The Center for Agriculture Profitability (CAP) was asked by the staff of U.S. Senate Committee on Agriculture, Nutrition, and Forestry Ranking Member John Boozman (R-AR) to provide commentary related to current proposals surrounding mandating certain levels of negotiated cash trade in major cattle feeding regions.
Posted here is the executive summary of the report, which is a product of that invitation. The full report is accessible at the link below.Full Report (PDF)
There have been ongoing, yet mixed, concerns about the decline in negotiated purchases in the U.S. fed cattle industry and whether it has created a situation where the number of transactions has been insufficient to ensure efficient price discovery (Anderson et al. 2004). This problem, referred to as market thinness, creates industry concern because thin markets are more volatile (Hayenga 1979); are subject to price manipulation by large firms (Mueller et al. 1996; Xia and Sexton 2004; Zhang and Brorsen 2010); and exhibit observed prices that tend to deviate from the competitive price (Adjemian, Saitone, and Sexton 2016). Market thinness issues are further amplified when transparency regarding prices and how they are set are unavailable to market participants (Adjemian, Saitone, and Sexton 2016). This is referred to as price transparency. In situations where there are thin markets and low levels of price transparency, there are increased opportunities for firms to engage in strategic behavior. This occurs because contract negotiations are often private and public reporting of contract specifications and prices is not required thus limiting the amount of information to public participants. Most fed cattle market participants agree the level and percent of negotiated purchases have been thinning. However, they disagree on whether market thinness and its corresponding effects have created issues for the industry.
The discussion around market thinness and price transparency and its effects on the industry has been elevated by recent meat processing plant fires in Holcomb, Kansas, and Grand Island, Nebraska, and the slowdown and temporary closures of meat processing plants during the ongoing COVID-19 global pandemic. These events led to both federal and industry-proposed responses to solve some industry participants’ concerns. Three responses have been proposed: 1) greater transparency through the creation of additional public reports from the United States Department of Agriculture (USDA) reporting the base price for all cattle transactions, 2) greater transparency through the development of a cattle contract library detailing the use of all contracts utilized by the industry, and 3) reduced market thinness through implementing a minimum level of fed cattle that would need to be purchased in the negotiated cash or negotiated grid market in each United States Department of Agriculture-Agricultural Marketing Service (USDA-AMS) cattle feeding region. The third proposal is commonly referred to as “regional minimums”.
The first two proposals have been met with appreciation by most industry participants. The first response was implemented in August 2021 when USDA-AMS released three new reports publishing the base prices for all cattle purchases including formula and forward contracts. Before this, only net prices received were reported by USDA-AMS for cattle purchased on formula, negotiated grid, and forward contracts. These reports attempt to resolve concerns about the public reporting of private negotiations in marketing contracts. Additional improvements and reports by USDA-AMS under the Mandatory Price Reporting Act to expand on industry concerns about price transparency are expected in the coming years. Numerous congressional bills have been drafted to address the second proposal. In December 2021, the U.S. House of Representatives passed the Cattle Contract Library Act (H.R. 5609) creating a public library for all types, quantity of head, and specifications of each marketing contract by region. If passed in the U.S. Senate, it would further reduce concerns about a perceived lack of price transparency. The third proposal has generated a significant amount of debate over the last two years. In November 2021, the most recent version of regional minimums was introduced in both the U.S. Senate and the U.S. House of Representatives. These bills come after a failed attempt by the industry to increase the levels of negotiated purchases to levels sufficient to ensure adequate price discovery. Some regions did increase the level of negotiated purchases during this time compared to historical levels and further policies could be developed or implemented. The belief is that requiring a certain level of minimum trade by region will decrease market thinness such that prices reported by USDA-AMS approximate the competitive price. Bills advocating for mandatory regional minimums have received mixed reactions from industry participants and observers.
Advocates for regional minimums claim markets are too thin, reliable price discovery is no longer possible, and given market fundamentals, the USDA-AMS reported prices are different than what prices should be. They further claim the reporting of prices is a public good and if the industry has been unable to self-regulate, then there is a need for the federal government to regulate business practices. They believe with regional minimums in place, price discovery will be sufficiently high across all regions such that the observed price will approximate the competitive price. This process will allow for correctly communicated market signals along the beef complex. They acknowledge the potential added costs with these policies but justify the added benefits of price discovery offset these costs.
Opponents of regional minimums claim the increased use of alternative marketing arrangements (AMAs), and thus the reduced use of negotiated purchases, allowed meat processors to better communicate the level and timing of cattle quality through premiums and discounts awarded by cattle carcass attributes. They argue this incentive mechanism improved the quality of beef entering the market and increased the price levels for all market participants, not just the users of AMAs. It has also created incentives to find and purchase feeder cattle capable of earning these premiums leading to a greater reliance on predicted genetic performance and value-added practices. Opponents further point out that while negotiated purchases have declined, this can partially be explained by aggregate market fundamentals (e.g., cyclical changes in the cattle cycle, reduced packing capacity, etc.). Finally, opponents claim that while current levels of negotiated purchases are low, they have not reached sufficiently low levels to hamper robust price discovery. Opponents justify this by suggesting the hog industry has sufficient price discovery with less than 5% of total purchases in the cash market. Their primary concern is that if regional minimums were implemented, the minimums would negatively impact the supply chain of quality cattle increasing industry costs. These increased costs would ultimately impact consumer demand and potentially reduce the total value for all industry participants.
Given these contrasting views about the implementation and effects of proposed regional minimums on the U.S. beef complex, the purpose of this report is seven-fold. First, we review and compare existing legislation requiring regional minimums in the fed cattle industry. Second, we categorize key policy parameters for regional minimums. Third, we evaluate how current proposals align with historical market behavior and provide a sensitivity analysis for key policy parameters. Fourth, we show how a level of robust trade could be estimated. Fifth, we provide a few alternative specifications to the regional minimums that, if implemented, could accomplish the objective of providing robust price discovery in the fed cattle industry while maintaining cattle quality considerations. Six, we discuss some policy alternatives to regional minimums. Seventh, we conclude the report and provide some broad conclusions and implications.
The main findings of this study include:
- The frequency of the data used to create regional minimums determines how responsive regional minimums should be towards short- and long-term trends.
- The method by which the levels of robust trade are derived is an important decision on whether negotiated trade will resolve perceived issues of price discovery.
- The length of time regional minimums are required to be met determines how reactive regional minimums can be to changing market conditions.
Historical Alignment of Policies
- Ad-hoc specifications perform the poorest of all current policies suggesting, even at extremely low levels of required negotiated trade (i.e., <10%), no region would pass 100% of the weeks. This is largely an effect of non-reporting weeks and these situations should be clarified in future policies.
- Regional minimums based on past market activity are set by negotiated purchases occurring in CO or TX-OK-NM. No other regions set minimums. Increasing the level of weeks in the rolling averages decreases the number of weeks not meeting regional minimums.
- Increasing the number of weeks that are required to meet a percentage of negotiated trade is less restrictive than requiring a larger percentage of negotiated trade to be met each week.
- The previous analyses suggest there is some justification for making regional minimums different across regions and that these minimums should be flexible over time.
- The historical amount of trade within a region does not necessarily imply more trade will be required. Rather, it is the amount of variation in price that determines the amount of required trade.
- Estimating a robust level of trade requires the industry to consider the pricing accuracy (c; $/cwt.); probability of being accurate (P; %); and how price variation is modeled. If a rolling variance is used, then using a shorter rolling average combined with a lower level of and a higher level of would be required.
Alternative Specifications of Regional Minimums
- If regional minimums continue to be a policy priority, there are several different ways they could be specified. The tradeoffs in these are between requiring sufficient trade so price discovery is adequate while still allowing producers to market cattle in a manner they believe is profit-maximizing. These alternatives incorporate what industry participants voiced over the last year about equitable price discovery across regions and concerns about regional minimums affecting cattle quality.
Policy Alternatives to Regional Minimums
- The primary question to be addressed is whether there is inadequate price discovery. In this situation, the solution increases the level of negotiated purchases either voluntarily or by mandate. Even with improved price discovery, consideration needs to be given to what is driving the variation in prices reported for negotiated purchases. Explored policy alternatives seek to improve price transparency through changes in USDA-AMS reporting which may resolve some industry participants' concerns.
The main purpose of this report is to show how current and potential alternative specifications of regional minimums would have historically aligned with observed market behavior. However, the fundamental question in the debate of the validity and effectiveness of regional minimums first rests on whether robust price discovery has historically occurred over time and within each USDA-AMS region. If there has been a lack of price discovery during certain times of the year or systematically within certain regions, then creating regional minimums is one alternative to increase negotiated trade to robust levels. Thus, if either of these two conditions are met, then one should not expect any formulation of regional minimums to match historical market behavior. This does not necessarily imply regional minimums are poorly constructed or would be ineffective at increasing price discovery. On the contrary, to create regional minimums so that they matched historical market behavior considering either of these two conditions would be counterproductive to the objective of increasing negotiated trade to a robust level. Rather than solving issues of price discovery, the enacted regional minimums would only continue permitting deficient levels of price discovery to persist under the guise of “improved price discovery”.
As with all policies, benefits and costs may not be equally shared along the supply chain. This analysis does not take an opinion on whether regional minimums are a net benefit or a net cost to the U.S. beef complex nor does it attempt to quantify these impacts, of which there are likely many. But rather, its primary purpose is to compare proposed solutions and show how current and potential alternative specifications of regional minimums would have aligned with historically observed market behavior.Read the full report.