Factors that Contributed to Transition in the U.S. Beef Market
Prices don't seem quite as rosy as they did a couple of years ago. We've come down from some of the highest highs we've ever seen. Now, the reality of harder times stares us in the face. How did we get here? That could be an article in itself, but we'll attempt to lay out a 30,000-foot view for you as it relates to the beef sector.
In 2004 and 2005, producers started to slowly build beef cow numbers. Drought came knocking in 2006, halting expansion. Beef cow numbers declined until 2014 due to financial crisis as well as droughts again in 2011 and 2012.
After the recession, producers paid off debt and better positioned themselves for the future. As consumers' financial positions improved, demand increased. At the same time, a weak U.S. dollar made our beef relatively cheap to our international customers, further increasing demand. This whirlwind of events worked to drive prices up. Then, rains finally came and forage was replenished in predominate beef production regions. Producers had the chance to respond with increased production, and they did by increasing cattle numbers at a historically strong rate. With geopolitical unrest in 2015, the U.S. dollar strengthened, leaving more beef here at home at just the time producers had supplied more calves. Record crops had made feed cheap, so there was also more protein (beef, pork, chicken) available across the board. With an increased protein supply, competition increased as well. Since feed was cheap, calves were grown to record weights in 2015, which only exacerbated the situation of declining cattle prices. While cattle numbers have increased at a historically strong rate, the U.S. dollar has maintained its strength as well. As cattle numbers are expected to increase over the next few years, prices are also expected to decline. Hopefully, most of the price decrease has been realized already. Even though cattle prices have declined significantly from the highs, they're very similar to the prices we observed in 2010, which were considered strong prices at the time.
Wheat has been a somewhat similar story. Wheat prices were stronger in 2012 through 2014, allowing U.S. wheat producers to have substantially higher net cash income. Now, prices have declined to levels more similar to the early and mid-2000s. This has brought wheat producers' average net cash income down by more than 55 percent since 2014. Mark Welch, Ph.D., at Texas A&M University points out it is not uncommon for wheat prices in a new price era to drop back down to the highs of the previous price era, which is what has occurred (Figure 2).
Even though current prices are not all that dissimilar to what we've seen in the past five to 10 years, perhaps we feel more pain because production expenses have not decreased at the same rapid rate that our commodity prices have declined. This has put a crunch on net farm income. Looking at real net farm income (which accounts for general price level changes over time), 2016 net farm income was forecast to be the lowest since 2002 (Figure 3). This is a decrease of 18 percent from 2015 to 2016 and a 47 percent decrease since the high in 2014.
Nominal vs. Real Price
So what is "real" price? We often think of price as just price, but it is true that a dollar today doesn't buy what it used to. For this reason, we have nominal prices and real prices. Nominal price is the price just as you see it on the shelf in the grocery store today. It does not account for the changing value of money. Real price is the nominal price adjusted for the changing value of money. The annual Consumer Price Index (CPI) value is published each year by the U.S. Bureau of Labor Statistics and is used in converting the nominal price to the real price. Using the real price allows us to compare throughout time the buying power of our money. That's why, in evaluating net farm income, we used the adjusted real value. It allows us to compare net farm income throughout time to see if we are truly better or worse off than some period before.
Examining farm financial indicators (asset turnover ratio, operating profit margin, current ratio, etc.), we see a similar story. Overall, the financial condition of the industry has declined over the past couple of years. Just because the financial situation has weakened some does not mean we are in a bad spot though, certainly not back to what was experienced in the early 1980s. Purdue University agricultural economists Mike Boehlje, Ph.D., and Chris Hurt, Ph.D., make a few key points in their article "The Financial Crisis: Is This a Repeat of the 80's for Agriculture?" as to why we are not facing what we did in the 1980s. First, as opposed to the early 1980s, we have relatively low interest and inflation rates. Second, debt levels are much lower. The debt-to-asset ratio peaked at 22.2 in 1985 but was just 13.18 for 2016. This indicates a much stronger equity position across the industry. Third, we have liquidity. However, available working capital on hand to repay liabilities has rapidly deteriorated over the past couple of years as agricultural prices have decreased. Thankfully, many producers entered this period with a better liquidity position, which should help them be more financially resilient in this transitional market. Fourth, recent strong incomes help cushion this windfall. As compared to the late 2000s when grain/crop farmers earned the majority of the income, the cow-calf sector in particular has enjoyed record-high returns leading up to this time point in the market. A strong financial reserve held back can offer one of the best ways to manage through a transitional market.
Price recovery will be slow in feed grains over the next couple of years as we work through the large U.S. and world inventory that is currently on hand. Having cheap feed will promote animal feeding, furthering the continued abundance of available protein. The U.S. is a safe haven for the dollar; it is expected to remain strong and, in turn, lower the export of our products. Barring outside influences, there will be no abrupt turnaround in grain or livestock prices within the next year or two.
Not all hope is lost. We have tools to lean on and guide us through this market as it makes its transition downwards. The agriculture industry is known for its resolve and determination, and it will be no different this time. Some things, such as commodity prices received, may be out of our control, but we do have the ability to manage our production and its associated expenses.