Gaining a grasp on price discovery issue

Elements of Price Discovery

Part one of a series on understanding and addressing Price Discovery

from the California Cattlemen's Association Price Discovery Subcommittee

In order to understand the elements of price discovery, we first have to look at the type of transactions prevalent in today’s live cattle trade. USDA recognizes four unique trades in their Livestock Mandatory Reporting system, and it is these four that we will focus on.

Negotiated Price – Mutually agreed upon price negotiated prior to delivery. Example: Steers sell at $120 per hundred pounds (cwt.)

Negotiated Grid – Mutually agreed upon price negotiated prior to delivery with grid incentives or deducts applied. Example: Steers sell at a base price of $120/ cwt and premiums would apply for yield greater than 65 percent, Choice-Prime greater than 80 percent, etc. and possible deducts for yield grade 5.

Forward Contracted – Price based on futures market on or near delivery. Example: Steers sell for delivery in third week of August at $1/cwt over the August Live Cattle Futures Price.

Formula Price – Delivery occurs prior to pricing, typically uses the USDA 5 Area Weekly published price for week when cattle are harvested and grid incentives or deducts applied. However, the price is not published until after the harvest/delivery has occurred. Example: Steers for delivery this week, receive premiums for grid (i.e. yield, Choice-Prime percentage, etc.), and the base price for the transaction is not known until next week when the USDA publishes the National Weekly Cattle And Beef Summary Report. Formula pricing is frequently referred to as Alternative Marketing Arrangements (AMAs).

So then after understanding the basic trade mechanisms, what is meant by price discovery? That is not an easy answer. The beef industry tends to incorporate many different elements under the umbrella of Price Discovery. These elements are best categorized as follows:

Consolidation – Regulations in food safety, employment laws and environmental arenas have rewarded conglomerates who can allocate the resources necessary for compliance. Overtime, the four largest packers have evolved to control 80 to 85 percent of the live cattle market. There is no doubt regulations are the main force monopolizing the packing industry and we will continue to see increases in consolidation with today’s regulatory environment.

Supply and Demand – Remember the supply-demand curve from your first economics class? Well for the past two years we have seen peak supplies. Originally the industry was set to work through a huge influx of cattle on feed or “wall of cattle” in 2020. Then with the onset of COVID-19, packing plants were forced to decease harvest capacity as their large labor forces dealt with the effects of a pandemic. COVID-19 forced specialized laborers to stay at home and slowed chain speeds throughout the plants to address worker separation requirements and so on. More cattle continued to enter the system during this time and yet “hook space” was not available for the cattle already on feed. Luckily the forecast is to bring supplies current in 2021 and with drought prevalent in much of the United States we will quickly transition away from the over-supply situation.

Lack of Robust Cash Trade – As the industry trends toward formula transactions, the economic fundamentals that lead to “Price Discovery” are lost. Four main elements contribute to the weekly change in live cattle pricing: change in boxed beef cutout values, change in Live Cattle Futures, change in prior week cash prices and size of the trade (large lots bring premiums). The problem arises from “change in prior week cash price” where very little cash trade actually exists, and thus no new information enters the system. Nationally in 60 percent or more of the live cattle transactions price is not known at the time of the sale and the seller becomes a “price taker.”

Transparency – Larger packers (those who harvest 125,000 head or more annually) are required by USDA to submit their transactions twice daily. USDA then compiles the data, often omitting portions of the data due to confidentially clauses and publishes daily and weekly reports under the Livestock Mandatory Report Act. Confidentiality clauses exist to prevent the reverse engineering of transactions and identification of competitor bids. Lack of transparency also exists because formula trade becomes the “carry all bucket” for trades not clearly defined as negotiated, forward contract or negotiated grid.

Convergence – In a model where feeders trade exclusively with one packer, that packer inherently knows their supply numbers much more so than the public who

rely on the USDA Committed Cattle Reporting. Therefore, packers have insight of “cattle on feed” above and beyond the balance of the industry and price cattle (or establish the “cash market”) with knowledge independent of the future market. Such a model contributes to the lack of convergence between the live cattle cash market and futures market. Due to the involvement of significantly more entities in the feeding sector, convergence is much more likely to occur with the feeder cattle futures market.

So then how do we address price discovery? To do so we first need to understand the trade organization’s role in the process. With the big four packers controlling 80 to 85 percent of live cattle market, no single producer or entity has enough of a voice or market share to influence the process and even if they did, more than likely they would suffer some sort of retaliation. Therefore, this is an issue best spearheaded by a trade organization, and for those of us in California, that would the California Cattlemen’s Association.

Next, we need to look at the tools available to CCA. Those come in the form of supporting or opposing existing regulation, identifying a legislative sponsor and putting forth for new legislation, or working directly with the industry for a non-legislative fix. Since CCA is a state level trade organization and price discovery is a national issue, we channel our lobbying efforts through our national affiliate the National Cattlemen’s Beef Association (NCBA). Similarly, a legislative sponsor would be pursued at the national level rather than through the state.

However as, with any of the legislative approaches, be careful what you wish for. As even the best of intentions often become convoluted through the amendments process. In the second article in this series on price discovery, we will take a detailed look into the proposed legislative bills, President Biden’s Executive Order and the Department of Justice’s ongoing investigation. However, for now we will focus on the non-legislative approach. This approach requires an understanding of how different segments of the beef industry benefit and suffer from insufficient price discovery. An Alternative Marketing Arrangement (AMA) that mitigates risk for the feeding sector can be viewed negatively from the eyes of a cow-calf producer and yet without a stable feeding sector calf prices could be further suppressed. Or an AMA might send quality signals back down the supply chain in the form of a branded beef program.

No one has yet come up with a comprehensive cureall approach, although we have seen significant progress addressing one or more of the price discovery elements. For instance, NCBA formed a working group comprised of ranchers throughout the country who collectively conceived the framework for the 75 percent of Robust Cash Voluntary Program often referred to as the “75% Rule.” We are now in the third quarter of this program with measurable results.

Also on Aug. 8, 2021, USDA announced the publication of two new reports, the National Daily Direct Formula Base Cattle Report and a National Weekly Cattle Net Price Distribution Report. Both reports are aimed at addressing the transparency component of price discovery. Similarly, as the beef cycle transitions away from an over-supply of cattle on feed we will see the supply-demand curve move to a more favorable position for producers.

Look for the second article in this price discovery series in a future issue of the California Cattleman where we will give an update on the proposed legislation (i.e. Sen. Deb Fischer’s Cattle Market Transparency Act of 2021 and Sen. Chuck Grassely’s 50-14 bill), President Biden’s July 7 Executive Order targeting consolidation and the ongoing Department of Justice investigation into market-disruptive beef packing plant closures.