HUNTIN' DAYLIGHT -- PLENTY OF OPPORTUNITY AND RISK

by: Wes Ishmael

Welcome rains spawned by Hurricane Isaac are shining a brighter light on the opportunity to add pounds to cattle outside the feedlot this fall and winter.

The staggering level of harvested feed costs means that feedlot cost of gain is running clear past $1 per pound. According to the August Focus on Feedlots survey from Kansas State University, feedlot cost of gain is projected at $1.10-$1.13/lb. (basis steers) between September and the end of this year. Net returns for July (the most recent available were projected at -$290.98 per head and -$278.50 per head for steers and heifers respectively.) Keep in mind those net returns are on a cash-to-cash basis and cannot account for risk management utilized by feedlots.

Also, keep in mind those projections are for Kansas feedlots. Feed costs and projected cattle feeding losses increase exponentially for those located further away from grain supplies.

Consequently, stocker Value of Gain (the gross sale price of a head of cattle minus the gross purchase price, divided by the pounds of gain) is also, generally speaking, more than $100/cwt., meaning that the market is offering incentive to put more pounds on cattle outside the feedlot.

Derrell Peel, extension livestock marketing specialist at Oklahoma State University explains value of gain averaged around $55-$60/cwt. between 1992 and 2006. It has hovered around $100 since then; well north of that in many cases.

“I think the drought may be exaggerating that a bit currently, but I think the overall incentive to put weight on cattle outside of the feedlot will continue to be there going forward,” Peel says. “It means lots of opportunity for people who control forage.”

In early August, Stan Bevers, an extension agricultural economist with Texas AgriLife ran a budget for fall stockers on wheat pasture. With pasture cost of gain penciled in at $60/cwt., the value of gain was staggering.

At the end of July Peel offered the following example: Steers weighing 525 lb. were averaging about $140/cwt. in Oklahoma. Adding 225 lb. at 1.5-2.0 lb./day would generate a 750 lb. steer by November. The November Feeder Futures price at the time was $144.90/cwt. With a zero basis the gross margin was roughly $350/head or a value of gain of $1.56/lb.

“The extent to which this is a good market opportunity depends on the cost of production but even with relatively expensive feed costs, a cost of production well under this value of gain is likely,” Peel explained.

More recently, Peel noted that the market is favoring stocker cattle started at heavier weights and shipped at heavier feeder weights than what many would consider the norm.

“If the current price patterns persist, the traditional four-weight steer has a very low value of gain for the first 200 lbs. of gain that is only partially overcome if the animal is grown to heavy feeder weight,” Peel says. “By contrast, a heavier beginning weight of 575-625 lbs. has a value of gain well over a dollar a pound from the beginning of stocker production. With typical winter gains (OK wheat pasture), these animals will be marketed from 800-850 lbs. in the spring.”

Likewise, Andrew Griffith, agricultural economist at the University of Tennessee pointed out in his weekly Livestock Comments September 7, “…The larger increase in lightweight feeder cattle prices relative to heavier feeder cattle has caused a larger spread that narrows the profit margin when feeding lightweights to heavier animals. There may be an opportunity to purchase middleweight feeder cattle and market them heavier than normal and not be squeezed by the price slide.”

As Peel mentions, the current opportunity is not for everyone. Besides the inherent production, equity and price risks, there's plenty of marketing risk for folks who can't offer the resulting feeder cattle in load-lots.

Value of Gain Should Remain High

With that said, high value of gain should continue to be part of the market landscape.

There are the tight cattle supplies, for one thing.

USDA analysts explained in the August Livestock, Dairy and Poultry Outlook (LDPO) that feeder cattle supplies throughout 2012 have been the lowest since that particular data series began in 1995. Those supplies have averaged 3.37 percent less year-over-year for every quarter this year.

Moreover, there's no reason to expect competition for corn to fade away.

In last month's column I mentioned the fallacy of the nation's policy of locking food prices with energy prices via the Renewable Fuels Standard (RFS) and mandated ethanol production using corn. Then and now, lots of folks are demanding that the mandate be waived or at least reduced in light of this year's drought-decimated crop.

Based on a couple of different studies, apparently a waiver would make less difference than logic suggests.

“…If U.S. ethanol consumption were somehow banned, then U.S. corn prices would drop to an average of $2.67 per bushel,” said Bruce Babcock, Cargill Chair of Energy Economics at Iowa State University. “But there is no mechanism for implementing a ban on corn ethanol production. The only tool that the U.S. government has at its disposal to lower corn prices is to waive the mandate.”

Babcock conducted a July study on the impact the current drought would have on crop and bio-fuel prices. He conducted it again with the lower corn productions estimated in the August World Agriculture Supply and Demand Estimates. Part of that explores the impact of a waiver for the RFS.

“Two findings stand out,” Babcock says. “The first is that the flexibility built into the Renewable Fuels Standard allowing obligated parties to carry over blending credits (RINs) from previous years significantly lowers the economic impacts of a short crop, because it introduces flexibility into the mandate. The 2.4 billion gallon amount of flexibility assumed in this study lowers the corn price impact of the ethanol mandate in this drought year from $2.49 per bushel to $0.58 per bushel. This means that waiving would lower corn prices by about 7.4 percent.

“The second finding is that if the current price of ethanol relative to gasoline accurately reflects the value of ethanol to blenders, then the price of ethanol will be supported at quite an attractive level as long as ethanol quantities are not pushing up against the blend wall. This implies that ethanol plants will be a strong competitor for corn even without a mandate…”

Similarly, a study from Purdue University also suggests corn prices would not necessarily moderate if the federal government's corn ethanol mandate were temporarily suspended.

The report, Potential Impacts of a Partial Waiver of the Ethanol Blending Rules, suggests that corn prices could fall under some scenarios should the U.S. Environmental Protection Agency grant a partial waiver of the corn ethanol provision of the RFS, but only under certain market conditions.

“The range of impact of an RFS waiver goes from zero to $1.30 per bushel for corn,” says Wally Tyner, a Purdue University energy policy specialist and the report's lead author.

In the Purdue study, Tyner, along with fellow agricultural economists Chris Hurt and Farzad Taheripour, looked at future corn and ethanol prices with and without an RFS waiver, how RINs and crude oil prices could factor in ethanol use, and what might occur if the drought worsens.

“If corn prices remain high, which seems likely, and crude oil remains at $100 a barrel or lower, then reducing the RFS could reduce the demand for ethanol and, consequently, the demand for corn,” Tyner says. “If the waiver resulted in less demand for ethanol that would, in turn, lead to lower corn prices than would have existed without the waiver. It also could lead to more ethanol plant closings - at least temporarily.”

Conversely, an EPA waiver could have little effect if crude oil moves beyond $120 a barrel and oil companies continue blending ethanol at current levels, Tyner says.

Under its normal schedule the EPA has until October to gather information on the extent of any economic harm done by the original RFS level and to decide if it will issue a waiver. For consumers, the decision could affect what they pay for fuel and food.

Should a waiver lead to reduced ethanol use, the EPA could have an influence on who bears the brunt of the drought-related corn losses, Tyner says.

“The total amount of harm from the drought is in the tens of billions of dollars,” Tyner explains. “The EPA cannot change the loss. It can only potentially redistribute it among the affected parties: ethanol producers, livestock producers, corn growers, and domestic and foreign consumers.”







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