Livestock News

Analysis: Bill on cattle price discovery may chill beef innovation

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The Cattle Price Discovery and Transparency Act was introduced in March 2021, after pressures wrought by COVID spotlighted difficulties faced in the beef supply chain. President Biden has brought new attention to some of this long-simmering discontent in his plan to boost competition in the meat industry.

However, a new analysis shows that the bill may hinder pricing innovations according to the Fryar Price Risk Management Center of Excellence. The center provides research in price risk management that improves decision making for farms and businesses. The U.S. Senate Agricultural Committee requested the center conduct an analysis.

The analysis, released this week, was authored by John Anderson, center director and head of the agricultural economics and agribusiness department for the University of Arkansas System Division of Agriculture and the Dale Bumpers College of Agricultural, Food and Life Science; James Mitchell, extension economist for the Division of Agriculture; and Andrew McKenzie, Fryar Endowed Professor in Risk Management, and associate director of the Fryar Center Price Risk Management Center of Excellence.

The bill is meant to address concerns about the use of market power to reduce fed cattle prices and inflate marketing margins, as well the quality of “price discovery,” the process by which buyers and sellers arrive at a price for an asset — the very thing on which markets function. 

The bill would set mandatory minimum thresholds for certain trade types in the five regional fed cattle markets. The regional markets, as defined by the U.S. Department of Agriculture, are Texas, Oklahoma and New Mexico as one region; Kansas; Nebraska; Colorado, each as their own region; and Iowa and Minnesota as a combined region.

Background

Fed cattle — those cattle that have left the ranch and are in feedlots — are mostly traded through “alternative market arrangements,” or AMAs, which are standing agreements between feeders and packers. Under an AMA, the sales price is established by a mutually agreed upon formula. In 2021, about 60 percent of these transactions were AMAs.

The second most common means for cattle to be traded is through prices negotiated directly between the feedlots and the packing plants. In this system, all animals in a pen generally receive the same price. Negotiated sales encompassed some 30 percent of sales in 2021.

The third, and least common means, is through forward contracts, which comprised less than 20 percent of all transactions in 2021.

While negotiating pen prices may be convenient, its downside was that inferior cattle were priced the same way as superior ones. That means it “does not effectively transmit market signals from buyers to sellers. In the beef/cattle industry, this meant that price signals about consumer preferences related to beef did not necessarily make it back to feedlots and cow/calf producers,” Anderson said.

“This put the beef industry at a significant competitive disadvantage relative to chicken and pork, whose more tightly integrated/coordinated supply chains conveyed market signals very efficiently,” he said. “Both industries took market share from beef throughout the 1980s and 1990s.”

AMAs began to overtake use of negotiated trades between 2005-15. In addition to providing incentives for cattle producers, “they have come to play an important risk management role for participants on both sides of the market,” Anderson said.

Over the decades, analysts have raised concerns about the relationship between AMAs and price discovery, including that AMAs depend on prior negotiated prices, such as the previous week’s reported live cattle prices. The decline in negotiated transactions and the rise in AMAs to amplify those prices has led to fears of mispriced cattle.

Potential effects of the legislation

The authors found that the House bill “runs the risk of stifling further innovation in pricing mechanisms in the fed cattle sector.”

By setting minimum thresholds, “by privileging an average pricing system in the sector, the legislation makes it less likely that innovations such as AMAs will be pursued,” Anderson said. “Innovations that might further reduce transactions costs and/or support further production changes to more closely align the beef end product with consumer tastes and preferences could be beneficial to maintaining and even growing beef demand in the future.”

The bill was also meant to address concerns related to price discovery due to smaller numbers of negotiated trades, known as a “thinning market.”

“The conceptual case for price discovery issues in the fed cattle market as negotiated transactions decline is straightforward; however, whether or not the market actually manifests problems with price discovery has been widely investigated over several years by many highly qualified researchers using a variety of different methods and data,” Anderson said. “This work has yet to yield consistent evidence of price discovery problems in the fed cattle market.”

While research has failed to document tangible benefits to the market from a higher level of negotiated trade, Anderson said that many market participants support encouraging more negotiated trade, feeling that such trade does offer intangible benefits to cattle producers such as assurance of a level playing field between smaller cattle feeders and larger meat packers. If more negotiated trade, for its own sake, is considered a worthwhile goal, that could probably be achieved through less costly means than the proposed mandate.

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