While livestock contracting isn’t a controversial topic, Bernt Nelson said it’s been his main focus since arriving in Washington, D.C., to serve as the livestock economist for the American Farm Bureau Federation. At a USDA Forum held recently in Virginia, Nelson addressed the issue of market fluctuations and contracting.

“Contracting exists in all sectors of meat proteins,” said Nelson. “The mechanics are a little different and they operate more heavily in one sector than another. In comparing cattle to hogs and poultry, the biggest difference is that hogs and poultry both have vertical integration; the cattle sector does not.”

Most hog and poultry integrators own the animals and provide feed and veterinary care while the farmer supplies labor and management. The concept is to produce products economically and efficiently.

As he explained the contracting process, Nelson said that 70% of American pork is produced under some form of contract and about 75% to 85% of poultry production is under contract. The methods and terms of contracts vary by commodity, geographic region and the parties involved. Animals that are not contracted are marketed on negotiated cash trade or at an auction.

Because the cattle industry doesn’t incorporate vertical integration, contracting is different – and is also referred to as alternative marketing arrangements (AMAs). Nelson said this marketing has led to questions regarding transparency in the meat packing sector.

“The four largest packing companies in the country control about 85% of the market share,” he said. “Packing concentration has limited competition between packers, and it is our view that this has resulted in lower prices and has given the packer an advantage. The debate regarding policy in this area focuses largely on the use of contracts to adjust captive supply.”

Captive supply describes the cattle a packer has contracted under AMAs. Contracted and packer-fed cattle can shrink the cash market – the more contracts offered, the fewer cattle are sold on negotiated cash trade. A smaller cash market results in higher volatility in that market.

“With market volatility, there’s somebody on both sides of a market: a buyer and a seller,” said Nelson. “Sometimes volatility is a good thing, and sometimes it’s a bad thing. The U.S. cattle industry is largely regional, and the region depends on how a farmer sells cattle. This means policy solutions are not a one-size-fits-all.”

The current American cattle inventory is the lowest it’s been in 73 years. A USDA inventory report released in January showed cattle inventory at 87.2 million head, the lowest number since 1951. The report also showed the number of cattle on feed at 14.4 million, which is up 2% year over year.

“The cattle herd has been shrinking for over five years, yet the supply of cattle on feed has grown,” said Nelson. “Some of this may be due to natural market conditions. Seasonally, we’re going into a time of year where demand for beef is lower. Calf prices have gone up after falling hard in September, so there’s some incentive for placing cattle on feed. The other story is that the packer has been able to slow the speed of processing and increase the supply of cattle.”

Nelson explained that a large cattle supply helps manage the cost of purchasing cattle for processing. The longer processors can hold up supplies, the less they’ll have to compete to secure cattle. The result is a positive margin.

Beef cattle contracting challenges

Beef cattle operations saw an influx of young producers interested in the industry. Photo by Sally Colby

Potential solutions for market fluctuations over the last several years have been met with outside pressures. One view is to allow the market to compete as it should. Other perspectives suggest government intervention.

Outside pressure includes inflation that drives up supply costs along with increased corn prices. During COVID, feeder margins for cattlemen were red while packing margins skyrocketed.

“Then drought changed everything,” said Nelson. “We had back-to-back droughts after a triple-dip La Niña event. This damaged pastures and drove input costs up further. Farmers and ranchers had to decide whether to decrease herd size or go out of business.”

While the average age of farmers is 58, young farmers entering the market are an important sector. Nelson says 28% of beef cattle farms include a young producer – someone under 35 – involved in the business. The beef cattle sector also had the most new and beginning farmers.

One of the price solutions the USDA initiated is the Cattle Contracts Library Pilot Program. “This contract library includes mandatory price reporting and provides transparency to include the number of contracts in play,” said Nelson. This tool has been widely used, especially in regions that use AMAs.

Nelson said most solutions have focused on increasing market competition for more transparent price discovery. The use of AMAs is highly variable by geographic location. Contracted and packer-fed cattle shrink the cash market, creating greater volatility.

“We have an aging farm population with an influx of young farmers,” said Nelson. “They are facing obstacles to grow in continuity and in animal ag. If we look at USDA inventory projections for the meats sector across the board, we see decreases in inventory in every sector. The prospect of expansion is costly, and we’ve interest expenses go up as high as 43%.”

For aging farmers transitioning a young person into the business, the prospect of them purchasing cattle is currently expensive due to lower inventory. Borrowing capital requires taking on costly interest payments. With the cost of capital going up, there’s the potential, much like in the ‘80s, to create a liquidity problem.

“We have to unite and work together on this,” said Nelson. “Solutions to concentration and competition have to be unified to keep farmers farming and keep the U.S. livestock sector competitive in both domestic and global markets. Once we lose that market share, it’s a difficult road to get it back.”

by Sally Colby