Weakening Drought and Economic Incentive Turns Attention Toward Expansion

by Ethan Oberst, CattleFax Analyst

Summary
The most recent United States Department of Agriculture (USDA) drought monitor shows a large portion of the country is recovering from drought. However, the drought still continues in the west, mainly in California with dry areas across the south and southwest. The Pasture and Range Condition Index also indicates the U.S. has seen significant improvement in moisture conditions. The index is a weighted average based off of the number of cattle in each state and the percent of each state that falls under one of USDA’s ratings: very poor, poor, good, fair, excellent. 

Background
As seen in the index, the U.S. as a whole has seen conditions comparable to the favorable weather of 2010. All regions are seeing improved conditions compared to the historically dry 2012, and most have seen improvement over 2013 range conditions. Seasonally, there is a decline in the range conditions entering the first of July (27th week), however this year due to a cooler and wetter July, the range conditions have held steady to only slightly declining, giving cow-calf producers even more reason to think about expansion. Optimism for more moisture has been supported by the El Niño weather pattern possibly strengthening moving into the fall. 

Discussion
The El Niño weather pattern, occurring in the Pacific Ocean, continues to develop, which means extended cooler, wetter weather for some parts of the country and warmer, drier periods for others. The El Niño episodes are defined by the warming of the Pacific Ocean that causes a change in weather patterns for countries bordering the Pacific Ocean. El Niño’s effect on North America occurs in the form of a warmer, drier winter in the north and a winter that is wetter than normal in the south and southwest; possibly allowing California to see some adequate relief. 

The economic incentive to expand is also present as the calf supply shortage and record high cattle prices across all segments has caused the calf market to continue to make record highs. The high demand for calves has been fueled by calf users experiencing record profits over the last year, low costs of gain due to less expensive corn and improved weather increasing feed resources across all regions of the country. The 2013 average price received for a 550-pound steer was $168/cwt, while the year-to-date average for 2014 is currently $227/cwt, an increase of $59 over last year. With the supply shortage continuing into the fall, prices could push even higher. The CattleFax average estimated price for 550-pound steers for 2014 is $240/cwt and the 2015 estimate is $255/cwt. As with a typical cattle cycle, the economic incentive is the main driver for cow-calf producers to start the expansion process after the liquidation phase has reduced supplies enough for there to be an economic incentive again. With record profits in the cow-calf segment the economic incentive to expand is present. 

The cattle cycle has not seen a significant expansion phase since the 1991 to 1996 expansion, increasing by 1.7 million cows (2004 to 2006 expansion was cut short by drought in the Southern Plains). Expansion can happen on two fronts, retaining heifers for breeding stock as well as maintaining the cows currently in the herd through a reduction in culling percentage. Looking at the 1991 to 1996 expansion data for both of the areas mentioned it is evident that expansion started off with a large reduction in cow slaughter in 1991 by 14.7 percent. Also in that time period there was a reduction in the cow cull rate - down to 8.3 percent. A cow cull rate near or under 9 percent is a significant indicator when discussing possible expansion. The historical average cull rate is 10.1 percent measuring back to 1975. Pairing that reduction with the increase in the number of heifer replacements held is a strong indicator of an expansion phase. From 1991 through 1995, there was a year-over-year increase of heifers held with intentions of entering the cowherd. When the replacement heifers held equals 18 percent or more of the total beef cow herd it is worth noting. In the1991 to 1996 expansion that number was near or over 18 percent. 

We can compare the same indicators for the current proposed expansion phase. Replacement heifers with intentions of entering the cowherd have been increasing year-over-year since 2011. Since 2012, the percentage of replacement heifers of the overall beef herd has been near or over 18 percent. The industry has been showing heifer expansion for several years now, but most recently has spilled over to the mature cows. The cow cull rate has been slowly declining for the last several years, meaning that ranchers are culling a smaller percentage of their herds. However, there has been a major transition in the last several months toward expansion, as weather has cooperated this past spring and summer. Looking at the chart, there has been a move from a cow cull rate and ultimately a cow slaughter rate that would be typically seen during a non-expansion year to a rate more commonly seen during an expansion year. 

This year’s cull rate is expected to be below 10 percent and in 2015, well below 9 percent. Another indicator that expansion is on the horizon can be seen in the years when heifer slaughter percentage of total fed slaughter is around 35 percent. That was seen in the ‘91-‘96 expansion and slightly in the ‘04-‘06 expansion. There has been a year-over-year decrease since 2010 and it’s anticipated to dip to the 35 percent levels by year’s end.

Conclusions
It is clear that the cow-calf segment is entering an expansion phase powered by both the stout economic conditions we have seen as well as Mother Nature relieving a majority of cow country with much needed rains. As the strong economics are expected to continue, the expansion will weigh heavily on the weather. If pasture/range conditions and feed resources can find enough moisture to support a larger cowherd then we will see an expansion that could last several years.  

Additional Resources

Tags: Beef Issues Quarterly, Fall 2014, Issues Updates

October 4, 2014