Analysis & Comments. Cattle Markets: Review of 2015 and Outlook

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1 Analysis & Comments Livestock Marketing Information Center State Extension Services in Cooperation with USDA January 5, 2016 Letter # 1 Cattle Markets: Review of 2015 and Outlook As 2015 progressed, cattle markets faced some significant headwinds, including: year-onyear declines in export sales; large supplies of pork and chicken competing in the domestic market; and huge imports of beef from Australia. Then the bottom fell out with a non-typical fed cattle market meltdown driven by large supplies of very heavyweight and in many cases over finished animals that had built-up, especially in Midwest feedlots. The 5-market average fed cattle price reported by USDA s Agricultural Marketing Service in their Market News reports crashed by about $27.00 per cwt from the week ending August 30 th to the week ending October 4 th. Yearling and calf prices followed suit. Finally, in late December fed cattle prices rebounded dramatically, but for the last week of the year cash markets were still more than $25.00 per cwt below a year earlier. Several factors combined to slow marketing rates by cattle feeders in 2015, including: huge cattle feeding profits in 2014; very high feeder animals cost with little prospect of doing anything but losing money when placed on-feed; packers jawboning about carcass weights but not sending clear price signals to feeders; and rather inexpensive feedstuff costs compared to recent years. Throughout the year, increasingly volatile cattle futures markets made risk management very difficult. By the fourth quarter consequences of the above factors were finally apparent and cattle feeders began to adjust. In 2015, especially late in the year, financial losses in the cattle feeding sector were unprecedented. U.S. beef production was well below a year ago during the first half of 2015, but projected fourth quarter output was 1.5% above 2014 s. The longer-term supply outlook is for cyclically larger U.S. beef production. However, in 2016 and 2017 some of the other factors working against cattle prices in 2015 may be mitigated. First, as 2016 progresses, U.S. imports of beef from Australia are expected to moderate significantly because Australian output appears unsustainable. Further erosion in U.S. beef export tonnage could persist into early 2016, but then should stabilize and could post modest year-over-year gains in the second half of the year, if foreign economic conditions improve. The large ramp-up in domestic supplies of pork and chicken that occurred during 2015 is not likely to be repeated in Annual U.S. commercial cattle slaughter in 2016 should post its first year-over-year increase since Average dressed weights are forecast to be above a year earlier during the first three quarters of 2016; yet, the final quarter could be down slightly compared to 2015 s. U.S. commercial beef production is forecast to be 3% to 4% above 2015 s and the largest since Production is expected to continue growing in 2017 with output up 3% to 6% year-over-year.

2 Page 2 On an annual basis, prices of all types of cattle are projected to cyclically decline throughout However, the factors that drove prices lower and caused dramatic price swings during the last few months of 2015 will not necessarily repeat. In terms of profitability, returns will improve dramatically for cattle feeders in 2016 after a disastrous Cow-calf operations will remain profitable but will continue to see declines for the next few years. Positive margins for stocker operations may prove elusive and will require a sharp pencil and a good marketing plan, as they face yearling steer prices that may be more volatile and drop more quickly than those of calves. A Look Back at 2015 s Market Drivers Calendar year 2015 was full of dichotomies. Cattle prices were strong early in the year and posted year-over-year increases, then the second half brought large price declines and extreme volatility. Even with lower calf prices, cow-calf operations had a profitable year, while cattle feedlots bled red ink. On the demand front, what we can measure regarding domestic consumer demand for beef remained quite good through the third quarter of the year (latest analysis available when this was written). In contrast, export demand was disappointing for both beef and beef byproducts. The U.S. economy was rather strong compared to the rest of the world, which impacted international trade, both imports and exports. In calendar year 2015, calf and yearling prices averaged slightly above 2014 s on an annual basis, but fed cattle were down. For the year, the estimated price average for calves (500-to 600- pound steer) and yearlings (700-to 800-pound steer) in the Southern Plains was about $ and $ per cwt., respectively, and the 5-market average fed cattle price was near $ per cwt. During the fourth quarter of 2015 the industry experienced a downturn in prices compared to earlier in the year and measured against the quarterly record highs established in the fourth quarter of In 2015 s fourth quarter prices were volatile, calf prices averaged 29% below 2014 s, and yearlings were down 26%. Fed prices declined by 23%, compared to year ago. Still, calf prices in the fourth quarter of 2015 were the second highest ever. Strong Domestic Beef Demand, Poor Exports After an overall strong growth year in 2014, the U.S. economy consistently, although slowly and with some steps backwards, continued its growth trend during GDP gains outpaced that of most other advanced economies and that of many developing countries as well. Consistent economic growth was the major factor causing U.S. consumer beef demand to improve, in the face of high retail prices. Clear signs of a significant economic slow-down in China and pressure on commodity and financial markets emerged during the summer of In conjunction with deteriorating economic conditions in many other overseas markets, especially during the first three quarters of 2015, exchange rates continued to work against U.S. exports (beef, variety meats, and hides) and encouraged more beef imports. Domestic Consumer Demand The Choice Retail Beef and All Fresh Beef Demand (AFBD) Indices for the third quarter of 2015 continued to show positive shifts in demand. The demand index stood at 94, up almost 7

3 LMIC Page 3 points compared to third quarter of 2014 and the highest it has been since This number includes a slight increase in per capita disappearance, up 0.25 pounds (or 2%). The increase in per capita disappearance can mainly be attributed to increased U.S. beef imports during According to USDA s Economic Research Service (ERS), on the price side, AFB posted a 6% increase in retail price compared to third quarter of This price change, although still moving up, did so at a much slower pace than in 2014 when it had a 14% jump compared to The bottom line is, U.S consumer s demand for beef actually increased (demand curve shifted positively). Beef is not the only protein experiencing increased demand. Pork also showed strong demand at the retail level during 2015 s third quarter. Compared to 2014, the pork demand index was up just over 2%, and was the strongest it had been since the third quarter of Per capita disappearance increased 9% year-over-year and prices decreased a relatively modest 8%. This is a more classic example of supply and demand interactions; pork production increased substantially, consumers and the market responded to lower market clearing prices, but the price drop was less than if demand had been normal, indicating improved demand. Beef Imports Increase and Exports Stumble The U.S. attracted more beef imports due to slow economic growth rates in Asia and the Middle East. Additionally, U.S. beef imports were supported by on-going drought in Australia, which continued cowherd liquidations in that country. Importantly, Russia maintained bans on meat and poultry products from Europe, Oceana, and North America, causing shifts in normal trade flows, and a strong U.S. market and value of the dollar attracted foreign beef. For the year, beef imports are projected to be up 20% compared to 2014 s, and the third highest annual level behind 2004 and 2005 (data from USDA-ERS). Of the major countries that sell beef to the U.S., Australia made up 38% of the total volume in 2015 and increased their tonnage sold to the U.S. by 35% compared to 2014 s. Much of the imported beef was consumed, which drove the increase in per capita beef supply for 2015, however the imported beef also built-up in frozen stocks. Stocks are estimated to be 7% above 2014 s at year end or up about 44 million pounds year-over-year, mostly consisting of frozen boneless beef. On a tonnage basis, LMIC projects U.S. beef exports in calendar year 2015 were down nearly 15% compared to 2014 s. That tonnage was about 22% below 2011 s record high. Exports to South Korea remained strong throughout the year, even as sales to most other countries faltered. U.S. exports of beef byproducts (hides and offal) also slumped in Byproduct, drop value, offal; these all refer to the same products and represent an important revenue source (that is often overlooked) for packers in both the beef and pork industries. Cattle byproducts consist of cheek meat, hearts, livers, tripe, tongues, bone meal, tallow, hides, and several other products. These byproduct values are driven by international demand, as domestic use is relatively low. In the beef industries the byproduct value has been down trending since March, and has been significantly below year ago value levels since October. Byproduct values put in the most recent low for 2015 during the end of December at $10.56 per cwt. on a live steer basis, as reported by USDA s Agricultural Marketing Service (AMS). That was down $5.13 per cwt.

4 Page 4 from 2014 and almost $1.00 below the prior five-year average ( ). The cattle drop value is mainly affected by its largest contributing product the hide. According to USDA- AMS, in December, the hide (Butt Branded) was $70.00 per piece, more than $30.00 below a year earlier. The beef industry has not been the only one to struggle with byproduct values. The hog byproduct value hit its most recent low the end of December at $3.00 per cwt. on a live hog basis, which was $2.58 lower than 2014 s and almost $2.00 lower than the prior five year average. The hog byproduct value had more downward price pressure during the fourth quarter than what the beef industry experienced Ramp-up in Competing Meat Supplies As reported by USDA, total red meat includes four types - beef, pork, lamb, and veal, - which are measured on a carcass basis. The poultry items are: broiler (young chicken), other chicken (mature birds), and turkey, which are on a Ready-to-Cook basis. Of course, that is a wide array of proteins with different demand profiles. The long term trend is for U.S. production of red meat and poultry to increase and 2015 s level was record large. Another production record is likely in 2016, although the year-over-year gain will be modest compared to 2015 s. Total U.S. red meat and poultry production in calendar year 2015 is projected to be record large at about 94.3 billion pounds (commercial plus on farm production, on a carcass weight basis), up 2.7% from 2014 s and surpassing the 2008 record high (93.6 billion pounds). The drivers behind record production are pork and broiler tonnage. Beef tonnage was down yearover-year (off 2.3%) and the smallest since Pork output for 2015 was projected to jump 8.0% while broiler output increased about 4.0% year-over-year, both will be record large. Projected turkey production was 3.7% below 2014 s. In contrast to record large total red meat and poultry production in 2015, on a per person basis, disappearance was not record large. However, a large year-over-year increase posted. Per person disappearance adjusts for population growth and changes in imports, exports, and frozen stocks. In2015, per capita disappearance was about 9 pounds (4.4%) above 2014 s and the largest since Disappointing exports, especially chicken, during the year contributed to a much larger competing meat and poultry supply facing U.S. consumers. Many countries banned U.S. chicken due to Highly Pathogenic Avian Influenza cases on turkey and egg farms. Russia maintained their ban on importing poultry from several countries, including the U.S., and a lack of economic growth in key foreign markets also limited sales. For the year, LMIC projects broiler export tonnage in 2015 was down about 14% or 350 million pounds and the lowest since Cattle Feeder versus Cow-Calf Returns Cattle feeders made money in 2014; in fact, estimates put their returns at the highest level since Those returns allowed cattle feeders to keep bidding aggressively for feeder animals during the first several months of 2015, even as their closeouts were in the red. As feedlots dealt with larger and larger red ink losses, the option of feeding current inventory to heavier weights, instead of purchasing new feeders, appeared attractive. However, feeding losses soon surged to record levels. On an annual basis, 2015 was the worst ever by LMIC estimates (going back to the mid 1970 s). Cattle sold in the last four months of 2015 had the largest losses typically

5 LMIC Page 5 exceeding $ per steer sold based on feeding-out a 750-pound steer and including all economic costs of production. Cow-calf operations remained profitable in 2015, but levels declined from the phenomenal level of Weather and pasture conditions were fairly mild throughout the U.S. from spring to fall of 2015 and allowed for increased flexibility and grazing time for cow-calf and stocker operators. LMIC calculates returns over cash costs plus pasture rent and uses an average steer and heifer calf price for the Southern Plains for the months of August through November and calendar year average cull animal prices. Returns were especially pressured by calf prices late in the year. In 2014, at nearly $ per cow, returns over estimated cash costs plus pasture rent surged about $ per cow above 2013 s. Even though cash returns fell dramatically in 2015, they were still the second highest ever (not adjusted for inflation). The 2015 calculation is nearly $ per cow. In 2015, a few cost categories actually declined (e.g. fuel), however pasture rental cost posted a large year-over-year jump up. Prospects for 2016 and 2017 The main headwind to prices in the next few years is an increasing beef supply driven by herd expansion. However, do not plan for a repeat of 2015 s market to occur in The major factors may move in the same direction, but the large year-over-year increases in competing meat supplies, surging value of the U.S. dollar, and a late-year backlog of over finished cattle in feedlots are not forecast. In terms of prices, when combined, all the factors that caused dramatically lower prices and increased volatility in the cattle market during the fourth quarter of 2015 created an uncommon situation. U.S. Cattle Inventory, Slaughter, and Production Trends The 2015 U.S. calf crop was up 1.2%, its first year-over-year gain greater than 1% since All signs point to a larger percentage increase in The next USDA annual (January 1) cattle and calf inventory count will be released January 29, Expectations are for an increase of 2-3% in the 2016 calf crop. Both heifers held for beef cow replacement purposes and beef cows retained will continue growing year-over-year during LMIC forecasts that commercial cattle slaughter in 2016 should post its first annual increase since Average dressed weights are forecast to be above a year earlier during the first three quarters of 2016; yet, the final quarter could be down slightly compared to 2015 s. U.S. commercial beef production is forecast to be 3% to 4% above 2015 s. U.S. beef production is expected to continue growing in 2017 with output up 4% to 5% year-over-year. Still 2017 s U.S. beef output will not be large by historical standards; current forecasts are for production to be similar to 2013 s. Competing Meats: Production Growth Rate to Moderate Compared to the large ramp-up that occurred in U.S. chicken and pork production in 2015, much more modest growth is forecast for the next two years. Further Avian Influenza disease outbreaks in the U.S. might continue to stifle poultry exports. If economic conditions improve in foreign markets, the U.S. chicken and pork industries should be well positioned to take advantage. Currently, both chicken and pork exports are forecast to increase.

6 Page 6 LMIC expects a 2% increase in broiler production and a 1% to 2% increase in pork production in 2016, compared to In other words, 2016 will not be a repeat of the significant supply increases in both pork and broilers, as was seen in In 2016, record-large red meat and poultry output of about 96.0 billion pounds is forecast, up 1.5% to 2.0% year-over-year. On a per person basis, disappearance will remain well below record levels, for 2016 likely in the range of 211 to 213 pounds per capita. That is a slight increase of 0.4 pounds for the year and very small compared to 2015 s rise. International Trade: Not a Repeat of 2015 With regards to the value of the U.S. dollar, regardless of when interest rates are raised, it is very unlikely the dollar will experience another value increase of the same magnitude seen in On the world beef supply side, the U.S. is poised to regain some market share that was lost to Australia in recent years. The Australian cattle herd has shrunk due to drought, and their beef supply will be reduced. This would cause Australian beef prices to increase and become less attractive compared to U.S. beef. Expectations are that U.S. imports of beef will moderate significantly compared to 2015 s because Australian output appears unsustainable. As world economies improve so should the international demand for U.S. beef. Forecasts for U.S. beef exports put 2016 levels near that of 2015, and an increase in U.S. beef exports is expected in This is due to U.S. cattle and beef prices cyclically eroding in 2016 and 2017, and the expectation of improved world economies. Simply put, another decrease in export volume to the magnitude seen in 2015 is not expected in Corn and Feedstuffs, Always a Risk The western Corn Belt (west of the Mississippi) experienced very favorable growing conditions with timely and appropriate amounts of rain during The eastern Corn Belt however, namely Illinois, Indiana, Ohio, and Missouri, dealt with too much moisture too often. Coming into corn harvest, the question was whether higher yields in the western Corn Belt would offset lower yields in the eastern states. That question was answered when the U.S. produced its third largest corn crop in 2015, only less than 2014 s and 2013 s. The average national corn price in 2015 hovered around $3.55 per bushel. Looking ahead, 2016 national corn area planted could post a small year-over-year increase. Weather and moisture conditions will be the deciding factor for overall corn production in Assuming normal weather conditions sets the stage for fairly stable corn prices in the coming year. However that could easily change depending on weather. Importantly, with a growing number of cattle in the U.S., producers need to be prepared to respond quickly to corn prices, if they increase. Typically, corn prices are inversely related to feeder animal prices; that is, higher corn prices trend to depress calf and yearling prices and the adjustment can be abrupt. If drought occurs producers will need to evaluate resources and act. Prices Expected to Continue Eroding The longer-term outlook is for cyclically larger cattle numbers and U.S. beef production. For the next few years, uncertainty remains regarding beef demand, both domestic and foreign.

7 LMIC Page 7 Of course, long-term, a potential market factor is always feed grain and forage conditions. At this point, the assumption is normal conditions on a national basis, but with growing cattle numbers, crop and forage developments will be important market drivers. Normal seasonal patterns suggest that the lowest fed cattle prices will occur in the summer quarter. But, seasonally feedlot placements were reduced in the last few months of 2015 due to cattle feeding losses. If that pattern persists into early 2016, cattle coming out of feedlots will be delayed and bunched-up in the second half of the calendar year, pressuring fed animal prices. Seasonally, the lowest calf and yearling prices are likely to the posted during the fourth quarter. On an annual basis, fed cattle prices in 2016 are forecast to drop year-over-year by 6% to 9%, averaging in the lower to mid-$130 s per cwt. The lowest fed cattle prices are likely in the second half of the year, still prices in the fourth quarter could exceed the very depressed levels of late In 2017, another 1% to 4% decline in prices is forecast, on an annual basis. Calf prices may decline 10% to 12% year-over-year in 2016, importantly the percentage drop from 2015 s level could be smallest in the fourth quarter. Still, calf prices in the fourth quarter are expected to average below 2015 s. Calendar year 2017 should bring further erosion in calf and yearling prices. For the year, LMIC currently forecasts calf prices dropping by 1% to 3% from 2016 s. In the Southern Plains, the fall of 2017 could post a quarterly average steer calf (500-to 600-pound) price significantly below $ per cwt. for the first time since $ Per Cwt SLAUGHTER STEER PRICES 5 Market Weighted Average, Weekly JAN APR JUL OCT Data Source: USDA-AMS Livestock Marketing Information Center Avg

8 Page 8 $ Per Cwt MED. & LRG. #1 STEER CALF PRICES Pounds, Southern Plains, Weekly JAN APR JUL OCT Data Source: USDA-AMS Livestock Marketing Information Center Avg Bil. Pounds 6.8 COMMERCIAL BEEF PRODUCTION US, Quarterly JAN-MAR APR-JUN JUL-SEP OCT-DEC Avg. 2010/ Data Source: USDA-NASS, Forecasts by LMIC Livestock Marketing Information Center