Optimal Risk and Production Management with Record Cattle PricesMon, 11 Aug 2014 11:06:43 CDT
Derrell S. Peel, Oklahoma State University Extension Livestock Marketing Specialist, writes in the latest Cow/Calf Corner newsletter
Record high cattle prices leads to new questions about risk and production management. Actually, the questions are the same but the answers may be slightly different. High cattle prices have significantly increased capital requirements for stocker cattle, feeder cattle in feedlots or breeding animals for cow-calf production. The large dollar requirement means that overall financial risk is higher now in the cattle business. Market (price) risk and production risk are both important components of financial risk.
High cattle prices lead naturally to concerns about market price risk. The need for price risk management depends on several factors, including the producer's financial vulnerability and capacity to handle price volatility. Overall market outlook is also an important consideration. Short run market volatility is always a concern and, at current market levels, a modest market correction could mean price changes of $10 to $30/cwt. depending on animal class. However, underlying market fundamentals suggest that prices are likely to generally stay strong or move higher for the next couple of years and downside market risk as a trend will be generally low. In this environment, minimum price tools, such as Put options or Livestock Risk Protection (LRP) contracts, are likely more preferred to fixed price tools, such as futures hedging or forward contracting. However, adding a call option to a short hedge or forward cash contract will also maintain upside market potential while providing minimum price protection. Price volatility is likely to be short lived in the current market and production agility which provides flexibility in marketing animals can also be an important means to counter short term price volatility. At some point, markets will top and market price risk management with more downside risk will take on renewed importance but that time appears to be many months away at this point.
A relatively bigger concern today than protecting market price is making sure that you have something to sell. Production risk is a big part of financial risk at this time as things like death loss and reduced productivity have significantly larger financial impacts. Though death loss always causes loss, there is an optimal level of death loss which is not zero because the marginal benefit of reducing (or attempting to reduce) death loss below a certain point is less that the marginal cost. However, high animal values today suggest that additional measures to reduce death loss (or at least reduce the probability of animal death) are warranted. For example, enhanced use of metaphylactic treatment of animals in some situations or additional labor to detect sick animals and treat more aggressively may be worth the additional cost. Generally, higher animal values suggest that increased marginal expenditures on inputs to ensure animal health and productivity may be economical. Also animal theft is on the rise because of high animal values and additional expenditures on security measures are warranted. Perhaps additional means of animal identification or security should be used or more frequent checking of animals can reduce the risk of theft or increase the chances of recovering stolen animals. One stolen calf would buy a nice security camera.
Likewise, for the cow-calf herd, additional measures to enhance reproductive productivity are justified by high animal values. For example, additional expenditure to ensure cow body condition at breeding resulting in some increase in pregnancy rate and calving percentage may be worth evaluating. There are many other examples of adjustments in production that can increase benefits or reduce the risk of losses. For example, the value of fertility testing bulls, or stated another way, the cost of not fertility testing bulls is much higher today than with lower calf prices.
There are a multitude of marginal adjustments in production practices to take advantage of high animal values or reduce the risk of losses or lost opportunities. This is not time to operate with old rules of thumb. Economic theory is clear; when the value of the output increases, more use of inputs is consistent with profit maximization. Producers need to evaluate all aspects of production systems to identify ways to tweak their production system to enhance profitability.
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