1 / 18

Retained Ownership-Value Added

Retained Ownership-Value Added. John Marsh Professor Department of Agricultural Economics and Economics Montana State University July 2006 M ontana B randed B eef A ssociation. Preface.

chen
Download Presentation

Retained Ownership-Value Added

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Retained Ownership-Value Added John Marsh Professor Department of Agricultural Economics and Economics Montana State UniversityJuly 2006 Montana Branded Beef Association

  2. Preface The following analysis illustrates the potential to hedge the base price in value-based or grid pricing of fed slaughter cattle. Producers face numerous risks when retaining ownership of calves for finishing purposes. Producers with high quality fed cattle can improve their returns using grid pricing because of premiums paid, which, on balance, may provide higher returns than those based on average pricing of fed cattle. As live (fed) cattle prices vary, so do base prices in the grid formula. The following demonstrates the potential to cross hedge the grid base price using the live cattle futures contract. The prices and costs used in the analysis are based on those observed in the cash markets and futures markets in July 2006. As of November 2006 these prices have substantially changed. Producers should be able to substitute their own prices/costs in the worksheet formulas for personal evaluation of retained ownership decisions. Assumptions used in the analysis could describe a typical operation, but they will vary according to individual producers.

  3. Alternatives Cow-Calf Producers • Sell-calves (weaning) • Retain-background (lighter calves) • Retain-finish (heavier calves) Sell fed cattle liveweight or on the grid (value based)

  4. Breakeven Analysis • Breakeven (BE) sale price of feds, liveweight basis: • Futures hedge price greater than BE sale price is return to ownership including risk. • Breakeven (BE) buy price of feeder calves: • Market feeder calf price less than BE buy price indicates potential returns to retained ownership.

  5. Risk Factors • Occur because of changes in market demand, supply, and stochastic factors. • Variance in prices of fed cattle, feeder cattle, and feed (Figures 1 & 2). • Feedlot rate of gain.

  6. Risk Factors, cont. • Quality and yield grade performance • Variance in carcass and boxed beef prices—relationship to grid base.Manage risk through contracting and futures/options.

  7. Hedging Sale Price • Use live cattle futures to directly hedge liveweight sale of feds. • Use live cattle futures to cross hedge grid base price of carcasses (if possible). • Requires high correlation between live cattle futures price and beef carcass price. • Correlation coefficient of 0.90 (Figure 3).

  8. Example of Cross Hedge • Wean calves November 2006, background/finish calves until following June 2007 (205 days) • Beginning weight = 575 lbs.Ending weight = 1,200 lbs.Rate of gain/day = 3.05 lbs. • Cost of gain = $0.54 lb x 625 lbs gain = $338/hd (background and finish) • Use live cattle futures contract, choice grade cattle.

  9. Example of Cross Hedge, cont. • Projected grid base sale price:Pfutures June 2007 = $84.00/cwt+ expected basis = - 2.50/cwt $81.50/cwt (liveweight) Carcass base price = $81.50/cwt ÷ 0.64 dress yield = $127.35/cwt • Your basis and dress yield may differ.

  10. Example of Cross Hedge, cont. • Projected grid revenue:$127.35/cwt (base) + $5.00/cwt premiums = $132.35/cwt $132.35/cwt x 7.68 cwt (weight of carcass) = $1,016.45/hd or carcass • Your expected premiums may differ.

  11. Example of Cross Hedge, cont. • Breakeven Analysis: feeder calf price TR = TC (total revenue = total costs)$1,016(TR) = Pfeeder x 575 lbs (feeder calf cost) + $338 (cost of gain)Solve for breakeven feeder price:

  12. Example of Cross Hedge, cont. • Thus, if market price of calves in November is less than $118.00/cwt, consider retained ownership. • For example, if market price was $110.00/cwt, then retained ownership return is $118.00/cwt - $110.00/cwt = $8.00/cwt.$8.00/cwt x 5.75 cwt (weaning weight) = $46/head expected return to ownership and risk • Would like to protect this $46/head through cross hedge, if selling on the grid.

  13. Hedge the Base Price • In November 2006, sell June 2007 live cattle futures (JF `07) = $84.00/cwt • Early June 2007 offset (JF `07) = $79.00/cwt $ 5.00/cwt profit • Futures cattle price declined $5.00/cwt in this example. Perfect correlation says carcass base price declined $5.00/cwt ÷ 0.64 = $7.80/cwt. Imperfect correlation results in a spread difference, however. • Assume constant basis. Ignoring hedge costs here (commission and interest on margin).

  14. Hedge the Base Price, cont. • This $5.00/cwt profit on futures amounts to a $7.80/cwt protection on the grid. • That is, with near futures price:$79.00 JF `07 - $2.50 basis = $76.50/cwt local fed price$76.50 ÷ 0.64 dress = $119.50/cwt carcassgrid $119.50/cwt carcass grid + $7.80/cwt protection = $127.30/cwt hedged carcass base price. • If $5.00/cwt premiums, then hedged $46/head.

  15. Summary • If futures price increases still lock in the $127.30 carcass base price with near perfect correlation. • Problems occur with weak correlation between live cattle futures and beef carcass price since spreads can work against you. • Because of possible price increases, some might buy put options (hence, establish a floor with potential upside price gain). • Value to producer of feedlot performance and carcass data information.

More Related