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HUNTIN' DAYLIGHT -- SINKING AND SWIMMING

by: Wes Ishmael

Just before Hurricane Rita roared ashore, only a few weeks after her ugly sister Katrina walloped the Gulf Coast region in a record setting way, it was easy to make believe the cattle market was invincible.

BSE? No problem. The market took some lumps soon after the cow was discovered in December of 2003, and then promptly zipped back into hyperspace. By the time the first native-born case was discovered here last summer, it was as if the market didn't care; apparently consumers here were not concerned. Spun differently, consumers are confident the industry continues to place safe food on the supper table.

Limited beef exports, especially to the most lucrative pre-BSE markets? Who cares? Feeder calf prices were supposed to have peaked earlier this year, then by the middle of September, they were bumping record high levels again.

Obviously folks in the cattle feeding business have a different view of the export market, as high feeder cattle prices and dwindling fed cattle prices—still missing $10/cwt. or so from what could be if pre-BSE markets were in place—have sliced open new veins of economic loss.

Open up the Canadian border to live cattle? Whatever. The flood of market-crashing cattle predicted by industry chicken-littles has never materialized. Fed cattle younger than 30 months of age were already coming into this country via boxed beef. Increased packing capacity in Canada, increasing Canadian export market strength, increasing freight costs, the strengthening Canadian dollar: there just isn't the economic incentive for Canadian producers to ship feeder cattle south of the border, or for U.S. buyers to bid on them like there was before BSE.

The largest natural disaster in U.S. history? Notwithstanding the folks caught directly in the path of the storms whose lives have been irrevocably changed, the massive destruction has been positive to the cattle market, if anything.

Think of that. According to USDA, agricultural losses from Hurricane Katrina are estimated at $900 million. That's production loss. It doesn't account for losses to production infrastructure, personal losses and on and on. According to Risk Management Solutions, private sector insured losses from Katrina are expected to total $40-$60 billion; total economic losses are expected to exceed $125 billion.

Yet, the cattle market picked up some healthy steam between Katrina and the time Hurricane Rita blew in. That was due in part to speculation that already anemic grain prices would decline further with a corn crop projected to beat early USDA estimates—which would make it the second largest crop on record—and the predictions that disruption to grain shipping caused by Katrina would mean there could be piles and tons and silos of the stuff with no way to get it where it needs to go.

As well, speculation continues about damage to the poultry industry. If significant enough, poultry prices would rise, which in turn benefits beef.

The caveat to these short-term economic supports for feeder cattle prices has obviously been the run-up in fuel prices/freight costs. By many estimates, freight costs for long-haul cattle have increased a third or more during the past 18 months. Immediately following Katrina there were plenty of reports of freight costing $3 per loaded mile, a smooth 50-cent increase to what it was just before. Take a gander at the feeder calf prices in the Southeast and you start to get an idea of how much western buyers are discounting for freight. Still, those prices are historically high.

Calm Before the Storm

Undoubtedly, there are a passel of reasons for this historic paradox—the cattle market shrugging off so many sequential shocks—including renewed domestic beef demand that has increased 25% or so since 1998. A robust national economy hasn't hurt anything, either. But, supply-side fundamentals are surely at the root of it all.

The past 24-30 months have represented the proverbial perfect storm for sellers. The liquidation phase of the last cattle cycle started to look like the Energizer Bunny. Despite growing incentive to expand the national herd, Mother Nature's widespread drought kept the possibility in check for the longest time in history.

As supplies dwindled, domestic beef demand finally increased. So, here were more consumers willing to pay more money for more beef at a time when cattle numbers were declining. No, cattle numbers and beef production are not equivalent, and with fewer cattle the industry continues to churn out record and near-record beef supplies. But, along the way, the cattle feeding industry continued to consolidate. So, you had fewer cattle feeders with too much feeding capacity chasing fewer and fewer cattle in a market where consumers continued to boost demand and the price they were willing to pay for beef.

All of that was before Canada discovered its first case of BSE in May of 2003. When that happened, when the U.S. border was closed to both live cattle and boxed beef from Canada, when the U.S. had Canada's lost export market share all to itself, the market launched into orbit.

Bottom line, supply relative to demand has allowed producers to enjoy an extraordinary, historic—some would say once-in-a-lifetime—front row seat to profit potential.

That's what's so spooky about trying to chart the fledgling steps of the new cattle cycle. Reflecting about what led to the new price plain producers have achieved is a little like a classic bit from comedian Ron White. He tells about the illogic of some health nut a few years ago, who strapped himself to a tree as a hurricane approached, in order to prove that he was in good enough physical shape to withstand hurricane force winds. Reflecting on this person's ultimate demise, White explains, “It's not that the wind was blowin', it's what the wind was blowin'.”

In this case, it's not the fact that supply was dwindling, it's that supply was dwindling while demand was increasing. Now, it appears supplies will increase as consumers may find it more difficult to spend as much money on beef as they were, even if they want to.

It's not so much that the industry has been in an enviable position to weather these hurricanes and the man-made market shocks preceding them, it's how these natural disasters will ultimately impact the consumer piggy bank, which in turn can accelerate the beef industry toward the cyclically unwelcome downside.

Energy prices were obviously already threatening the nation's economic growth before Katrina came along. Even if the refineries and infrastructure in the Gulf resume operations quickly and at capacity, there's no reason to believe that consumers won't have to spend more money on gas, heating and cooling than a year ago.

Likewise, Hurricanes Katrina and Rita will probably increase prices in other areas—everything from construction supplies and services, to insurance and business travel. That's in addition to the money the nation and communities are spending to accommodate the hurricane aftermath, funds that either take away from other programs and services, or have to be recouped from the public in some way. In each case, that's more consumer money that won't be left for buying beef.

Moreover, when consumers do buy beef they may be paying more for it since rising fuel costs impact the production side of the business, too.

Of course, it's not like the cattle market should unravel anytime soon.

In the great scheme of things, the Livestock Marketing Information Center (LMIC) remained bullish on cow-calf profitability, saying, “Estimated cash returns for cow-calf operations in 2005 will remain high, but will retreat from 2004's record. The major factor squeezing returns will be higher production costs including fuel and utilities. Returns likely will erode further in 2006 and 2007.”

For perspective, in 2004 LMIC estimated net returns over cash costs at a record high $150 per cow. The previous high was $88 in 1987.

“In 2005, cow-calf returns will moderate. Calf prices for this fall are expected to be down slightly (this forecast was in June), and total cash receipts may decline nearly $10 per cow, or 2 percent. Driven by higher energy costs, per cow cash costs in 2005 are expected to be nearly $19 per cow above those in 2004 (up about 4 percent),” explains LMIC. “So, net cash returns per cow in the Southern Plains are projected to be just below $120 per cow in 2005. Still that will the second largest ever.”

Between increasing production costs and cyclically declining calf process, LMIC estimates annual cash return per cow at $40-$50 next year, and at just over $30 in 2007. If correct, this return to cyclical normalcy means a 140% to 200% reduction in cash returns per cow next year compared to what LMIC is forecasting for this year.

A return to more typical cyclical market forces, compounded by production cost increases at the hands of the impacts of Katrina and Rita have the potential to accelerate the transition from the high side of the price cycle to the declining side.

Supply bought the industry an amazing run in profitability. The only way to sustain it is to grow demand ahead of supply. Even disasters, natural or man-made, can't change these basic fundamentals.

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