> Thank you for having me, Tip.

>> Shannon, you recently spoke at the Washington Cattlemen's Association Convention about current market forces and the challenges that the current situation presents to livestock producers. Your title was risk management implications for Washington cattle producers in a year of unprecedented volatility. As you know, we've been doing a series of episodes on how ranchers can increase ranch financial health, including some lesser known risk tools, like price insurance, that had been I think underutilized in the past. We've talked some about branch records, managerial accounting, various ways to measure performance indicators. And Jack has talked here before about insurance. But step number one, either, whether we're considering insurance or just analyzing sort of internally an operations financial health, that is knowing what various financial risks are. And it feels like today there's a lot more factors at play than just, you know, cattle on feed and the fact that there's drought somewhere that's resulting in destocking. You know, at one point, there was a fairly predictable, roughly decadal cattle cycle that people could sort of work, you know, work countercyclically to maybe make better money than they would otherwise. But that, that decadal cattle marker really hasn't been in place for about 20 years. So, there's a lot more factors going on in the global food market than I think what we used to have to worry about. I think it would be worthwhile to have you talk about some of that again today.

>> Yeah, great, Tip. And thanks for summarizing that. And I think on the cattle cycle, one thing that's accelerated it is the extended droughts that we've, that have occurred in 2012, and more recently across the west, that's accelerated some of those stock, e stocking decisions, and how these dynamics have positively impacted the prices in the United States. But also, as we look at risk, one of the things that we need to really keep in mind is that we are facing a lot of risks that are out of our control. And those risks include international risks that we've seen impact agriculture markets, starting with the Ukrainian War, with Russia, and the dramatic impacts it's had on energy markets, fertilizer markets, and also wheat, as it's impacted the wheat price as well. So, the combination of several of those international factors, as well as domestic factors, has lots of both positive opportunities, and also risk concerns that we should keep in mind as we try to manage through 2023 and beyond.

>> Those mostly look like risks to me. And not a lot of opportunity. And I realize we'll get around to that. But, yeah, talk about what some of the  why is that more volatile than what has been the case in, you know, already fairly volatile cattle markets?

>> Yeah, some things that have really impacted the cattle markets is the domestic markets in our inflation, stemming from the COVID recovery, and also policies of spending, and the impacts that it's had on interest rates, the direct relationship between inflation rates and the use of interest rates to increase, to decrease inflation, but the interest rates increase, that increases our interest rate risk. We've talked, you talked a little bit about that on previous podcasts, the exposure to interest rate risk. But also what's important to consider is as interest rates go up, it has a direct correlation on exchange rates. And those exchange rates impact up to almost a quarter of our market as we supply those international markets. And that exchange rate increase on the record high of the Japanese yen, you've probably heard were close to at par or better than par with the EU. And those prices have dramatic impact on those international markets. And we've been lucky in 2022 where we've seen some decreases in major markets to Mexico and Canada that have been off set by increases in China. And so we're on pace to set record export levels in 2022, despite these shipping factors and price factors that as we look into 2023 and we are anticipating improved prices, we have to remain cognizant that changes in those export markets, shocks in those export markets, can have dramatic effect on our prices. And so while we're optimistic for improved prices through 2023, that doesn't reduce the need for risk management on price and other conservative efforts as you look forward to responding to opportunities in 2023.

>> Yeah, we may have a number of people listening to the podcast that are not very familiar with what, what the export of beef looks like. What are the primary beef export markets? And how have those changed say over the past decade?

>> Well, Japan has always been a strong export market. And it's improved. When you talk about the history of export markets, and the impacts of disease, namely BSE, and the shutdown of those export markets, and the great recovery of those export markets, that's been important. And so Japan's a leading market, Mexico, and Canada are leading markets, as well as South Korea. China is very interesting is that up until a couple years ago, we had very little exports of beef into China. But due to the trade war that occurred, then beef, some non tariff constraints on beef concerning age requirements, concerning traceability requirements, concerning health requirements, and recognizing of those processes, that opened up the market into China, and China remains a very hopeful market, given their vast population growth, their economic growth, although there are some clouds on the horizon in China on that growth due to their stringent COVID policies, and there are still ongoing lockdowns due to COVID.

>> How do you see those risk factors affecting the possible price of both fed cattle and feeder calves now and next year?

>> Well, I think that stems back to really looking at, we've been declining in cow numbers, so the supply is going to be reduced both in terms of number of cows and the number of calves starting the production process into 2023, as well as decreased beef production expected in 2023. And so all those factors of the drought this year in 2022 across much of the southwest, and into the northern west as well, had cattle placed on feed early. So, those dynamics of supply will be developed through 2023. But also due to the drought and ongoing cow calling, due to the destocking, those factors are very critical. The cow calling last year is recorded to be as high as it was since 1996. And so those calling dynamics due to drought are very important as we look at prices in those price dynamics across the next year. Now, if you remember back, I think part of the importance is to pull the drought impacts that the United States has in the 2012, 2013 year of those drought impacts, over the Midwest, which greatly impacted the cow herd, which then led to record high prices in 2015. And then in 2015, the market turned down, and then took a further turn down in 2016. So, three or four years after that dramatic drought was the price cycle, and then the period of time where prices were elevated, directly attributed to that drought. And so if we look at 2022 and the outlook for 2023, given the winter outlook of the La Nina weather pattern, we see that drought impacts to have effect over the next couple years. And those drought effects really leaded, as I mentioned, lead to those record high prices. And the importance of, and the importance here is to look at what kind of price risk protection to put in place that's important in managing your ranches. You talked quite a bit over the past, well, recent podcasts on key performance indicators, profitability, cost of production, and those factors are clearly critical in looking at what that price management is going to so that you can maintain those profitability factors that are needed to maintain and manage your ranch.

>> Well, I repeatedly offer the disclaimer that I'm not an economist. But it seems like having supply going down in demand remaining stable or going up should translate into, you know, decent prospects for cattle prices in the near future.

>> Yes, that's, that is correct, that all the outlook reports, all the trade articles are talking about this combination of destocking. Also important, the high quality of beef that's being produced through the expanding proportion of choice, or choice graded beef. And that high quality is really critical. And it's really supported the markets, both domestically and internationally. What's interesting is that U.S. beef commands the highest price internationally. It's not an equal price for all sources of beef supplying the international market. And U.S. beef demands the highest price because of its quality parameters. And that's a strength that's not going to, that's not of much risk, because I think those trends are well established, and will maintain. It's more the demand risk was mentioned a little bit earlier that is really critical, because that demand risk can shift on a negative news article, it could shift on a geopolitical event, it can shift on some other disease or other biosecurity aspect, food securities mainly.

>> Now, I guess turning away from some of the risk factors that we, that an individual producer does not have any control over, what are some of the more internal sources of risk that people should be thinking about and attempting to manage for? And then we'll go from that to talking about how to protect risk more broadly. But what are, I guess what are some internal risks? And what are traditional methods to mitigate for internal price risk?

>> Yeah, the internal risks really clearly stem have knowing those key performance indicators, and cost of production measures, internal to your ranch. And so I think that's really important to stress that knowing that, knowing that information is clearly an important factor on establishing your risk management plan. Because if you don't have your, if you don't know your cost of production per unit of animal, it's going to, in turn, lead to just trying to strategize on crop insurance or the livestock risk protection, or the PRF insurance levels that you seek to purchase, to protect those risks. But clearly the internal risks stem from better knowledge of your internal accounting and those key performance indicators.

>> It does seem like there is, I don't know about disagreement, but definitely a couple different schools of thought in terms of trying to manage cost of production, or manage profitability, I should say. Some would say that the primary focus should be on enhancing revenue and being willing to spend money in order to get revenue. We heard Stan Beaver say that, though, that you may not be able to afford having, you know, a 95% calf crop. It may cost too much to achieve that. And so you have this other school of thought that says you've got to really aggressively drive down your cost of production and look for ways to be a low input producer. I think, sometimes in these, I won't call them arguments, but disagreements about which way to focus, people are sort of talking past each other. And there's quite a bit of a sense in which most sides are right. Do you have any thoughts on, you know, where and how to chase this down?

>> Yeah, I think that first you need to, in my opinion, Stan, as you mentioned, Stan did a great job on those previous podcasts talking about those key performance indicators, which started with the number of bred females. Knowing that so that you can correctly and accurately analyze your production, reproduction efficiency, your calving efficiency, and getting ahold of that inventory level, what you produce, that, you don't need an accountant to help you. You don't need an extension economist to help you put those inventory numbers together. And so if you start with those inventory numbers, that's a key important factor to analyze. And then your replacement heifers and your efficiency of raising those replacement heifers, is also critical. And that fits into those production parameters as well that all ranchers could clearly evaluate on their own. And then on the cost side, that's a, that's a harder question to evaluate, because I don't think most ranches are out there overspending now. So, the cuts on spending are hard, because you've been driven to efficiency to survive up until this point, particularly over the past couple years, because those, since 2016, those prices have not been as high as most people would like to see, so it forces, if there's been a history of looking at costs in order to make ends meet. And so as you mentioned, as the challenge on revenue and drought revenues, you went through quite a bit of discussion on reducing and analyzing your fixed costs. And the fixed costs are more generally defined to include the labor, to include all the machinery and equipment costs. And so you're going to have to, if you're looking to evaluate the cost side, you're going to have to use your accounting and your management records to evaluate those costs and see if there's opportunity to be more efficient in that cost structure.

>> Right. Or if cutting a cost also has a corresponding loss in revenue from declining quality or whatever.

>> Correct.

>> Well, my impression, and from some data that we gathered on some of these price risk tools, like LRP, it looks to me as if these tools are underutilized. Is that your assessment of it as well?

>> Yeah. We can look at LRP usage relative to the number of potential calves in the state. And quite a bit of difference across the country on which states are very heavily enrolled in LRP. But we've grown, but we still have well below 20% usage, potential usage of that LRP program, in the Pacific Northwest. And so it's increasing, it's gaining popularity, the PRF tool is gaining popularity as well. And when you measure its use over time. But there's still a lot of opportunity. There's still lots of ranches that may not see the advantage of using these tools and the opportunities of using these tools. And 2022 was a relatively good price year. Our price, the cattle prices went, trended upwards. And there were some dynamics. And it was interesting to me that even in 2022, there was opportunities to use LRP in a very efficient manner to cover your premium costs, and put that, put the price floor under, under your risk in those calf markets.

>> Thanks, Shannon. We're going to do a whole episode soon covering the livestock risk protection program in more depth. And in there, we'll walk through some examples. But for now, Jack, can you offer a brief overview of LRP, and address some of the common misunderstandings you see on how the mechanism for establishing payment works?

>> The single biggest point of I guess misunderstanding or confusion that I encounter is having, ensuring that producers clearly understand the function and place that the cash marketplace, meaning the Chicago mercantile feeder index, and the fact that their settlement on a policy, or excuse me, on an endorsement, is not directly tied to the market sale of their livestock. But in sitting and listening earlier to the comments that Shannon was making, he talked about Ukraine and drought, and both, and you as well, Tip, had pointed out that even in a year like this where we've seen a dramatic uptick in prices, we've had a number of producers that have been able to successfully implement price protection in their operations to where it has benefited them. I've been able to successfully use LRP on some cattle of my own. And as we were on the, as I was in the waiting room to come into this podcast, I had another customer that we worked with in July, it would have been July 13th, we took out specific coverage endorsement on 50 steers. That individual, based on the market, July 13th, they were able to put a price floor under their, a 599 pound steer calf at 204.37. That cost the producer $5.81 per hundred. They just ended up with the feeder index coming through, and the final adjustments. Their settlement price was 193.06. That ended up being an $11.31 gross loss. The producer, after premium, netted $5.50. So, on that 599 pound steer, that's an additional $32.95 per head. For example, if they, if those cattle were marketed somewhere in that 185, 100 weight range, that's going to bring the total value of about $1,108 per head. That's another 30, close to $33 that they would add on to it. Over that 50 head endorsement, that ended up a net benefit a little over 1,600 and, just shy of $1,650. So, they were able to successfully protect themselves and effectively gain one additional calf in additional proceeds to their operation by successfully using the livestock risk protection program. The nice thing about that is the producer knew on the 13th of July exactly what their maximum exposure was. They could build that into their budget. They knew what it was going to cost them. And they did not have to worry about a run up or a run down, something happening in the market. They knew at the end of the day they were going to have to pay $5.81 per hundred weight. The way this worked for them, they actually will not have to write the check. The policy is going to pay for itself. The loss exceeds the premium. They provide the proof of ownership documentation to satisfy the rules of the livestock risk protection program. And they should receive proceeds in a very short time, depending upon their ability to return the claim form back to the carrier. I've had a number of producers that have had a very wide amount of success, meaning that the 10, I've seen quite a few that were 10 to $12 a hundred weight losses. And when you talk to people, they didn't think for a million years that they would end up receiving an indemnity payment with the strength that the market has had. But there have been enough hiccups along the way that have caused that index to back up or come off a little, whether it be, like Shannon had talked about, the inflationary impacts, global grain prices, supply and demand projections, et cetera. But LRP has been a very, very popular tool, and one that with the recent additions made by USDA by expanding those head count limits, it's opened it up to a much broader audience of producers that will hopefully benefit their operations as well.

>> Yeah, that's a great hook. I often make the mistake of trying to lead into something with information that maybe isn't so interesting. But that's a compelling example. Why don't we go backwards from there and describe a bit what is the original purpose of the LRP? And who is eligible? Because you just mentioned that there are people eligible now that weren't before because of some real changes. What was the original purpose? And who, who, who's eligible?

>> So, right now, any, any individual, whether it be an individual or a company that owns and either feeder cattle and/or fed cattle, has the ability to purchase coverage. And when we say coverage, you're basically, like Shannon had alluded, you're putting a price floor. You're buying a policy against a reduction in the market. And they have, they being the United States Department of Agriculture Risk Management Agency, USDA RMA, have expanded the size of operations effectively by increasing the head counts. Several years ago, there was a 6,000 head per year maximum threshold. It is now 25,000 head. And they have also increased the premium subsidy. There is a 35% premium subsidy that comes out of the farm bill. So, and the third, and I think maybe the most important component, is the premium is due at the end of the endorsement. Four or five years ago, when I policy was, was written, and an endorsement was taken out, the individual, the producer had to write a check that day for the coverage. Now, and obviously depending upon what these might be, you could be looking at a couple hundred dollars to several thousand dollars' worth of premium, just depending upon the size of operation, and the level of coverage. That can cause a real pinch in people's operating budgets, because what we're talking about is protecting the price of the commodity that we have not yet marketed. So, in many operations, we're focusing on that one paycheck. Or if we're fortunate enough to market two calf crops, we're focusing on the sale date of those calf or yearling crops to bankroll the operation. So, by moving the premium due date until the end of the endorsement, that basically means at the end of the endorsement, which we try to time that as close to when the cattle would be sold as possible, that gives the producer the ability to know, yes, this is, we've got the market, we've got the calf sold, and is there a loss or no loss. If there isn't a loss, they know they need to write the check. They'd have the proceeds from their sale of the calves to be able to help cover it. If there was a loss, they would know that that's coming, and they could get the paperwork filled out, and that would help shore them up from where they thought they would have been in the market.

>> Yeah, and you mentioned that the market is based on the CME feeder index.

>> Yes, sir. The CME feeder index is the USDA's seven day rolling average where we've got, and Shannon, you know better than me, is that 30 markets over the course of the week that are reporting in the seven day rolling average of an 800 pound feeder steer, to truly, truly capture and show the value of the cash market. They utilize the CME feeder contracts in terms of the feeder months to be able to establish the expected end value. And it is then settled off of that index, which is the cash market. So, giving, giving the producers the best of both worlds, the opportunity to have that expected value set, and hopefully influenced in a positive manner through some of those outside dollars that might be investors in the market, and the true settlement tool is done by the CME feeder index. And that's the actual receipts off of those cattle. And that index is published every day. For example, the CME feeder index from November 11th was 175.23. So, as we, as we think about that, that's what the, that is the entire foundation of the LRP program. They use that index value to establish the value of a weight class two steer, which is 600 to 1,000 pounds. They adjust it up by 10%, for the value of a weight class one steer, which is up to 599 pounds. They use that index value as the value of a weight class one heifer, which is up to 599 pounds. They then take a 10% reduction to capture the value of a weight class two heifer. And then they utilize the five area weighted average on fed cattle for the fed cattle settlement.

>> And a couple questions that maybe are obvious to anybody else who's listening, but to understand that an individual producer can enroll regardless of the size of their operation.

>> You are correct. You can  I've sold five head policies on up to 500. So, and excuse me, endorsements. So, the policy, a producer would take a policy out with whichever respective approved insurance provider he or she chooses. Taking a policy out does not obligate them to purchase anything. It simply gets them set up and established in both the carrier and USDA system to make sure that the name, Social Security number, and the fact that they are conservation compliant, and have an AD1026, that's the conservation compliance document, that the Farm Service Agency has on file, once a producer fills out his or her or a company application, they are then ready to go. So, I just sent out an e mail a couple minutes ago that would have the offerings for today. For example, right now as we look out, and Shannon had talked about some of the optimism in the market due to the supply and demand functions, and some of the things that we've seen with the reduction of mama cows with a calling. The insurance actuarials would echo Shannon's excitement as we look to the future. Looking out today, 43 weeks into the future, a producer could take out a policy. It would have an end date for September 11th of 2023 on a 599 pound steer. They could put a floor of 219.06. And that would only cost them $7.51 a hundred weight. So, $45. I remember myself last year buying coverage in that 17 to 21 week window somewhere between 150, 160 and 170, and it was 45 to $50. So, there's a lot of opportunity for a fairly lengthy endorsement, where producers could really lock in some positive market position. And at the end of the day, if a producer ends up paying their premium, that means that the CME feeder index was at least par with their coverage price. So, if we get to the 11th of September, and the CME feeder index, the adjusted index for a wait class one steer is that 219.06, I would imagine we're going to be having a fairly positive conversation because that means you would have been able to protect a 925 pound steer at 199.14. That would, that would run a producer $6.81 a hundred or $63. So, there's some real opportunities for producers of all sizes, of all types, to be able to build a very conservative, and a very easy risk management system that they understand completely, that's going to protect them if we see something like a Ukrainian invasion, something that causes unknown or unexpected impacts on our markets. People can sleep a little better at night.

>> Yeah, and you can [inaudible] a number of animals?

>> Correct.

>> Like say I've got 500 head, I can enroll 100 of them.

>> Correct. And out of that 100, we could do that on 1, 2, 3, 10. You could, you could stagger it out. I was just speaking with a producer about that. He says, well, I've got 400 steers that we market each year. I might want to look at this and maybe do 25% of them. And then over that, out of that 100 head, they could, they could split that up however they wish. You don't have to do it all at once. I didn't mean to cut you off, Shannon.

>> Sorry. I just was going to add that it is important to recognize that this is a proactive tool. You don't want to wait until the market turns and then try to get in. Because at that point, if time, the market is turned against you because of some event, and it might be a case where they're not going to be able to sell any endorsements for a few days as the market adjusts, and so clearly keep in mind that a proactive approach to this planning is needed.

>> I would agree wholeheartedly. What I've recommended to the producers that I work with is as they start calving, or as they start to purchase yearlings, if they're going to be put in grass cattle together, that they really start to focus and watch. That generally gives them the opportunity to think and look at maybe a little shorter endorsement, which should hopefully have a lower premium, if we're talking about a shorter time frame. But like Shannon said, you always want to be looking. You never know when the next hiccup could come, or bump in the road. So, having the ability to protect yourself, be it at once, or incrementally, is absolutely essential. And it's another one of those where if producers could just know when that market was going to turn, Shannon, they might not need LRP, but it's one where I've had customers that have, have still had some positive results, even after the market has turned, they just may not have been as large. But the important thing is once they're able to put a floor under it, they know what their maximum exposure is. And the biggest thing is we're starting to look at and see producers that are having 25 to $40 net returns back. That's, that's real dollars. That adds up to, like I said earlier, the effect, effectively putting 1, 1 1/2, or 2 more head on the load. In which you didn't have to pay the pasture. You didn't have to feed them. You didn't have any of the potential desk risk, or excuse me, death loss. It's been, it's been a very positive component. And even, even to those that have had to pay their premiums, the piece of mind that it's given them has been a real key. When I spoke with the yearling producer that was looking at locking in some coverage on a couple sets of 900 pound steers that he had done, and at the end of the day, he had to write his premium. He says, well, I was able to sleep at night, because I knew if this thing went sideways, I was covered.

>> Yeah, I've got a couple questions related to sleeping at night. And either one of you can not answer, and we'll just cut this out, but, in general, I would say the livestock producers are more skeptical of government subsidized programs than folks in other sectors of agriculture. Do you think that that's been a barrier to adoption? In my own thinking, I guess I would feel like of all the things the federal government could spend money, subsidizing some useful insurance that helps stabilize American agriculture is a decent place to invest what ends up being not that much money in the grand scheme of things. Have you seen a change in attitudes toward government subsidized price tools like this?

>> I think the biggest reason for producers not participating is not the government subsidy. I think it's just been a lack of understanding what the program was, how it worked. And, again, that previous requirement of having to front the premium day one versus the current process where that premium is due at the end of the endorsement, just a basic function of cash flow, I think. And this, just by moving that premium to the back end, I think was the single best thing that USDA did in terms of making this a more robust and a more user friendly tool, because it's been able to allow producers to keep cash flow back in their budgets to do the day to day things they need to rather than paying an insurance premium.

>> Right. Shannon, any thoughts on that?

>> I would echo what Jack said about the changes in the program that have improved the use in terms of a reduced cost, the premium paying at the end. And so I think it's a matter of understanding the program. I wouldn't portray it as a government program. I would say it's a government  the underwriting standards are backed up by the government. But the program design, the program purpose is to be fair and effective to the producers to provide that price floor and that risk management so that they can withstain price shocks and remain focused on their business and their community and future just through not having to endure the full brunt of a negative market impact.

>> Yeah, I think that's a critical distinction, to separate out a premium subsidy that's supported by the federal government versus a payout program like the conservation reserve program that has had declining popularity. They're very different things.

>> Yeah, it is definitely a management tool that the ranches need to invest in as part of their portfolio of all the risks that they face. And this is just one tool.

>> Well, I think we will pause this there, because we will have some additional episodes with a little bit more focus on the mechanics and walk through some examples of how, of how LRP can work. And also visit with some folks that have used it to their advantage. So, we're going to go ahead and stop here. And we'll look forward to some additional content on this topic. Thanks, Shannon, and thanks, Jack, for getting on today.

>> Thank you, Tip.

>> Yep, thank you.

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>> The views, thoughts, and opinions expressed by guests of this podcast are their own and does not imply Washington State University's endorsement.

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