Cattle producers should see a bit of relief from high feed expenses over the next few months. The CME DEC ’22 Corn contract has fallen from a contract high of $7.64/bu. on May 16 to $6.23/bu. Some other commodities used in feed rations, such as distiller’s grains, have seen similar downward moves. These feed price changes can have a compounding impact on feeder cattle prices. As inputs become cheaper, feeder cattle become a relatively more profitable investment which lifts their value. It is common to see corn and feeder cattle prices move in opposite directions.
In the chart below, the CME DEC ’22 Corn price (black line) has declined significantly from mid-June to now. Corn is a significant input in feeding cattle and the CME OCT ’22 Feeder contract (green line) experienced a corresponding increase in value.
Since the contract high two months ago, cost of gain (COG) has fallen significantly while feeder cattle also became relatively more profitable. If COG is calculated:
then estimated COG, including yardage, fell from $1.11/lb. to $0.90/lb. from mid-May to the present, providing at least $0.20/lb. additional revenue before even considering the change in value of feeder and fed cattle. This also makes dry-lotting cows and placing lightweight cattle on feed a more feasible option given low pasture availability and historically high price of forage.
In a year like 2022 evaluating profitable input application rates is extremely important but inputs that require ongoing application through the season can be difficult to evaluate. Crop and input prices change through the year, so each input application is an individual decision that is also part of the greater profit maximizing strategy. Consider producing irrigated corn in northern Texas.
With December futures trading at $7.31/bu., and the average basis in the region ($0.50/bu.), we’ll assume a producer can lock in $7.81/bu. At this point in the production calendar, recommended practices assume 9 acre-inches (AI) of irrigation have been applied to-date, which represents a sunk cost. With a high cost for natural gas (the primary irrigation fuel in the region), what is the most profitable irrigation amount for the rest of the season? Standard production practices for the remainder of the season call for irrigation at a rate of 6 AI in July, 5 AI in August, and 2 AI in September, totaling 22 AI for the year. The current futures price of the corresponding natural gas contracts is $6.94/MMBtu, $6.906/MMBtu, and $6.86/MMBtu, respectively, yielding a weighted average irrigation cost of $6.92/MMBtu. Given typical irrigation technologies in the region, once acre inch of irrigation typically requires one MMBtu, so the weighted average cost per acre inch for the rest of the season will equal roughly $6.92/AI.
The Marginal Cost (MC) of each additional AI remains the same ($6.92/AI, orange line) for producers who lock in their irrigation needs today in terms of weighted average. Using the regional irrigation yield curve (green line), we can estimate the incremental benefit, Marginal Revenue (MR, blue line), of each AI beyond the 9 AI already applied (e.g. 1 additional AI = 10 total acre-inches). Corn yield response is positively related to irrigation to a point but begins to lag and eventually declines with increasing application. As the yield response fades, Marginal Revenue (MR) diminishes.
Using the rules of MR and MC (MR=MC is max profit, MR < MC is a loss per unit, MC < MR is increasing returns per unit), we can see that max profit occurs at approximately 7.5 additional AI for the remainder of the season, totaling 16.5 AI for the year. A function of very little yield response from additional irrigation after 16 AI, the outcome suggests that the most profitable irrigation amount may be less than the recommended 22 AI per year. However, it is critical to talk to your agronomist and consider factors tangential to yield like test-weight and changes in expected weather conditions when making input decisions.
Retaining ownership of calves beyond weaning is a value-added process that provides cow-calf enterprises access to a greater share of the retail dollar. There are costs and benefits to selling at weaning as well as costs and benefits when retaining ownership, each of which must be evaluated on an annual basis. Estimating expected returns is challenging in a normal year, and has been complicated in 2022 by drought, widespread culling, high feed costs, and increasing calf prices. Below is an analysis of the retained ownership decision using today’s market expectations.
We can roughly estimate the expected revenue generated from the sale of a weaned calf today. The average price of a 7-8 weight steer in Joplin, MO the last week of April ran $1.63 per pound, meaning a 750-pound steer calf brought $1,224.38. So the question of retained ownership is how much additional revenue (value-added) over $1,224 can I expect from selling a fed calf, and what is the additional cost associated with the added value.
If we assume a current calf weight of 750 pounds for a 2021 spring-born calf, and an average daily gain (ADG) of 3.5 pounds, we can assume a target harvest date of mid-October at approximately 1,350 pounds. The board price for an October delivery fed steer last week averaged approximately $1.43 per pound. If we locked that price in today, a 1,350-pound steer would generate $1,930.50 in revenue. Compared to selling today at $1,224, retaining ownership would generate an additional $706/head. Now let’s look at the cost of achieving that additional $706.
Cost of Gain (COG) is a function of days on feed, cost of feed, and pounds of feed per pound of gain. It is commonly estimated using corn price, so it is significantly higher this year than in recent years. The increased cost of corn has cost of gain in the neighborhood of $1.20 per pound to $1.50 per pound depending on the feeding location, including an approximate 33% markup for yardage fees, overhead, and miscellaneous expenses. Subtracting COG from the expected value-added ($706.12) leaves the bottom-line Expected Net Revenue change from making the retained ownership decision. The table below shows the expected net revenue impact of retained ownership for various COG estimates ranging from $1.20 to $1.50 per pound of gain.
Given the current COG and relative calf values retaining ownership through the feed yard seems to be a relatively less profitable choice against selling a weaned calf. The market appears to value an additional 600 pounds of gain at a little over $700/hd while the cost of that gain could range from $720 to $900.
Lamb prices have reached record highs over the past 18 months. One reason is growing lamb demand. Today’s figure is Google searches for phrases including or similar to “How to Cook Lamb.” Internet traffic on this topic has steadily increased since 2004. But, in general, searches for instructions on how to cook lamb have risen steadily, with sharp growth occurring since the pandemic.
Why the growth post-pandemic? Lamb was already growing in popularity, as evidenced by the search history in the chart above. Generational changes in tastes and preferences, as well as diversifying demographics led to sustained, though small growth in lamb consumption through the mid-2010s. Restaurants like Zoe’s Kitchen that offer Mediterranean cuisine and other restaurants like Arby’s began to increase lamb offerings on menus. But the real jump in consumption came during the pandemic, when the price of other protein products skyrocketed and those products became harder to find due to supply chain issues. Though lamb remains a relatively expensive protein product, the increase in the price of beef, pork, and chicken meant that lamb became relatively more accessible. Combined with more time at home, many consumers seemed willing to try cooking new meals – including lamb.
Finally, today’s chart illustrates the significance of holidays to the lamb market. The left-hand red line represents search traffic for how to cook lamb around Christmas in 2019, and the right-hand red line represents search traffic for how to cook lamb around Easter in 2020. Search traffic spikes each year around Christmas and a set of spring holidays which include Easter, Passover, and Ramadan. The spring period is an incredibly important season for lamb demand, which is why we focus on it around this time each year. Fun fact, the top searched phrase for how to cook lamb over the last two years was, “How to cook lamb in an instant pot?”.
Determining what to pay or charge for custom rates is a challenge in normal years. There is very little publicly available data on custom rates, and though many universities publish surveys of custom operation rates, they usually aren’t updated every year.
This year, rapidly rising input costs will likely compound the already challenging process of agreeing on what to pay for custom operations. However, we can estimate approximately how much we expect custom rates to increase based on the change in costs for two critical inputs: fuel and labor. Combined, these two inputs represent approximately 25% of the cost of field operations during an average year, with overhead (repairs, maintenance, depreciation, transportation, etc.) representing the other 75%.
Restructuring the economy post-COVID-19, supply chain disruptions, and mass movement of workers around the country all led to rapidly rising wages in 2021. The Bureau of Labor Statistics (BLS) reports that the cost of employment rose approximately 4.5% across the board and approximately 4.3% for farming occupations in 2021. Surveys of private firms suggest they are planning for wages to rise 3% to 5% in 2022; a nominal increase that does not keep up with the current rate of inflation, meaning that real wages would be down. On its own, a 5% increase in wages would represent a 1% change in the cost of custom operations to maintain profit margins, on average.
As recently as December 2021, the Energy Information Administration (EIA) forecast a modest increase in the average annual cost of WTI Crude from $68/barrel in 2021 to $73/barrel in 2022. However, cash WTI Crude is currently trading at $115/barrel. The recent war in Ukraine and Russia’s role in the global energy market led to a two-week spike in the price of WTI Crude, up from $90/barrel to $115/barrel. If prices remain at approximately $115/barrel, (many economists assume it will get more expensive before it gets less expensive) it will represent a 70% increase in the cost of crude over the 2021 average price. On its own, a 70% increase in the cost of fuel represents a roughly 10% increase in the cost of custom operations on average.
The table below shows the expected change in the cost of custom operations as a function of different WTI Crude values. The February EIA Short Term Outlook (which was published prior to the Russian invasion of Ukraine) placed the 95% confidence bounds on 2022 forecasted average price of WTI Crude at $40/barrel and $60/barrel. The cost of fuel and labor account for a different percentage of each custom operation’s cost, so the change in the cost of fuel impacts each category differently. If the cost of fuel remains at $115/barrel and wages do increase 5% year over year, we can expect all custom operations to cost 10% more than in 2021, with the cost of grain harvest up 10%, the cost of tillage up 12%, the cost of planting up 8%, the cost of chemical and fertilizer application up 6%, the cost of forage harvest up 19%, and the cost of hay baling up 12%. If you don’t utilize custom operators, you may also view these figures as the expected increase in cost to conduct these operations yourself.
Change in Cost of Custom Operations, 2021-2022, based on Different WTI Crude Prices and 5% Wage Increase
