Can Beef Export Gains Outpace Corn Fundamentals?
By Gregg Doud, National Cattlemen's Beef Association Chief Economist
Outlook articles can be fun to write when the number of variables and influences that could potentially be affecting the cattle market is limited. They’re much tougher when the variables are so vast that it is nearly impossible to sort the wheat from the chaff.
Commodity analysts typically like writing longer-term outlook pieces this time of year because those who care enough to read such things understand that new variables enter into the pictures of agricultural commodity pricing each day and that the predictions made probably need to be quickly forgotten. In such articles, it is customary to simply list the major topics of the day along with the traditional economists’ exercise of describing ‘one hand’ of the issue followed by ‘on the other hand.’ [Insert joke about one armed economists here.] Nonetheless, here it goes.
The effects of 9.8% unemployment on disposable income and U.S. consumers’ willingness to eat out are not hard to grasp. Historically, nearly 50% of U.S. beef consumption has occurred outside of the home. In fact, hotel and restaurant demand remains a key driver of overall beef demand. This category has struggled mightily since 2008 and is a key reason why wholesale prices for middle meats (steak) have struggled but this may be about to change. The National Restaurant Association’s Restaurant Performance Index in October was pegged at its highest level since September 2007 with both sales and traffic levels improving. Optimism is high in this industry at the moment and this bodes well for beef demand in 2011. On the other hand, the housing sector continues to struggle mightily and projections for Gross Domestic Product (GDP) growth in the 2-2.5% range suggest it could take years for unemployment rates to decline. State and local government budget outlooks, particularly for California, are also a factor that bears close attention in the coming months.
Cattle-Fax has calculated the price of lost export market access in the cavernous wake of BSE (bovine spongiform encephalopathy) since December 23, 2003, has been 13.5 billion pounds of U.S. beef. It is impossible to know exactly how much these additional sales opportunities have cost beef producers. However, it is certainly the case that the loss of export market access has reduced the number of cattle fed as well as the demand for feeder cattle and cows over the past seven years. These lost exports have cost everyone in the beef industry dearly and they’re still costing us today. We still cannot export beef to China, and Japan’s 20-month age restriction limits us to roughly 30% of our potential into that market.
Recent Cattle-Fax estimates suggest that increasing Japan’s age restriction to 30-month access could be worth as much as an additional $60 per head on each and every head of finished cattle produced in the United States. The good news is that the U.S. government is trying. The Obama Administration’s effort to finally seize control of its trade agenda by grabbing hold of the Korean free trade agreement (FTA) after being stuck for more than three years between completion and congressional ratification has been an incredibly encouraging sign. We’ve also seen attempts to engage China and begin a dialogue with Japan on beef market access, but it is impossible to know how long into 2011 it could take before such efforts bear fruit. For the beef industry, the mere mentions of China or Japan are associated with frustration and a sense of helplessness. This frustration then turns into an empty pit in the stomach of ranchers who contemplate what might have been when considering that in 2010, the United States could potentially export an all-time record in terms of dollars of beef and beef variety meats, exceeding the $3.86 billion level reached in 2003. This is remarkable considering that we’re leaving at least $1 billion in business on the table that we’re not able to do with just Japan and China alone.
The global meat marketplace has changed dramatically in seven years, and despite the shortcomings in Japan and China, the United States has expanded beef exports dramatically in markets that hardly existed seven years ago, including Russia, the European Union, Egypt and several other Asian markets like Taiwan, Hong Kong, Indonesia and the Philippines. Short plates, outside skirts, bone-in short ribs and chuck rolls to Asia and rounds to Russia have been a tremendous driver of beef prices in 2010 with strong Asian economies and a weak U.S. dollar clearing the path. This will undoubtedly continue in 2011 with the drop credit also playing a strong supporting role.
A potentially historic situation may also develop in 2011, in which the United States could become a net exporter of beef for the first time in history. A weak U.S. dollar is helping the competitiveness of all commodities the U.S. exports. However, at the same time, the weak dollar is also making the U.S. a poorer destination for beef exporters around the world. The United States is now seemingly a market of last resort for exporters of lean (manufacturing) beef. A dollar-for-dollar exchange rate with both the Canadians and Australians will depress imports, particularly from Australia. Even more remarkable, Brazilian beef, in U.S. dollars, is considerably more expensive than the U.S. cull cow cut-out value due to the value of the Brazilian Real versus the dollar coupled with very strong domestic demand for beef in Brazil due to their growing economy. The result: Cattle-Fax projects an average price of cull cows in 2010 of around 60 cents per pound.
Cow Slaughter/Herd Rebuilding
We’re not retaining heifers, and we’re not expanding the herd so it’s no wonder we’re culling cows with seemingly reckless abandonment given the prices offered for old momma cows. In fact, U.S. beef cow slaughter is currently a whopping 10% above last year, meaning we could have 600,000 fewer beef cows in the herd on Jan. 1, 2011, than we had the previous year.
How do we change this trend? Or, maybe more appropriately, how will producers really know when it’s really time to expand? This question has been all the rage amongst beef industry pundits in recent months and it will undoubtedly continue as one of the hottest topics in 2011. Here is but a brief list of the factors that go into this equation:
- Higher input costs associated with the biofuels/commodity boom;
- The ongoing conversion of untold acres of grazing land into cropland due to higher crop prices;
- Higher hay prices for the same reason;
- Uncertainty created by government regulation and tax policy;
- Access to credit (and other associated barriers to entry);
- The age of many producers who no longer have any desire to mess with heifers at calving time(one could also refer to this as a labor issue);
- A soft U.S. economy that has weakened beef demand and muted the delivery of any sort of game-changing economic (price) signal to cow-calf producers to forego current cash flow in favor of better returns in the future; and
- Bankers are telling producers they want cash now instead of investment in expansion now and cash later.
While the answer to this expansion question is as vast as the number of business models in this industry, the incentive to expand can also be summed up into one word: Profit. Cattle-Fax suggests that the price signal necessary to tip the scales toward expansion is around $135-140/cwt basis a 550 pound calf. We were a long way from that for most of 2010, but in the weeks leading into 2011, the market has changed in a big way and this price point signal
certainly could be triggered in the coming year.
A recent editorial noted that when the federal government in Washington wants to support something they mandate its production, subsidize it or protect it via tariffs on imports and that the U.S. ethanol industry has the unique distinction of receiving all three. Despite rumors of austerity as the 111th Congress concludes its historic plunder of the treasury, ethanol subsidies will be alive and well in 2011 and likely beyond. The potential move to a 15% blend mandate scenario may not have an immediate impact on corn demand, but it could certainly mitigate the blend wall issue and extend for years to come the upward sloping trend line in corn use for ethanol. This suggests that growth in corn use for ethanol will continue unabated as it approaches the five billion bushel mark in the coming year compared to 4.8 billion bushels in the current crop year. With current oil prices hovering around $90/barrel, ethanol producers should remain profitable until corn reaches roughly $6.25-$6.50 per bushel and it could take prices higher than this in order to actually ration corn demand.
Thus one of the dominant factors affecting feeder cattle prices in 2011 will actually be whether or not the United States will be able to produce a record corn crop in 2011 to prevent a reduction in corn stocks to a level that will set alarm bells off all around the globe. U.S. corn is expected to account for 53% of world corn trade during the current crop year. With U.S. corn stocks tight, any unexpected demand from China due to their growing livestock and industry demand for corn or unforeseen circumstance in Brazil, Central Europe or Russia could be potentially explosive to corn prices. Any U.S. weather concern in the spring or summer of 2011 could actually be a key indicator of profitability for the cow-calf producer or feedlot next year. After USDA’s historic head fake with the ample September 30 stocks report followed by an astounding decrease in production released with its October crop report only days later, analysts are currently pegging corn ending stocks at anywhere from 500 million to more than one billion bushels. USDA is in the middle of this range at 832 million bushels, which is considerably below the one billion bushel comfort zone. The point is that there is strong potential for a significant amount of volatility to be introduced into the cattle feeding sector in 2011 and this could lead the cow-calf sector to yet again decide against expansion in the coming year.
It is hard to understate how important it is for the beef industry to not experience some sort of mishap with the 2011 U.S. corn crop. The impact of higher costs per pound of gain in the feedlot no longer only affects the price of feeder cattle. The influence of ethanol coproducts in Nebraska and the Midwest under a “high” corn price scenario also has the ability to influence basis levels for fed cattle via changes in regional utilization rates for feedlot and packing capacity.
This places more focus on the influence of the La Niña weather pattern currently entrenched across North America. Fortunately for the cattle industry, while La Niña suggests significant dryness across the hard red winter wheat belt, history would suggest that trend-line yields for corn are more the rule than the exception during La Niña years. The downside is that it has created poor conditions for traditional winter wheat grazing programs. La Niña is already creating unusual weather around the world, which is also affecting crop conditions for wheat and oilseeds.
By early spring, everyone will be sick of hearing about the ‘battle for acreage’ between corn and soybeans and this time around we’ll probably need to throw in cotton and wheat for good measure. The U.S. soybean balance sheet is already ‘tight as a tick’ due to China’s seemingly insatiable demand. Just weeks into the new crop year, China has already procured 23% of the entire U.S. soybean crop. It is no wonder ‘beans in the teens’ is the theme. Add in a little adverse weather for Brazil and Argentina at some point and yet again, market volatility will reign supreme.
Can beef export gains outpace corn fundamentals? Will key price points for feeder cattle be triggered that induce expansion? Fortunately, it appears that the answer to both of these questions could be “yes” in 2011 and that suggests there is reason for considerable optimism about the beef industry during the year ahead. Continued growth in exports and improving domestic demand should mean profits for all segments of the industry most of the time in
2011, assuming the corn market doesn’t blow us out of the water.
On the other hand, there are several government related variables that require very close attention in the coming months. Environmental issues, the proposed Grain Inspection, Packers and Stockyards Administration rule, ethanol policy and taxes are but a few of the issues that come to mind. It would also be a fantastic present at some point in 2011 if these long lost beef export market access issues were resolved, particularly with China and Japan. On the other hand, there is currently considerable concern that an inability to solve the NAFTA trucking issue with Mexico could lead to sanctions in the form of tariffs on U.S. beef as has occurred with so many other agricultural exports to Mexico in recent months.
Wildcards aside, the value of the dollar and sustained economic growth in the U.S. and around the world bode well for beef demand in 2011. Yet it is clear that with today’s higher cost structure, higher calf prices are required to spur investment in the form of heifer retention to rebuild the U.S. beef cow herd. Market watchers will focus on these deferred live cattle futures contracts throughout 2011 to provide this signal. Of course cattle prices must also remain competitive with pork and poultry for a consumer dollar that will likely remain quite cautious in the coming year.