Coming Up to Speed on Beef Demand
by Marcus Brix, CattleFax
Anyone who has listened to a CattleFax presentation in the previous 12 months will recognize the confluence of factors that were deemed to be the market’s “perfect storm.” Prices for beef, pork and poultry were elevated due to tight per capita supplies and stronger demand. Intuition would say higher prices should lead to demand destruction, yet since all of the competing meats were facing limited supplies, customers were willing to pay more for what was available. Retail beef demand increased 7 percent year over year in 2014 with a record-high annual average all-fresh retail price of price of $5.60 per pound. Fed cattle prices averaged $154 per hundredweight in 2014, which was up substantially from $126 in 2013. CattleFax estimates the feedlot sector made profit of roughly $200 per head at this price level. While both supply and demand were very supportive to profits last year, there is still an important piece missing from this discussion.
Cattle feeding is a margin business. The concept of cattle feeding is simple: buy a young steer or heifer, provide a high energy ration to grow them in size, and sell them when they’re at or close to slaughter weight. The cattle feeder is a price taker when selling their fed animals because of their location on the demand chain. The primary demand level in the beef industry is the consumer, they make the decision how much beef gets eaten and therefore how much beef the retailer needs to stock. The retailer demands product from the packer at the wholesale level. The beef processor’s need for supply becomes fed cattle demand and the feedlot is their supplier. It can be a tough market as there are a very limited amount of processors with which to negotiate price. There is limited amount of profit that can be squeezed out of the supply chain, and whoever has the leverage can collect a greater portion of that profit. In 13 of the last 25 years, poor leverage has actually lost the cattle feeder money, sometimes more than $5 per hundredweight on closeout prices. Very tight supplies of fed cattle typically lead to a strong leverage position for the cattle feeder, and this past year was a perfect example.
Leverage can be observed as a ratio of fed cattle price minus the drop credit, divided by either the beef cutout or retail beef price. Expressed as a percentage since 1990, the cattle feeder has received 22.4 percent of retail beef price for fed cattle. In the last year that ratio stretched to near record levels, averaging 24.7 percent. An additional 2.3 percent may not seem overwhelming, but on a per hundredweight measure that means $11.21 of the $28 per hundredweight year-over-year increase can be attributed to the cattle feeder holding more leverage. To put that in perspective, demand for fed cattle was up 16 percent in 2014 and the demand contribution to fed cattle prices only totaled $10.06 hundredweight.
As mentioned earlier, tight cattle supplies are favorable to the cattle feeder’s leverage position. In 2014, steer and heifer slaughter declined by 1.3 million head, the largest single year decrease since 2004 and the last case of bovine spongiform encephalopathy (BSE). The current forecast for slaughter in 2015 is down another 350,000 head with the largest declines in the first half of the year. It’s not until 2016 that slaughter should begin to increase year-over-year, thus a more established expansion. Thanks greatly in part to favorable weather in the plains regions, 2014 was a strong beginning to the expansion phase. The beef cycle, which historically peaks every 10 years or so, has entered the transition into a larger beef cow inventory. CattleFax data on beef cow slaughter, heifer retention, and the steer to heifer slaughter mix were the first signals that markets had entered expansion. The most recent USDA cattle inventory data released in January 2015 confirmed our beliefs and showed an increase of 600,000 beef cows, similar to the rate of expansion during the start of the 1990s expansion era. In the upward transition years, our current stage in the cycle, feedlot profits become larger. As the cow herd declined from 2010 to 2013, cattle feeders lost about $32 per head annually, then recovered losses in 2014. As the expansion nears its peak, feedlot profits slow to a neutral level.
Beef production will remain lower in the early years of the expansion phase. Current forecasts for annual beef production in 2015 totals 260 million pounds, a 1.1 percent decline. Our estimate for total meat production, however, is higher by 2.1 percent due to rapid production gains on the competing meat side. Both pork and poultry producers underwent their own expansion in 2014, and expansion in those industries greatly outpaces expansion in the cattle industry. This year’s forecasts are placing pork production up 2.4 percent at 540 million pounds and poultry production up 3.7 percent at 1.6 billion pounds. CattleFax also estimates, per capita, U.S. residents ate 199 pounds of red meat and poultry in 2014. That number is expected to increase to 204-206 pounds in 2015. With leftover trade disruptions from the resolved west coast port strike, and China/Hong Kong banning U.S. poultry imports, there is a lot of excess competing meat volume that the market will need to absorb, potentially between 500 and 950 million pounds. Stable demand for pork and poultry would result in deep price discounts for those meats. The cross-price elasticity for beef suggests price cuts for competing meats affects the price of beef very little, yet as the price ratios get too far out of balance the substitution effect must eventually come into play.
CattleFax currently estimates retail beef prices to average around $5.90 per pound in 2015 and fed cattle prices to average slightly higher year-over-year at $155 per hundredweight. With slaughter projected lower again this year, the cattle feeder should remain comfortable from a leverage position. The ratio thus far in 2015 suggests we will average around 24.2 percent of the retail price, down 0.5 percent from last year. Lastly, even with very large meat supplies from competing industries, expect fed cattle demand to remain stable throughout this year.
Tags: Beef Issues Quarterly, Issues Updates, Spring 2015
March 25, 2015