December 21, 2016

A new day dawns for US beef: Low feed costs, a strong market rally reverse a forty-year downtrend
An eFeedLink Hot Topic
  • High cattle prices initially caused a retention of heifers and calves, causing 2015 inventories and beef production to go in opposite directions
  • During a 1.5 market retreat, farmers released cattle as soon as they could. It minimized finishing weights but pushed slaughter and beef output up 5%
  •  High cow/calf returns are keeping their culling at minimal levels. Beef cattle numbers rose over 3% even as overall inventory growth tapered off.
  •  With US beef output rising and Australian herds depleted, there is opportunity to seize market share
A frothy, mid-decade record setting rally in US cattle futures is dead and gone, but the much needed American beef sector renaissance it kick-started carries on. From their record highs of US$170/head in late 2014, live cattle futures bottomed out at US$100/head in the fourth quarter of 2015 before rebounding to near US$115/head near the end of 2016.
Previously American beef cattle farms endured the 2000s with prices only 20% above their 1990s average, while facing feed costs up to 350% higher. Thereafter, the early 2010s saw a multi-year drought coincide with feed costs hitting record highs.
In retrospect, this induced a final, sharp bottoming out to a four decade secular decline in America's cattle herd. From their 1975 high of 130 million, they fell to 88.5 million head just as rising export demand and the stable domestic consumption suddenly made for a shortage of cattle. America's forty-year decline in beef consumption bottomed out and cattle inventories were now too low to keep pace with export demand or America's own population growth.
The resulting 2013 to 2015 cattle price rally coincided with feed costs falling by up to 60%, thereby providing the best beef farming returns seen in decades. A powerful incentive to restock herds took hold, especially after late 2015, when the multi-year drought finally broke in some US pastureland areas. With farmers eager to rebuild their herds, the period from 2014 through late 2015 was keynoted by high heifer and calf retention rates.
With cattle requiring years to reach maturity, the impact of record prices and fat returns are felt long after a rally is spent and the last year and a half has been no exception. From its 2013 secular low of 88.5 million, America's national cattle herd stabilized, rising 0.7% in 2014 to 89.1 million head.
Thereafter, with retained heifers giving birth, 2015 saw America's cattle herd rise 3.2%, the fastest in three decades to just under 92 million head. –But there was a price to pay for this expansion: With farmers determined to expand herds, the number of cattle slaughtered fell 5% and so did 2015 beef production. With finishing weights rising, beef production fell by slightly less, down 2.3% to 10.817 million tonnes, down from 11.085 million in 2014.
It was the first time American beef production had fallen below 11 million tonnes since 1993 –but also the 11th time in fifteen years that US beef production had declined. However, with per capita consumption having fallen even more steeply than demand over the past 15 years, supply overtook consumption in the late 2000s. For a while, America was both the world's largest beef exporter and for one of the few times ever, a net exporter of beef too.
Within a few years, the above-mentioned drought and high feed prices induced a mass slaughter that ended its short reign as the top beef exporter and made it a net importer again. Imports increased from 0.93 million tonnes in 2011 to 1.52 million tonnes in 2015, before the past year's inventory increase (and higher beef production) beat them back to 1.37 million tonnes in 2016. Even here however, echoes of the mid-decade cattle price rally are having an impact.
Over the last 1.5 years, many cattle conceived during the 2014 price rally matured at a time when prices were in a two year downtrend. The only rational thing to do was to sell maturing cattle as quickly as possible, lest prices fall further. Consequently, 2016 saw slaughter rates rebound 5.3% from their previous year's previous decline and total 30.86 million head. This enabled beef production to rebound a strong 5.3%, to 11.39 million tonnes.
With the herd increase decelerating, the rise in slaughter rates is also tapering off. For 2017, slaughter is projected to rise another 2.6%, to 31.66 million head out of an estimated national herd of 94.6 million. While this is the highest slaughter number since 2013, the actual rate is 11.1% lower: 2013's slaughter of 33.4 million, which was from a smaller herd of 88.50 million head.
Going forward however, the industry consensus is that cattle prices have bottomed out and are poised to rebound, though nowhere near the record levels of 2014-15. However, even if cattle stay at the high end of their early 2010s price range, feed costs are less than half what they were in late 2012. With pastureland conditions improving, profit margins remain substantially better than they were at the turn of the decade.
The prospect of no more deflation and adequate beef cattle rearing returns is expected to have a positive impact on finishing weights and cow maturation time. With margins still profitable and no fear of prices falling substantially further, farmers are feeding cattle to 1.1% higher finishing weights (though this may turn out to be too conservative USDA estimate).
Thus, 2017's 2.6% increase in slaughter is expected to disproportionately boost beef production by 3.7%. If prices stabilize or start trending upwards, finishing weights could be pushed higher, making for a beef production increase of 4% or more.
Moreover, with margins remaining healthy, farmers are being choosey about the type of cattle they are slaughter, preferring to focus on mature steers. Although 2017's US cattle herd will be 6.9% larger than it was at its 2013 secular low, calf slaughter will total 440,000 –44% fewer than in 2013 and unchanged from 2016 levels. Similarly, the number of cows slaughtered will only increase 1.3%, which is only half the overall increase in cattle slaughter.
It reflects the fact that returns on herd-boosting, cow-calf pairings are at secular highs. Exceeding a Rabobank estimated US$500/cow in both 2014 and 2015, cow calf returns have fallen up to half but are still several times higher than their sub US$100/cow average return for the years 2000 through 2013 inclusive. Hence, the proclivity to retaining animals capable of expanding cattle herds in the future.
This shows that with market deflation over, US cattle ranchers are investing in younger cattle. This clearly implies they are already investing in an anticipated future upturn in cattle numbers –and to be more specific, in larger beef cattle herds. Last year saw the rate of cattle herd increase fall from 3.2% in 2015 to 1.6% in 2016.
But when breaks down the numbers further, actual beef cattle inventories bucked the trend, rising a strong 3.5% in 2016, from 29.3 million to 30.33 million head. This exceeded the expectations of most industry watchers.
Rabobank for example, correctly predicted that the longterm decline in US cattle numbers had ended, but expected beef cattle to total less than 29.5 million head in 2016, not 30.33 million. –Clearly farmers used the market downturn to cull cattle not dedicated to beef production, such as older dairy cows, which have endured far worse and more enduring deflationary conditions than the beef and cattle market.

With domestic beef production rising 1.9% faster than consumption in 2016 and 1.1% this coming year, America's gap between beef supply and demand is rapidly closing. After drought and high feed costs pushed imports up 64% from 2011 (0.93 million tonnes) to 2015 (1.53 million tonnes), rising domestic production is reducing them by 20.3% over two years, to 1.37 million tonnes in 2016 and a USDA projected 1.22 million tonnes in 2017.
The sustained increase in America's cattle herd made possible not just a reduction in imports but an 8.9% increase in exports, from 1.028 million tonnes in 2015 to 1.120 million tonnes in 2016, the first yearly rise in exports since 2013.
Interestingly, 2017's USDA forecast of a 6.5% rise in exports to 1.193 million tonnes has much potential to be exceeded –but also carries a slightly smaller but real of being too optimistic.
On one hand, thanks to high breeding returns kick-started by US cattle's earlier rally, a 2014 through end-2017 increase of 6.1 million cattle head coincides with an aggressive culling of Australian cattle. Cornered between low dairy prices and a nasty drought, Australian cattle herd fell by 2 million head from 2015 through 2016.
While Australia's culling caused a short-term surge in the country's beef exports, with its cattle numbers depleted, shipments are falling by more than 28% in two years, from 1.85 million tonnes in 2015 to a projected 1.33 million tonnes in 2017. With New Zealand undergoing a dairy market induced crash in its own cattle numbers, total Australian and New Zealand beef exports will have fallen by over 610,000 tonnes in two years.
While world beef exports are nominally higher than they were in 2015, most of the increased production either came from Brazil or India. The former has a reputation for lower grade meat while the latter's beef exports are lower quality cuts derived from buffalo. This left the world market several hundred thousand tonnes short of high quality beef –just in time for America rising, newly rebuilt cattle inventory.
This means that 2017 is bound to see US beef increase its market share in large Asian importers like Japan and South Korea, which traditionally relied on Australian beef for the bulk of their imports. With China also recently re-opening its market to US beef, the shortfall in Australian and New Zealand supplies means that with a little luck, US beef exports could total closer to 1.3 million tonnes than the 1.2 million being currently forecast.
Of course, with the US dollar rising sharply since the election of Donald Trump, there is a possibility that this macroeconomic trend could price some US beef exports out of Asian markets. The good news is that unlike India or Brazil, most US beef is exported to wealthy Asian markets. Moreover, its high quality beef exports occupy the top tier of the world market, where demand is less likely to fall by much because of price increases.
Hence, while US beef is (as usual) at the mercy of its expensive dollar's currency movements, market fundamentals still favor exports to come in above the forecasted amount. More importantly, the prospect of steady, positive beef farming returns and slow, steady increase in longterm inventories means that after decades of decline, American beef cattle are in a solid rebuilding phase. With demand for beef growing far faster outside America than inside its own borders, the country's transition from historical importer to net beef exporter seems assured.

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