1. 1 Cattle Outlook & Risk Management James Mintert, Ph.D. Professor & Extension State Leader Department of Agricultural Economics Kansas State University Nevada Cattlemens Association Convention Elko, Nevada November 17, 2006 www.agmanager.info/livestock/marketing jmintert@ksu.edu

2. A Shrinking Industry Responding to a Lack of Profitability Current inventory is about 26% smaller than in 1975

3. Rising Productivity Is Partially Responsible

4. But Weaker Demand Was Key Beef Demand 1980-1998

5. Measuring Changes In Beef Demand 1998-2004 Demand in 04 Was Up About 25% from 1998 Level

6. Measuring Changes In Beef Demand 1998-2005 Beef Demand During All of 05 Decreased About 4% But Demand in 05 Was Still Up About 21% from 1998 Level

7. Demand Improved Steadily from 98 through 04 Downward Blip in 02 Following 9/11

8. Downturn Got Underway in mid-2005

9. 9 Beef Demand Shifters Whats been taking place recently? Demand index does not indicate why shifts occur Possible reasons for recent downturnPossible reasons for recent downturn –Low carb diet effect has worn off –Larger chicken supplies –Consumers disposable income growth slowing Expect more domestic demand weaknessExpect more domestic demand weakness How do we turn this around?How do we turn this around?

10. 10 International Trade Outlook

11. U.S. Was A Net Exporter From 1981-2003

12. Top 5 Importers Accounted for 91% of U.S. Exports U.S. needs to recapture these markets to regain $s and volume

13. Cattle Imports from Canada Are Increasing But Remain Well Below 2002s Record Level Jan-July 2006 imports 32% below 2002s and 21% below 2001s

14. Beef Imports From Canada Decline

15. Result: U.S. Imports Falling Below 2005s

16. 16 Where Are We Headed? Trade Other countries may have comparative advantage in cow-calf productionOther countries may have comparative advantage in cow-calf production U.S. strength is in high quality beef productsU.S. strength is in high quality beef products Exports to Pacific Rim increasing in 07Exports to Pacific Rim increasing in 07 Regaining market share will take several yearsRegaining market share will take several years –Market access is key Consumer incomes in importing countries are key to long-run growth in exportsConsumer incomes in importing countries are key to long-run growth in exports

17. Long, Slow Road to Export Recovery

18. Export Recovery Means Net Beef Imports in 2007 Could Be 1/2 2004s

19. 19 Supply Side in the U.S.

20. Mid-Year Inventory Was Above 2005s, And…

21. Strong Profitability Encouraging Expansion, But…

22. Livestock Marketing Information Center Data Source: USDA/NASS Poor Pasture Conditions Could Be Holding Back Expansion

23. U.S. Beef Cow Slaughter Up 17% vs. 2005

24. But Producers Have Been Holding Back Heifers

25. Slaughter Is Expected To Rise Modestly

26. Long Term Trend Toward Higher Weights But Will Rising Grain Prices Hold Weights Down?

27. And Beef Production Will Rise Cyclically

28. Prices Near Record High in 06 & Again in 07 Prices Near Record High in 06 & Again in 07

29. But Higher Corn Prices Lead To Lower Bids for Feeders

30. Cattle Feeders Will Adjust Bids Based Upon Higher Feed Costs Prices in 07 Headed Lower

31. Rising Corn Prices Pushing Prices Lower

32. Higher Feed Costs Mean Lower Prices Are Ahead Cycle Peak in 05 & 06

33. 33 Ethanol, Corn Prices, & Cattle

34. 3 Largest Corn Crops On Record

35. But Corn Usage Has Been Growing Rapidly

36. Ethanol Usage Growing Rapidly

37. U.S. Will Need More Corn Acres How Do We Get Them?

38. It Will Take Higher Prices To Push Acreage Higher Average Prices Will Be Higher and Frequency of Price Spikes Could Increase

39. Where Are Corn Prices Headed? Higher Corn Prices Spell Trouble for Livestock Producers Ethanol increases the likelihood of price spikes

40. 40 Increasing Market Volatility Means Managing Risk Will Be More Important In The Future Livestock Risk Protection Insurance: How Does It Work?

41. 41 LRP-What Is It? Livestock Risk Protection (LRP) InsuranceLivestock Risk Protection (LRP) Insurance LRP for feeder cattle available in NevadaLRP for feeder cattle available in Nevada –Provides protection against a decline in CME Feeder Cattle Price Index while you own cattle CME Feeder Cattle Price Index is a 7 day weighted average of cash feeder cattle prices across the U.S.CME Feeder Cattle Price Index is a 7 day weighted average of cash feeder cattle prices across the U.S.

42. 42 How Does LRP Work? To use LRP to protect against a price decline, –you would purchase LRP insurance for a particular set of cattle (# of hd. & ending wt.) –you must choose –Coverage Price (this is similar to an options Strike Price) –End Date (e.g., the date coverage ends) –Price you pay is known as LRP premium

43. 43Definitions Expected End Value Expected End Value A forecast of the CME Feeder Price Index on the insurance policys end date A forecast of the CME Feeder Price Index on the insurance policys end date Coverage Level Coverage Level The % of the expected end value covered by the policy The % of the expected end value covered by the policy

44. 44Definitions Coverage Price Coverage Price Level of protection provided by policy in $/cwt. Level of protection provided by policy in $/cwt. Expected End Value X Coverage Level = Coverage Price Expected End Value X Coverage Level = Coverage Price End Date End Date The date that coverage period ends for each contract The date that coverage period ends for each contract You selects weeks of coverage desired (within limits set by RMA-usually 13 to 39 weeks) You selects weeks of coverage desired (within limits set by RMA-usually 13 to 39 weeks)

45. 45 LRP Feeder Cattle Premium To calculate actual LRP premium you must know To calculate actual LRP premium you must know Number of cattle ready for market (weighing less than 9.0 cwt) on End Date Number of cattle ready for market (weighing less than 9.0 cwt) on End Date Target Weight per head Target Weight per head Ownership share in cattle Ownership share in cattle

46. 46 LRP Feeder Cattle Premium Insured Value Equals Insured Value Equals # of Head x Target Weight (cwt) x Coverage Price x Ownership Share (%) # of Head x Target Weight (cwt) x Coverage Price x Ownership Share (%) Total Premium Equals Total Premium Equals Insured Value x Rate Insured Value x Rate Producer Premium Equals Producer Premium Equals Total Premium minus USDA Subsidy Total Premium minus USDA Subsidy USDA Subsidy = 13% of Total Premium USDA Subsidy = 13% of Total Premium

47. 47 LRP Premium Calculation Example An operation has 100 head of feeder cattle on Aug. 16 An operation has 100 head of feeder cattle on Aug. 16 Expects to market the feeder cattle at a target weight of 7.00 cwt each in mid-November Expects to market the feeder cattle at a target weight of 7.00 cwt each in mid-November Insured share is 100 percent Insured share is 100 percent Assume Expected End Value (updated daily by RMA on its website) is $116.45 per live cwt Assume Expected End Value (updated daily by RMA on its website) is $116.45 per live cwt

48. 48 Premium Calculation Example Producer selects a coverage price which is a % of the Expected End Value published by RMA Producer selects a coverage price which is a % of the Expected End Value published by RMA Assume producer selects $110 per cwt. coverage price (e.g., 94% of RMAs Expected End Value) Assume producer selects $110 per cwt. coverage price (e.g., 94% of RMAs Expected End Value) For this coverage price, the rate is 0.6773% For this coverage price, the rate is 0.6773% The premium subsidy is 13 percent The premium subsidy is 13 percent

49. 49 Premium Calculation Example 100 head * 7 cwt = 700 cwt. 100 head * 7 cwt = 700 cwt. 700 cwt. * coverage price ($110) = $77,000 700 cwt. * coverage price ($110) = $77,000 $77,000 * insured share (1.00) $77,000 * insured share (1.00) = $77,000 Insured Value

50. 50 Premium Calculation Example $77,000 * rate of 0.006773 = $521.52 Total Premium $77,000 * rate of 0.006773 = $521.52 Total Premium $521.52 *.13 (subsidy) = $67.80 subsidy $521.52 *.13 (subsidy) = $67.80 subsidy $521.52 (total premium) minus $67.80 subsidy = producer premium of $453.72 = $0.65/cwt. producer paid premium $521.52 (total premium) minus $67.80 subsidy = producer premium of $453.72 = $0.65/cwt. producer paid premium

51. 51 Calculating Indemnity Indemnity is payable if actual ending price is less than coverage price Indemnity is payable if actual ending price is less than coverage price Calculate indemnity by: Calculate indemnity by: Multiplying number of head by target weight (in live cwt.) Multiplying number of head by target weight (in live cwt.) Subtract actual ending value from coverage price Subtract actual ending value from coverage price Multiplying total weight by difference between actual ending value & coverage price Multiplying total weight by difference between actual ending value & coverage price

52. 52 Indemnity Calculation Example Expected End Value for 13 weeks of coverage is $116.45 per live cwt. Expected End Value for 13 weeks of coverage is $116.45 per live cwt. Producer selects a coverage price of $110 per cwt. (e.g., 94% of Exp. End Value) Producer selects a coverage price of $110 per cwt. (e.g., 94% of Exp. End Value) Actual End Value is $97.77 per cwt. (e.g., CME Feeder Cattle Index = $97.77 on End Date) Actual End Value is $97.77 per cwt. (e.g., CME Feeder Cattle Index = $97.77 on End Date)

53. 53 Indemnity Calculation Example 100 head * 7.00 cwt = 700 cwt. 100 head * 7.00 cwt = 700 cwt. Subtracting actual ending price of $97.77 from the coverage price of $110 = $12.23/cwt. Subtracting actual ending price of $97.77 from the coverage price of $110 = $12.23/cwt. Multiplying 700 cwt. by $12.23/cwt = $8,561 Multiplying 700 cwt. by $12.23/cwt = $8,561 Multiplying $8,561 by insured share of 1.00 = gross indemnity payment of $8,561 Multiplying $8,561 by insured share of 1.00 = gross indemnity payment of $8,561 Net indemnity payment = $8,107.30 Net indemnity payment = $8,107.30

54. 54 Indemnity Calculation Example What happens if CME Feeder Index on End date = $112? What happens if CME Feeder Index on End date = $112? Subtracting actual ending price of $112 from the coverage price of $110 = neg. $2/cwt. Subtracting actual ending price of $112 from the coverage price of $110 = neg. $2/cwt. Therefore, no indemnity payment is made to producer Therefore, no indemnity payment is made to producer This is analogous to a feeder cattle put option that expires worthless This is analogous to a feeder cattle put option that expires worthless

55. 55 LRP Coverage Prices & Levels Price guarantees change dailyPrice guarantees change daily Premiums change dailyPremiums change daily Coverage available ranges fromCoverage available ranges from –70% to about 95% of Expected End Price, –Max guarantee generally less than 95%

56. 56Premium Premium quotes via RMAs Premium Calculator available on USDA-RMAs web site Premium quotes via RMAs Premium Calculator available on USDA-RMAs web site Premium must be paid on day LRP insurance is purchased for coverage to be provided Premium must be paid on day LRP insurance is purchased for coverage to be provided Rates available at Rates available at http://www.rma.usda.gov/tools http://www.rma.usda.gov/tools Under livestock reports Or use link on AgManager www.agmanager.info/livestock/marketing

57. 57 LRP Summary LRP protects against a decline in LRP protects against a decline in Feeder cattle price level as measured by CME Feeder Cattle Price Index Feeder cattle price level as measured by CME Feeder Cattle Price Index LRP does NOT guarantee the basis LRP does NOT guarantee the basis LRP does not guarantee a cash price LRP does not guarantee a cash price Policy does not cover any other peril Policy does not cover any other peril

58. 58 LRP Summary LRP Summary Insure the exact number of head that you choose Insure the exact number of head that you choose Flexible contract size matches small operations vs. Flexible contract size matches small operations vs. Feeder cattle futures that represents about 67 steers weighing 750 pounds Feeder cattle futures that represents about 67 steers weighing 750 pounds Live cattle futures that represents about 33 steers weighing 1200 pounds Live cattle futures that represents about 33 steers weighing 1200 pounds Can incrementally minimum price a few head at a time Can incrementally minimum price a few head at a time

59. 59 www.agmanager.info/livestock/marketing