Canada s Independent Agri-Food Think-Tank. Analysis of the Cattle and Beef Markets Pre and Post BSE Final Report to the Competition Bureau

Transcription

1 Canada s Independent Agri-Food Think-Tank Analysis of the Cattle and Beef Markets Pre and Post BSE Final Report to the Competition Bureau Kevin Grier Senior Market Analyst George Morris Centre February 2005

2 Table of Contents Executive Summary... 3 Pre-BSE Industry Overview... 3 Post BSE Analysis... 4 Discussion of Pricing Rationale and Packer Profits... 5 Introduction... 7 Purpose of the Project... 7 Objectives... 7 Part I: Cattle and Beef Industry Overview Definitions, Terminology and Industry Measures Defining Common Industry Terms and Measures Cattle and Beef Industry Value Chain Identification of Industry Operations and Their Functions Composition and Geographic Distribution of Cattle Inventory Identification of Revenue and Cost Generators in the Value-Chain Marketing Channels Canadian Cow Marketings Cow Inventory Canadian Trade in Cows and Bulls Canadian and US Cow Slaughter Cow Marketing Totals Summary of Section Cow Beef Industry Competitive Analysis Commercial Beef Processing and Challenges in Canada Marketing Commercial Beef Summary Points Cow and Commercial Beef Price Determination and Price Discovery Commercial Beef Pricing Summary Points Cow Slaughter and Capacity in Canada Summary Points Conclusions Beef Markets and Marketing Canadian Beef Exports Canadian Domestic Beef Market Packing Industry Rationalization and Concentration in Canada Summary of Section Seasonality, Cycles, Price Relationships and Price Discovery Seasonality and Cycles Cattle Price Determination and Discovery Cattle and Beef Pricing Through the Supply Chain Cattle Pricing Relative to the United States Boxed Beef or Wholesale Pricing Relative to the United States Price and Supply Relationships in the Cattle Industry Summary of Section Part II: Economic Analysis of Pricing and Production Impacts of Key Events Post-BSE Cattle and Beef Markets Post-May

3 7.1 Initial Situation Overview May 20-Mid June Live Cattle Exports Live Cattle Marketing and Backlog Beef Exports Canadian Slaughter Slaughter Capacity Developments and Supply Cattle and Beef Prices Relative to the United States Summary of Section Post BSE Pricing Rationale Live Cattle Pricing Beef Pricing at Wholesale and Retail Packer Profitability Cattle Share of Retail Beef Prices Pre and Post-BSE Marketing Patterns Part III: Summary and Conclusions Pre-BSE Industry Overview Post BSE Analysis Appendix Data Sources Tables Graphs

4 Executive Summary The Competition Bureau is evaluating issues and developments associated with pricing in the Canadian cattle and beef industry. It is doing so in response to requests from some industry participants and the House of Commons Standing Committee on Agriculture and Agri-Food. The purpose of this paper is to provide an overview and analysis of the economic situation faced by the industry both before and after the BSE crisis. This paper is expected to provide guidance on whether supply and demand factors under the extreme stress of BSE conditions can explain the pricing developments that have occurred. It is expected that by providing this analysis, the Bureau will be better equipped to evaluate whether further investigation is warranted. The finding of one BSE infected cow in Canada has had a traumatic and destructive impact on the Canadian cattle industry. The primary cause of this impact has been the closure of the US border to live cattle imports from Canada. No other country in the world has been impacted to such a negative extent by BSE because no other country in the world is as dependent upon beef and cattle exports. The following are some of the findings of this report with regard to the state or nature of the industry prior to the discovery of BSE: Pre-BSE Industry Overview Geography The beef industry is largely western based. Over 40% of Canada s beef cows are in Alberta while together the three Prairie Provinces account for over 80% of the country s beef cowherd. In addition, the three Prairie Provinces account for over three quarters of the country s cattle on feed inventory. With regard to the packing industry, it is noted that in 2002, nearly 77% of the total Canadian cattle slaughter occurred in the west and 71% was in Alberta alone. Marketing Patterns In Canada about 23%, or 976,000 out of 4.2 million, combined fed and cull marketings * were exported to the United States on average each year. That normal level of slaughter cattle exports is combined with the approximately 100,000 head of feeder cattle that were typically exported. As such, it can be generalized that, pre- BSE, Canada typically exported about 1.1 million head of cattle each year, or a rough average of 20,000 head per week. Total fed and cull cattle marketings (slaughter plus exports) amounted to just under 4.2 million per year, or up to 81,000 per week. Approximately 19% of western cull cow marketings are exported, while 43% of eastern cull marketings are exported. Western cull cow slaughter exceeds eastern cull slaughter by over 40%. About 21-22% of both eastern and western fed cattle marketings are exports. For Canada as a whole, about 31% of cull marketings are exported while 22% of fed marketings are exports. Culls represent about 18% of total cattle marketings, 17% of Canadian slaughter and 24% of total exports. * Marketings are defined in this report as exports plus federally inspected slaughter 3

5 Eastern exports of cull animals exceed western exports by a factor of 2.3 times. Monthly cull exports averaged nearly 20,000, of which over 13,000 were from eastern Canada and approximately 6,000 were from western Canada Beef Markets and Packing Structure Over 70% of beef exports are destined for the United States. The US market consumes similar beef cuts as the Canadian market. Overseas markets tend to draw products that Canadian and US consumers do not value. Essentially Canada and the US are one North American market. Canadian demand for beef improved during 2003, as evidenced by increased consumption and relatively steady prices. Packer plant and company numbers rationalized in Canada during the last 15 years due to economies of scale and structural change. Alberta is not at a competitive disadvantage compared to other major cattle regions in the US, with regard to packer buying and market activity, when the border is open. The beef packing industry, as with most industries, has barriers to entry, chief among them are economies of scale. While these barriers are material, it is noted in section 7.6 below that there are new entrants and that existing firms are expanding. Cattle and Beef Pricing Cattle prices behave in a predictable seasonal pattern through the year with peaks in the spring and lows in the early fall/late summer. The cattle industry has a cyclical pattern whereby prices peak every years. The Canadian cattle industry has been in a state of near continual growth since In contrast, the US cattle industry has expanded and contracted with the traditional cattle cycle. Canadian cattle and beef prices are determined in the United States. Canadian cattle prices are typically less than US prices by the cost of transport to the major US markets. Canadian and US cattle and beef prices are highly correlated. Canadian prices move in concert with those of the US. Cattle, wholesale beef and retail beef prices are highly correlated over time. Prices at the three levels move in tandem with each other. Prices tend to be more volatile at the farm level than at retail and wholesale. Post BSE Analysis Initial Situation During the initial weeks of the BSE crisis the cattle and beef markets were characterized by the following factors: Inability to export either cattle or beef. Uncertainty regarding domestic demand. Unwillingness to market cattle or to slaughter cattle. Slaughter levels declined precipitously. Extraordinary losses for beef packers. Exceptional buildup of beef storage stocks. Inability to establish a market direction or pricing levels for beef products. 4

6 Supply and Slaughter A backlog of 60,000 fed cattle and 20,000 cows per month began to build during the summer of A potential backlog of up to one million head of cattle per year began to build during the fall of Beef exports to the US, and eventually Mexico and a few other countries, began and as a result slaughter levels surged higher in August/September Increased slaughter was also prompted by the summer 2003 government assistance program. Slaughter levels and capacity continued to accelerate through Slaughter and capacity in 2004 will reach record levels. Slaughter capacity growth will continue through 2005 growing by up to 20,000 head over pre-bse levels. Slaughter capacity levels and growth during 2005 are expected to be at unprecedented levels. Capacity additions come overwhelmingly from pre- BSE packers. Accelerating slaughter of fed cattle significantly reduces fed cattle backlog in Fed cattle slaughter is expected to meet or exceed marketing levels in Capacity challenges continue to exist for OTM cattle in 2004 and Growth in capacity was likely generated by extraordinary profit levels at the packer level during 2003 and Post-BSE Pricing Post-BSE cattle prices no longer displayed any relationship to the normal price determination relationships with the United States. Cattle prices declined precipitously in the initial weeks following BSE due to the lack of slaughter during the summer and the impact of the government assistance program. Over the course of 2003 and 2004, fed cattle prices have averaged about 35% lower than they normally would have been with an open border. Cow prices likely are about 60% lower than they would have been if the border had been opened over that time. Boxed beef prices were essentially un-established during the summer of Once the border to the US opened in September of 2003, Canadian prices were initially discounted to the US prices. As time progressed through 2004, Canadian and US boxed beef prices have moved together and price differentials have been eliminated. The combination of normal beef pricing levels and depressed cattle prices resulted in exceptional packer profits from September 2003 to the present. Discussion of Pricing Rationale and Packer Profits In any market in which supply exceeds demand, the price paid for the commodity can simply be the bare minimum amount required to entice the seller to move the product. To make matters worse, in the case of the cattle market, cattle feeders cannot hold cattle much longer than a few weeks before the animal must be moved. Cattle are not storable commodities. The cattle that are available for slaughter that are in excess of packer needs are essentially worthless to packers in any given week. This places cattle feeders in a very precarious situation and eventually it makes cattle feeders desperate sellers. Packers can logically therefore let the market ration cattle flows by lowering their bid prices. Note that in this situation or in any commodity market for that matter, the cattle feeder s cost of production has no significance at all. Furthermore, the price that the packer is 5

7 receiving for the beef is also of no significance. Recall that after September 2003 packers were receiving fairly normal prices for the beef. That fact, however, does not compel them to pay more for cattle. Even in pre-bse times on any given day or week, the price of beef may or may not be a factor in the price of cattle. Certainly in the post-bse period there was a complete disconnect between beef prices and cattle prices. This was caused by the border closure and the resulting severe over supply of cattle. From September 2003, when the US border opened to beef, until the fall of 2004 during which the border remained closed to cattle, there was a disconnect between beef pricing and cattle pricing. While packer and retail prices remained closely correlated there was absolutely no correlation between beef pricing and cattle pricing. This lack of relationship is to be expected given that beef prices at the packer and retail level were on a North American basis from September 2003 forward. That is to say that beef pricing was once again determined and discovered in its pre-bse methodology. Cattle prices on the other hand continued to be mired in a severely dysfunctional supply-demand circumstance, due to the border closure to live cattle. Conclusion Number One The key point is that the pricing situation in the cattle industry over the past year and a half since May 20, 2003 was entirely predictable. It was based solely on acute over supply caused by the border closure to live cattle. Cattle price changes, packer and feeder reactions and slaughter levels were all based on the abnormal supply and demand conditions due to the closed border. Conclusion Number Two The lack of connection between retail/packer beef prices and cattle prices is entirely explainable by the fact that one market, the beef market, is operating on an open, North American basis while the other is not. The beef market is in relative supply demand balance while the cattle market is not. Conclusion Number Three Profits since September 2003 unprecedented. The primary generator of these profits are the depressed cattle prices. As discussed repeatedly in this paper, the reason the price of cattle is so low is the extreme divergence between the supply of cattle and the packer demand (capacity) for the cattle. This condition will continue until the border opens or until the supply is curtailed. The profits resulting from normal beef prices and depressed cattle prices are entirely to be expected given the distorted supply-demand circumstances. 6

8 Introduction Purpose of the Project The Competition Bureau is evaluating issues and developments associated with pricing in the Canadian cattle and beef industry. It is doing so in response to requests from some industry participants and the House of Commons Standing Committee on Agriculture and Agri-Food. The purpose of this paper is to provide an overview and analysis of the economic situation faced by the industry both before and after the BSE crisis. This paper is expected to provide guidance on whether supply and demand factors under the extreme stress of BSE conditions can explain the pricing developments that have occurred. It is expected that by providing this analysis, the Bureau will be better equipped to evaluate whether further investigation is warranted. Objectives In order to accomplish the purpose of this paper, the following objectives will need to be addressed: 1. Identify and define common industry measures and terms. 2. Outline how the industry functions through each sector and illustrate revenue and cost generators at each phase. 3. Describe and clarify industry-marketing channels. 4. Illustrate industry characteristics with regard to pricing and supply. 5. Identify key events beginning May 20, 2003 and their market consequences. 6. Evaluate price and production impacts of key events. 7. Determine the reasons behind industry rationalization and concentration pre- BSE. 8. Explain the barriers to entry for beef packing. 7

9 Part I: Cattle and Beef Industry Overview This section of the report provides an overview of the industry s participants, structure, linkages, suppliers and products. It also includes definitions of industry terminology and a discussion of its methods of operation. The purpose of this section of the report is to give an understanding of the workings of the industry in both normal and post-bse periods. 1. Definitions, Terminology and Industry Measures 1.1 Defining Common Industry Terms and Measures This section of the report provides definitions of common industry terms. A key source of the industry definitions is the Report of the Alberta Auditor General on the Alberta government s BSE related assistance programs, July 27, AAA and AA Beef Grades Next to Canada Prime, AAA is the highest quality Canadian beef grade. The Canadian Beef Grading Agency characterizes AAA beef as derived from a youthful animal; good to excellent muscling with some deficiencies; firm, bright red rib eye muscle; small amount of marbling; 2 mm or more of fat that is firm in texture, white or amber in color. Arbitrage In economics, arbitrage is the practice of taking advantage of a state of imbalance between two (or possibly more) markets. It is often referred to as playing the spread or taking advantage of price differences between markets. The same asset must trade at the same price on all markets ("the law of one price"). Cattle and beef industry participants can arbitrage the sale of their products because of free trade in those products (before BSE). Arbitrage and the open border ensured that North America was essentially one market for cattle and beef. Auction Market A business that provides a physical and/or electronic means for the buying and selling of cattle in an auction format is the definition of an auction market. There are approximately 130 livestock auction markets in Canada. Backgrounder cattle Weaned cattle grazed on a pasture or fed a high forage diet for about 4-6 months before being sold to a feedlot. Basis This is the difference between a particular Canadian cash market price and the Chicago Mercantile Exchange futures contract. The most important component of the basis is the cost of transportation to alternative markets or packers outside of the particular Canadian market, southern Alberta for example. Beef Meat obtained from a bovine. The clean flesh derived from slaughtered cattle, limited to the skeletal striate muscle, and includes the tongue, the diaphragm, the heart, and the 8

10 esophagus; with or without the fat and the portions of the skin, sinew, nerve and blood vessels. Bovine spongiform encephalopathy (BSE) The form of transmissible spongiform encephalopathy (TSE) in cattle (i.e. bovines). Most bovines are detected with BSE symptoms only after 30 months of age. In humans, BSE has been linked to variant Creutzfeldt Jacob disease, a fatal neurological disease. Boxed beef Wholesale, cut up beef produced by a packer. Typically vacuum packed and packed in a box. The box may contain beef weighing approximately 60 pounds. Breeding herd Sexually mature male and female livestock that are retained to produce offspring. Canfax Canfax is the market analysis division of the Canadian Cattlemen s Association (CCA). Canfax provides timely cattle market information to subscribers, comprised primarily of industry participants. Cattle Domesticated bovine animals as a group, regardless of age or sex. Cattle on feed Cattle being finished for slaughter at a feedlot. Choice Other than Prime, the highest quality and value US beef grade. Cow-calf operation A ranch or farm where cows are raised and bred mainly to produce calves usually destined for the beef market. The cows produce a calf crop each year, and the operation keeps some heifer calves from each calf crop for breeding herd replacements. The rest of the calf crop is sold between the ages of 6 and 12 months along with old or nonproductive cows and bulls. The calves are often sold to producers who raise them as feeder cattle. Cull cow Culling is the process of removing an animal from a herd. Older animals (usually over thirty months) are culled each year and sent to slaughter to reduce the size of the breeding or dairy herd. The meat from cull cows is typically ground or utilized for further processed products such as corned beef and other processed products. Some of the loin or rib cuts may be marketed to foodservice purveyors. Cutout and Cutout Value The cutout is the value of the carcass determined by multiplying the wholesale or packer price of each primal cut and sub-primal cut (see below), by the percentage yield of each cut. This is the value of the carcass at the packer level based on the value of each of the individual cuts sold in the wholesale market. 9

11 Cwt. Short form for hundred weight, or 100 pounds. The industry uses imperial measures or pounds for measuring weight. Prices for cattle and beef are quoted in $/cwt or cents per pound. Drop credits Cattle byproduct revenues for items such as offal (edible and inedible), hides, etc. Fed cattle Steers and heifers (usually in a feedlot) that have reached optimum slaughter weight of 1,200 to 1,400 lb. Most will have been on a special feed of concentrates and grains for the last days. Feeder Cattle Younger steer or heifer cattle, typically less than one year but over 6 months, that are either on pasture or in background lots that will eventually be placed on feed. Feeder cattle are also referred to interchangeably as stocker cattle. Feedlot (or Feedyard) An operation, typically out doors, where younger cattle are fed grain and concentrates usually for days. The feedlot operation buys younger cattle, feeds the cattle and sells the finished animal for slaughter to a packing plant (see below). Finished An animal that has reached market weight and is ready for slaughter. Heifer Young female cow which has not yet given birth to a calf, average weight about 1,200 lbs. Live weight Animal weight when it is still alive. The cattle industry still largely operates with imperial measures (pounds), not metric measures. Mature cattle Cattle over 2 years old or female bovines that have had at least one calf. A mature male bovine is often employed for breeding purposes. Offal The less valuable edible and inedible internal organs and trimmings of a slaughtered animal. OTM Over thirty month, referring to the age of an animal. Usually cows or bulls. Packer / packing house Wholesaler packaging of meat for future sale, including slaughtering, processing and distribution to retailers. 10

12 Price determination The interaction of the broad forces of supply and demand that determine the market price level. Specific prices are determined by price discovery. Price discovery Process of buyers and sellers arriving at a transaction price for a given quantity and quality of product. Primals and Sub-Primals The basic components of the beef carcass. Primals include the chuck (shoulder), rib, loin, hip (round), shank, plate and flank. Sub-primals are cuts that are taken from the primals, for example, the short loin is a sub-primal of the loin and the chuck roll is a sub primal of the chuck. Rendering A cooking and drying process that yields both edible and inedible fats of varying grades and livestock protein meals. The rendering industry processes or "recycles" animal byproducts such as animal fat, bone, hide, offal, feathers, and blood into beneficial commodities including tallow, grease, and meat and bone meals. Select USDA grade designation below Choice. Specified risk materials (SRM) Parts of the ruminant which are most likely to contain infectivity when the animal is infected with BSE. These include brain, spinal tissue, eyes, tonsils, and lower small intestine. Steer A male bovine castrated early in life, usually as a calf. Thin meat Includes such cuts as flank steaks, boneless chuck, short ribs, spare ribs, special trim, tri tips, ball tips, and boneless brisket. UTM Cattle under thirty months of age. Typically fed steers and heifers. Yearling An animal that is one year old and has not completed its second year. 11

13 2. Cattle and Beef Industry Value Chain 2.1 Identification of Industry Operations and Their Functions The cattle and beef industry is divided into three main sectors: cow-calf, feedlot and packing. The four basic functions of the industry sectors are as follows: Cow-calf or ranching operations: primary function is to produce calves from breeding stock. Calves may be sold to feedlots, backgrounding operations or retained on the farm/ranch. Backgrounding: primary function is to grow the animals on either pasture or pens until they are ready for a full finishing diet, typically at less than one year of age. Feedlots: primary function is to feed cattle on a scientifically derived grain and protein based diet until the animal reaches slaughter weight at around 1,300 pounds. These fed cattle are typically less than two years of age. Packers: primary function is to slaughter cattle and market beef to retailer and foodservice businesses domestically and around the world. Live cattle are sold as either feeder cattle or slaughter cattle. Feeder cattle move onto pasture or feeding lots. Slaughter cattle are either cattle that have been fed (fed cattle) or breeding animals (cows and bulls). Slaughter cattle are sold by feedlots or ranchers (breeding animals) to packing plants. Packing plants in turn sell the beef either domestically or internationally to retail and foodservice distributors. 12

14 Cattle and Beef Industry Value Chain Auction Market Auction Market Further Processor Food Service Ranch/ Cow-Calf 500 lbs Backgrounder 800 lbs Feedlot lbs Beef packer Export Direct Sale Direct Sale Direct Sale Direct Sale Retail Grain Elevators/ Feed Mills : Product Flow : Market Relation Figure 1

15 2.2 Composition and Geographic Distribution of Cattle Inventory The latest Statistics Canada inventory report indicates that there are 16.8 million cattle in Canada. That inventory is divided into beef cows, milk cows, bulls, feeder steers and heifers and calves. Of the inventory, about 38% are cows while 60% are steers and heifers. The following table shows the Statistics Canada July 2004 inventory tabulations for dedicated beef cow-calf and feeding operations. * Table 1 Canadian Beef Cattle Distribution Beef Cow Calf Number of Inventory Operations % of Total % of Total Feeding Number of Inventory Operations % % of Total of Total Atlantic 1% 3% 1% 11% Quebec 5% 7% 4% 4% Ontario 7% 17% 16% 46% Manitoba 11% 11% 8% 8% Saskatchewan 29% 25% 9% 6% Alberta 41% 33% 59% 21% BC 6% 5% 3% 4% Total 100% 100% 100% 100% (Source: Statistics Canada, Livestock Estimating Unit, July Inventory, Cattle Statistics XIE). As can be seen from the table, the beef cow industry is largely western based. Over 40% of Canada s beef cows are in Alberta while the three Prairie Provinces account for over 80% of the country s beef cowherd. In addition, the three Prairie Provinces account for over three quarters of the country s cattle on feed inventory. The modest disparity between the western cowherd and the western feeding share is explained by the fact that Ontario still feeds a significant volume of western cattle. In Canada, Statistics Canada reports that there were 6.4 million cows on hand as of July It is important to note that in addition to beef cows, the total Canadian cowherd is also comprised of dairy cows. Of those 6.4 million cows, 1.1 million, or 17% were dairy cows. While the beef industry is western based, the dairy herd is more eastern based. Eastern Canada is the home to nearly 80% of the country s dairy cowherd. With regard to the packing industry, nearly 77% of the total Canadian cattle slaughter occurred in the west and 71% was in Alberta alone in With regard to slaughter breakdown, the west accounted for nearly 79% of steer and heifer slaughter with Alberta alone accounting for 76%. Cow slaughter is more evenly distributed between Eastern and Western Canada. Quebec slaughters about 31% of the cows in the country while Alberta handles 46%. The composition of the slaughter between east and west reflects the geographic distribution of dairy versus beef cows. * Those identifying themselves as strictly beef production units as opposed to mixed farms.

16 2.3 Identification of Revenue and Cost Generators in the Value-Chain Cow-Calf operations generate revenue through the sale of calves or other younger steers and heifers. The operations also generate revenue through the sale of cull cows (cows that no longer have a productive reproductive capacity). The cull cow portion of the enterprise s revenue might amount to 10-20% depending on the year and other circumstances. The cow-calf sector is very diverse with regard to structure. Some cow-calf operations are full time commercial ranches while others are diversified operations with only small cow/calf enterprises. Some operations are mixed farms while others are fully integrated breeding, backgrounding and feeding businesses. The main costs of operation include winter feed and bedding costs as well as pasture. Cattle feeders revenues are generated from the sale of finished cattle to the packer. Primary cost factors are feed and the feeder cattle that were placed on feed. The cost of the feeder cattle placed on feed typically amounts to well over 70% of total costs. Cost of feed will amount to roughly 15%. All other costs combined, such as veterinary, transportation and administration are less than 20% of total costs. Beef Packers generate revenue through the sale of beef. The overwhelming majority of beef is sold as sub-primal cuts in a box while a much smaller share is sold as either carcass beef or further processed in tray ready containers. Other important sources of revenue include by-products such as the hide and edible and inedible offal. The key cost component of the packing sector is the cost of the cattle. Cattle costs comprise about 85-90% of total costs. Labor, transport, administration and other costs comprise the remaining 10% of total costs. The Canadian Food Inspection Agency lists 28 plants as cattle slaughter facilities. For practical purposes, however, relatively few of those plants are material participants in the daily cattle market. The following is a listing of the nine main packers in Canada and their estimated weekly slaughter capacity as of September 2004: Abattoir Colbex, Quebec (Levinoff Meats): 3,600 Better Beef, Ontario: 9,500 Gencor, Ontario: 800 St.Helens, Ontario: 1,500 Ryding-Regency, Ontario: 1,500 XL Foods, Saskatchewan: 5,000 Lakeside Packers, Alberta: 24,000 Cargill Foods, Alberta: 24,000 XL Foods, Alberta; 5,000 The Colbex, Gencor and XL Foods (Saskatchewan) plants are cow slaughter operations. As of October 2004, estimated federally inspected slaughter capacity in Canada was approximately 78,000 head. Maximum slaughter capacity in 2002 is estimated to have been approximately 72,000 head per week. 15

17 2.4 Marketing Channels This section discusses the two principal marketing channels: (1) Feeder cattle markets and marketing, and (2) Finished (or fed) cattle markets and marketing. Feeder Cattle Markets and Marketing Feeder cattle are the primary product of the ranch or cow-calf operation. The basic marketing pattern for feeder cattle is as follows: Weaned calf background lot/pasture feedlot The weaned calf may be kept on the farm/ranch or sold at approximately 500 pounds. From that point growth occurs at a slow rate on a backgrounding lot or pasture. Alternatively some young calves are put directly onto the feedlot. After backgrounding or pasture, the yearling feeder cattle are placed onto a feedlot and finished for purchase and slaughter by packers. The total period of time from birth to purchase by packers is typically less than two years. Marketing patterns and timing are highly dependent upon market signals and perceptions of pricing opportunities. Feeder cattle marketing is largely a domestic endeaver with reltatively few exports. For example in 2002, Statistics Canada tallied 5.2 million calves in the summer inventory report. That same year, the USDA reported just 487,000 imported feeder cattle or less than 10% of the total inventory. That tally was inflated by the results of the severe western drought. In normal years, feeder exports amounted to around 100,000 head. Given the large concentration of feedlots in Alberta, the overwhelming share of western feeder cattle are marketed to feedlots in Alberta. Based on Ontario s relatively large share of cattle on feed relative to its cow numbers, I conclude that some western feeders are also marketed in Ontario as well. Feeder cattle are marketed either direct or via auction. Direct marketing is the direct business to business sale without the aid of auction markets or other intermediaries. There are no statistics compiled on volumes of feeder cattle sold via the varying marketing channels. Industry estimates indicate, however, that in Alberta approximately 85% or more of feeder cattle are sold through auction markets (including satellite, internet and video). 1 The figure is likely higher at the interchange between buyers and sellers at the calf to background level and likely lower at the background-feedlot level. There are approximately auction markets spread throughout the country where cattle are bought and sold through an open bidding process. The sellers are typically the cow calf or ranch operators while the buyers are the feedlots or their agents. Live Cattle Markets and Marketing For the purposes of this discussion, marketings are defined as slaughter cattle marketed either in federally inspected plants in Canada or exported to the US. The focus of this portion of the discussion is the years from 1997 through These six years provide a good picture of the industry pre-bse. From 1997 through 2002, Canada marketed an average of 3.4 million fed cattle and 770,000 cull cows and bulls per year. Of the fed cattle, approximately 78% originated in the west (2.7 million of 3.4 million). The west s share of cull marketings was 50% (383,000 of 1 Anecdotal insights obtained from market reporters and industry participants 16

18 767,000). Interestingly, eastern cow and bull slaughter in federally inspected plants was 42% ((311, ,000)/219,000) lower than in the west but eastern exports were 56% greater ((165,000-72,000)/165,000). Over that period of time, Alberta averaged two thirds of western cull slaughter and 95% of fed slaughter. The corresponding figures for Alberta and Canada were 39% and 75%. Table 2 shows the average of exports and slaughter for the two classes of cattle. Table 2 Canadian Cattle Marketing Volumes Av Alberta West East Canada C&B FI Slaughter 204, , , ,678 C&B Export NA 72, , ,076 Fed FI Slaughter 1,998,970 2,096, ,954 2,675,872 Fed Exports NA 581, , ,997 C&B Marketings 382, , ,754 Fed Marketings 2,678, ,207 3,414,869 (Source Slaughter data - Agriculture and Agri-Food Canada, and export data Canfax) 2 Table 2 is an exceptionally important reference as it shows normal marketing channels prior to BSE. It provides a picture of the order of magnitude of the domestic and export marketing channels. The following bullet points summarize some of the key factors that can be gleaned from the table: Approximately 19% of western cull marketings are exported while 43% of eastern cull marketings are exported. Western cull slaughter exceeds eastern cull slaughter by over 40%. About 21-22% of both eastern and western fed cattle marketings are exports. For Canada as a whole, about 31% of cull marketings are exported while 22% of fed marketings are exports. Culls represent about 18% of total cattle marketings, 17% of Canadian slaughter and 24% of total exports. In Canada about 23% or 976,000 out of 4.2 million combined fed and cull marketings were exported to the United States on average each year. That normal level of slaughter cattle exports is combined with the approximately 100,000 head of feeder cattle that were typically exported. As such, it can be generalized that pre-bse, Canada typically exported about 1.1 million head of cattle each year or a rough average of 20,000 per week. Total fed and cull cattle marketings amounted to just under 4.2 million per year or up to 81,000 per week. A general guide to the weekly marketings is as follows: Cow and bull slaughter in Canada: 10,000 Cow and bull exports to the US: 5,000 Fed Slaughter: 52,000 Fed Exports to the US: 14,000 TOTAL: 81,000 2 Canfax is the market information arm of the Canadian Cattlemen s Association. All data obtained from Canfax results from George Morris Centre membership in Canfax and access to members only data sets either through special requests or at the Canfax website (Canfax.ca). Canfax s source for live animal trade is the USDA s Animal and Plant Health Inspection Service (APHIS). 17

19 3. Canadian Cow Marketings This section of the report focuses on the cow component of the marketing data. The reason for this section is to illustrate how the cow sector differs from the fed cattle sector. Furthermore this sector may face the greatest challenges in the coming years due to the expectation that the border will open eventually to UTM cattle but not to cows or OTM cattle. 3.1 Cow Inventory This section of the report provides an overview of the size, type and location of the Canadian cow inventory. Table 3 outlines the breakdown of the location of the herd between east and western Canada as well as the herd s make-up with regard to either dairy or beef. Table 3 Composition and Location of the Canadian Cow Herd, January ( 000s) Beef Cows Dairy Cows Total Cows Beef % Dairy West Dairy East Beef West Eastern Beef East Dairy % Western Beef % % % 83% % % 83% % % 84% % % 85% % % 86% % % 86% % % 86% % % 86% (Source: Statistics Canada, Livestock and Animal Products Section, Cattle Statistics XIE) As of the summer of 2004, approximately 38% of the total Canadian cattle inventory was comprised of cows. Of that total, 32% of the total inventory was beef cows while 6% were dairy cows. 24% of the combined beef and dairy cowherd was located in the eastern half of the country while 76% is in the west. Table 3 illustrates that in Canada, approximately 80% of the total combined cowherd was of beef origin while 20% was dairy. Of the dairy herd, approximately 78% is located in eastern Canada while 85% of the beef herd is in Western Canada. Other statistical factors to note are that as of 2004, over 40% of the Canadian beef cowherd is located in Alberta while Saskatchewan contains the second largest share at nearly 30%. Ontario and Quebec have 7% and 5% respectively. Quebec has 38% of the Canadian dairy herd while Ontario has 34%. Alberta has 7% of the national dairy cowherd. The main point is that the western cow herd is beef based while the eastern herd is dairy based. 18

20 3.2 Canadian Trade in Cows and Bulls This section of the report focuses on trade and slaughter trends in cows and bulls 3 in North America prior to the BSE crisis. The purpose is to understand the market and marketing patterns for this sector of the cattle industry. While there have been periodic imports of cows or bulls into Quebec, for practical purposes the Canadian imports are insignificant. For example, since 1997, table 4 shows the annual totals of exports of cows and bulls from Canada into the United States. 4 It shows that monthly exports average nearly 20,000, of which over 13,000 were from Eastern Canada and approximately 6,000 were from Western Canada. It is worth noting that exports are seasonal volumes are greatest in the fall when producers make culling decisions. Table 4: US Imports of Canadian Cows and Bulls (Source: Canfax) C/B East C/B West Total , , , , , , ,805 56, , ,047 37, , ,717 48, , ,374 66, ,588 The following are some of the key facts with regard to cow and bull exports: Monthly exports averaged nearly 20,000 of which over 13,000 were from eastern Canada and approximately 6,000 were from western Canada. The trend in western exports has generally been lower 5 while the eastern trend has been erratic but generally higher. Exports are seasonally greatest in the fall when producers make culling decisions for the herd. Figure 2 shows the monthly tallies over the same period of time as well as the seasonal nature of exports. 3 Cows and bulls are combined due to the statistical reporting procedures of the USDA. As a general rule of the total combined inventory of cows and bulls, the cows would comprise roughly 96% of the total. Another indicator of the composition of this total is the fact that in Canada, cows comprise at least 97% of the combined cow and bull slaughter. Furthermore, the purpose of the meat from both cows and bulls tend to both go towards manufacturing purposes. 4 While there have been periodic imports of cows or bulls into Ontario, for practical purposes the Canadian imports are insignificant. The largest annual volume of imports into Canada was 70,000 in The upward surge in western exports in 2002 was likely due to the influence of the ongoing prairie drought. This drought forced a larger scale culling of the herd than would normally have been the case. 19

21 Average Monthly Cow and Bull Exports ,000 24,000 23,000 Head Per Month 22,000 21,000 20,000 19,000 18,000 17,000 16,000 15,000 Jan Feb Mar Apr May June July Aug Sept Oct Nov Figure 2 (Data Source: Canfax) * 3.3 Canadian and US Cow Slaughter This section of the report provides a description of the relative slaughter volumes for cows in both Canada and the United States. Canadian Cow Slaughter The share of cows in the slaughter mix is largely a function of where the industry is in the cattle cycle. If the industry is in the liquidation phase there will be a greater proportion of cows compared to when the industry is in a re-building mode. Since 1997, cows have comprised an average of 16% of total Canadian slaughter with the highest share being near 29% in 1997 and the lowest at around 14% in Over that time, Canadian cow slaughter has averaged over 511,000 head per year, with the highest tally being nearly 590,000 in * The second graph was constructed by averaging monthly exports over the six years from For reference regarding comparative size, it is noted that in the mid-1980 s for example, slaughter routinely exceeded 900,000 head. The following graphs on figure 3 show the monthly trends in cow slaughter from 1997 through September 2004 as well as the seasonal nature of cow slaughter. 20

22 Head Monthly Canadian Cow Slaughter 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10, Figure 3 (Source: Canfax) Figure 3 clearly shows the drop in cow slaughter after the BSE crisis in the spring of Prior to that, the main characteristic of the graph is the comparatively steady year-to-year trend in monthly slaughter, ranging from about 40-50,000 per month from 1998 through early In fact, prior to 2003, monthly cow slaughter averaged up to 43,000 head. 55,000 Average Monthly Cow Slaughter Head Per Month 50,000 45,000 40,000 35,000 30,000 Jan Mar May Jul Sep Nov Figure 4 (Source: Canfax) * As indicated by Figure 4, there are seasonal peaks and troughs in cow slaughter volumes. Seasonal peaks coincide with producer culling decisions (as with the exports). * The second graph was constructed by averaging monthly slaughter over the six years from

23 US Cow Slaughter US cow slaughter from 1997 through the summer of 2003 amounts to approximately 480,000 per month. In 2004, US slaughter dropped materially due to the absence of Canadian cows and the likely beginning of herd rebuilding. Figure 5 shows US monthly cow slaughter since US Cow Slaughter '000 Head Figure 5 (Source: Kansas State, Ag Manager Info) 7 On a monthly basis, US cow slaughter prior to 2004 averaged nearly 11 times greater than Canadian cow slaughter. However, the US cow herd is only 7 times greater than that of Canada. It appears that the relatively large volume of cows slaughtered in the US is primarily due to the export of dairy cows from Eastern Canada into the US. In Western Canada, cow and bull slaughter amounts to about 12% of the total slaughter volume. Given the regional make-up of the herd, that suggests that almost all of that slaughter would be beef cows. Western Canadian slaughter and US cull slaughter of beef culls are reasonably comparable. Thus, it can be concluded that the divergence (i.e. the relatively large US cow slaughter proportion) occurs largely due to importation of eastern dairy cattle from Eastern Canada. 3.4 Cow Marketing Totals Cow marketings are defined as the volume of Canadian slaughter plus the volume of cows exported to the US. From 1997 through 2002, Canadian cow marketings have averaged approximately 740,000 per year. 8 The peak year was 1997 at 850,000, while the lowest over that time was 2000 at 604,000. Figure 6 shows the marketing trends from 1997 through Actual cow slaughter plus cow and bull exports averaged 747,000. The estimated total above assumed that 4% of exports were bulls. 22

24 Thousands Head 1, Canadian Cow Marketings Canadian Cow Slaughter Cow and Bull Exports Figure 6 (Source: Trade- Canfax and slaughter - Agriculture and Agri-Food Canada, Red Meat Section, Annual Livestock Market Review) As rule of thumb, domestic slaughter tends to exceed exports of cows by a ratio of two to one. By comparison, fed cattle exports have traditionally comprised about 20% of fed marketings. About 43% of eastern marketings are exported and 19% of western marketings are exports. Most of the eastern herd is dairy cattle. 3.5 Summary of Section 3 The following are some summary points of the marketing and pricing of live cattle in Canada in the years prior to BSE in 2003 Western Canada cull slaughter exceeds eastern slaughter by 42%. Eastern exports of cull animals exceed western exports by a factor of 2.3 times. Monthly cull exports averaged nearly 20,000 of which over 13,000 were from eastern Canada and approximately 6,000 were from western Canada. The trend in western exports has generally been lower while the eastern trend has been erratic but generally higher. Cull exports amount to about 20% of total cull marketings in the west, which is similar to the ratio of fed cattle exports to marketings. US cow slaughter prior to 2004 averaged nearly 11 times greater than Canadian cow slaughter. The majority of the divergence between the cow slaughter in the two countries is due to a lower rate of eastern dairy cow slaughter. Western cull slaughter rates compare well to those of the US. 23

25 4. Cow Beef Industry Competitive Analysis The previous section of this report analyzed cow markets and marketings in Canada in comparison to the US. It evaluated inventory volumes, exports, slaughter and marketing trends over time and, in particular, prior to BSE. This section of the report examines the competitive forces affecting the market for cull cows and cow beef products in Canada, with an emphasis on eastern Canada. The purpose of this section of the report is to evaluate market conditions for cows and cow beef in Canada and in particular, the eastern Canadian dairy cow sector. This particular attention has been warranted given the dominance of dairy breeds in the east and the need to evaluate whether there are differences that need to be considered for this sector of the beef complex. In order to accomplish this purpose, however, it is necessary to describe the competitive forces at play in the entire Canadian cow beef sector. 4.1 Commercial Beef Processing and Challenges in Canada Cull cow and bull beef is often referred to as commercial beef. The slaughter of cows and bulls is sometimes called commercial slaughter. The following is a description of the key characteristics of the commercial cow beef processing industry in Canada. Procurement Procurement of commercial livestock for processors can be generated from three sources of potential raw material: 1. Beef cows 2. Dairy cows 3. Bulls Beef Cows Beef cows are typically viewed as breeding stock in North America. As such the cow will be kept in the active breeding herd until it no longer carries a calf or until it comes up dry. Given Canada s climate, calving and weaning seasons have created a very narrow window of time for these critical two functions: The vast majority of calving occurs between late February and early May; and Weaning time for the cow/calf pair tends to occur between late September and late November or after the fall harvest and before the snow permanently stays on the ground. This four-month period, when the majority of raw material would be available, has made it very difficult for any plant that has wanted to concentrate on the slaughter and/or processing of beef cows to have access to enough raw materials to make their operation viable. This same factor is not as pronounced in warmer climates. As a result of this and other factors to be mentioned later, US beef cow slaughtering and/or processing facilities have managed to be further developed than their Canadian counterparts since they have a steadier supply of raw material. Canadian plants therefore face a challenge for the other eight months of the year when they do not have a sufficient supply of raw material to run their plant. The answer to this question prior to the BSE discovery in May 2003 was to slaughter fed cattle. Following BSE the US border was closed to boneless beef from animals over thirty months of age and all live cattle. At that point, it appeared that an opportunity presented itself for plants to access more raw materials in the form of culled 24