Historic, Archive Document Do not assume content reflects current scientific knowledge, policies, or practices. nited States An Economic Research Service Report Department of Agriculture ■8 U.S. Beef Industry Technical Bulletin Cattle Cycles, Price Spreads, Number 1874 and Packer Concentration Kenneth H. Mathews, Jr. Lawrence A. Duewer William F. Hahn Ronald A. Gustafson Kenneth E. Nelson vr It’s Easy To Order Another Copy! Just dial 1-800-999-6779. Toll free in the United States and Canada. Ask for U.S. Beef Industry: Cattle Cycles, Price Spreads, and Packer Concentration (TB-1874). Charge to your VISA or MasterCard. For additional information about ERS publications, databases, and other products, both paper and electronic, visit the ERS Home Page on the Internet at http://www.econ.ag.gov/ National Agricultural Library Cataloging Record: U.S. beef industry : cattle cycles, price spreads, and packer concentration. (Technical bulletin (United States. Dept, of Agriculture) ; no. 1874) 1. Beef industry-United States. 2. Beef cattle-Prices-United States. 3. Packing-houses—United States. I. Mathews, Kenneth H. II. Title. HD9433.U62 The U.S. Department of Agriculture (USDA) prohibits discrimination in its programs and activities on the basis of race, color, national origin, gender, religion, age, disability, political beliefs, sexual orientation, and marital or family status. (Not all prohibited bases apply to all programs.) Persons with disabilities who require alternative means for communication of program information (Braille, large print, audiotape, etc.) should contact USDA’s TARGET Center at (202) 720-2600 (voice and TDD). To file a complaint of discrimination, write USDA, Director, Office of Civil Rights, Room 326-W, Whitten Building, 14th and Independence Ave., SW, Washington, DC 20250-9410, or call (202) 720-5964 (voice or TDD). USDA is an equal opportunity provider and employer. U.S. Beef Industry: Cattle Cycles, Price Spreads, and Packer Concentration. By Kenneth H. Mathews, Jr., William F. Hahn, Kenneth E. Nelson, Lawrence A. Duewer, and Ronald A. Gustafson, Market and Trade Economics Division, Economic Research Service, U.S. Department of Agriculture. Technical Bulletin No. 1874. Abstract In early 1996, the peak in the current cycle of cattle inventories coincided with a long list of negative factors—negative returns at the farm and feedlot, record-high feed grain prices, a severe drought in 1995-96, widening farm-retail price spreads, a low farmers' share of the consumers' Choice beef dollar, and reports of high profits for beefpackers. This confluence created an atmosphere in which some producers and members of Congress questioned whether the cattle industry was adversely affected by high packer concentration and market power. In this report, we examine the cattle cycle of the 1990's to determine if there are differences from previous cattle cycles and, if so, how and why they are different. We found that values for many variables at the 1996 cyclical peak in cattle inventories, while bad, were not the worst on record. Further, price levels during the cattle cycle of the 1990's were better, our models suggest, than they could have been, given earlier patterns of price adjustment. Finally, despite the growth of packer concentration, we failed to demonstrate large negative effects of packer concentration on cattle prices during the 1991-to-present cattle cycle. Keywords: Cattle cycles, price spreads, packer concentration, cattle slaughter, steer and heifer slaughter, and cow slaughter. Acknowledgments The authors appreciate the helpful comments of Dr. Jim Trapp (Oklahoma State University), Dr. Wayne Purcell (Virginia Polytechnic Institute and State University), Dr. Jim Mintert (Kansas State University), as well as reviewers from the U.S. Department of Agriculture, Grain Inspection, Packers and Stockyards Administration, Roger Schneider and Larry Haller, and Economic Research Service, Dr. Mike Ollinger and Dr. John Dyck, and the editor, Sharon Lee. Wynnice Pointer-Napper prepared the charts. Washington, DC 20036-5180 April 1999 Contents Page Summary. iii Introduction . 1 Characteristics of Cattle Cycles . 3 Cattle Inventory Adjustments. 5 Weather Effects . 5 Grain and Beef Trade Effects. 6 Cropping and Commodity Program Effects . 6 Beef Industry Structure Effects. 6 Demand Effects . 6 Price Spreads . 7 Beefpacker Concentration. 9 Comparing the 1990's With Past Cycles of Cattle Inventories . 11 Data . 11 Statistical Comparisons of Cycles . 13 Means, Variances, and Coefficients of Variation . 13 Relative Changes in Selected Variables from Previous Cattle Cycles .... 14 Correlations. 15 Price Spreads and the Cattle Cycle . 18 Long-Term Fluctuations . 18 Short-Term Fluctuations . 18 General Structure of a Price Spread Adjustment Model . 21 Estimation Results and Interpretations. 24 Simulations and Forecasts With the Asymmetric Model. 25 Concentration Measures for the Beef Packing Industry . 30 SCP Studies. 30 NEIO Studies . 30 GIPSA Conclusions. 30 Empirical Measures of Packer Concentration. 31 Conclusions. 37 References. 39 Appendix table-Data Series for Cattle Cycle Analysis . 41 Appendix-Our Asymmetric Model of Price Movements. 42 ii U.S. Beef Industry/TB-1874 Economic Research Service/USDA Summary Is the cattle cycle that began in 1991 worse than previous cycles? This is the question that some financially stressed cattle producers asked when they called on the Federal Government to intervene in cattle markets. This report, a study of relationships among cattle cycles, price spreads, and market concentration, concludes that the 1970's cattle cycle was worse for ranchers than the current cycle, and that farm prices in the current cycle may actually be better than one might expect. Cattle producers generally accept cattle cycles. However, in 1996, a combination of events created an atmosphere in which some producers charged that the cattle industry was adversely affected by high concentration and market power of beef¬ packing firms. These events included low cattle prices and widening farm-to- retail beef price spreads, a low farmers' share of the consumer spending on Choice beef, negative returns to cattle producers, and reports of high profits for beefpackers. In addition to these perceptions, peak cattle inventory numbers for the cattle cycle of the 1990's coincided with record-high feed grain prices. The U.S. farm price of com, which averaged $2.26 per bushel in 1994/95, rose to a peak of over $5.00 in July 1996. Further, the severe drought in 1995 and 1996 in some major cattle-raising areas forced many producers to reduce cow herds as forage supplies declined. Allegations were made that packers were using their market power to lower bids for cattle, thus lowering prices that producers received. Several test results indicated that the link between the cattle cycle and increasing concentration in the beefpacking sector runs counter to these perceptions. The study results indicate that the cycle of the 1970's was worse than the cycle of the 1990's, with average estimated losses for cow/calf producers almost twice as bad per cow at the low point in the 1970's as in 1996. Further, while overall price spreads for Choice, yield grade 3 steers are growing wider over time, the farm-to- wholesale portion is only slightly wider than its narrowest levels since at least the 1970's in nominal dollars. In real dollars, the spread is at its narrowest levels since before the 1970's. Test results showed no evidence to support the assertion that increasing slaughter concentration results in lower farm prices. The wholesale-to-retail portion of the price spread is growing because of costs for additional packing services and new products in the packing industry. Economic Research Service/USDA U.S. Beef Industry/TB-1874 iii The U.S. Beef Industry Cattle Cycles, Price Spreads, and Packer Concentration Kenneth H. Mathews, Jr. William F. Hahn Kenneth E. Nelson Lawrence A. Duewer Ronald A. Gustafson Introduction Cattle producers generally acknowledge the existence and importance of the cyclical behavior of cattle inventories, which have peaked in the United States about once a decade for the last century. Many cattle producers say, however, that conditions during the cycle that began in 1991 are worse than conditions during previous cycles. In 1996, a combination of conditions created an atmosphere in which some producers charged that the cattle industry was adversely affected by high concentration and market power of beefpackers (U.S. Department of Agriculture, 1996). These conditions included: (1) low cattle prices combined with widening farm-to-retail beef price spreads, (2) a low farmer share of consumer spending on Choice beef, (3) negative returns in the feeder and fed cattle markets, and (4) reports of high profits for beefpackers. In addition to these perceptions, peak cattle inventory numbers for the cattle cycle of the 1990's coincided with record-high grain prices. The U.S. farm price of corn, which averaged $2.26 per bushel in 1994/95, rose to a peak of over $5.00 in July 1996. In addition, severe drought in 1995 and 1996 in some major cattle-raising areas forced many cow-calf producers to reduce cow herds as forage supplies declined. Packers were accused of using their market power to lower bids for cattle, thus lowering prices for producers. Some financially stressed livestock producers pressed for government intervention in cattle markets. This report presents results of a set of related analyses designed to bring perspective to the allegations and the debate surrounding cattle cycles, price spreads, market concentration, and the interactions of the three. One objective of this study is to test the hypothesis that conditions at the turning point in this cattle cycle of the 1990's were no more severe than those of past cattle cycles in terms of inventory, price, price spread, or net income effects. Results from tests of this hypothesis indicate that the cycle of the 1970's was actually much worse than this cycle of the 1990's, with average estimated losses almost twice as much per cow at the low point in the 1970's as in 1996 for cow/calf producers. Further, while overall price spreads for Choice, yield grade 3 steers are growing wider over time, the farm-to-wholesale portion is only slightly wider than its narrowest levels since at least the 1970's in nominal dollars. In real dollars, the spread is at its narrowest levels since before the 1970's. We found no evidence to support the assertion that increasing slaughter concentration results in lower farm prices. The wholesale-to-retail portion of the price spread is growing because of packing-industry costs of added packing services and new products. We begin this report with a background section where we describe and characterize cattle cycles and price spreads. We also present a historical sketch of increasing packer concentration and provide statistical analysis of the current cattle cycle. Accompanying economic data are examined to see if there are statistically significant differences from previous cattle cycles. We find that the most recent cycle's turning point is within the bounds associated with Economic Research Service/USDA U.S. Beef Industry/TB-1874 1 previous cycle turning points, especially with respect to cow/calf profitability measures. Other cycles offer examples of more extreme values for selected variables like rates of change in cattle inventories, net returns per cow, and duration of various phases of the cattle cycle. The next section of the report returns to price spreads and focuses on the relationships between price spreads and both the cattle cycle and packer concentration. The section begins with some general observations on the long-term and short-term behavior of price spreads. The model, more fully described in Appendix B, is an asymmetric model of three equations to characterize net farm, wholesale, and retail Choice beef price movements. We modified the model in several ways to examine interactions between prices at different levels in the farm-to-retail chain, as well as effects of the cattle cycle and packer concentration on price spreads. The asymmetric character of our model comes from a specification incorporating supply and demand variables that allow differences in the magnitude and speed at which prices adjust either up or down. Economists have estimated many models where the farm price moves first and drives the wholesale price, which in turn drives the retail price. Rather than pick the farm level (or any other) as the primary driver of all prices, our asymmetric model allows the retail, wholesale, or farm price to drive the others, and allows for complex interactions where all prices adjust simultaneously to movements of the others. Combining the price spread work with cattle cycle phenomena, we find only small cattle cycle-related effects on price spreads. We also find that, rather than being too low or wide, prices may not have been as low and price spreads may not have been as wide as model results indicate they could have been. The last section of this report describes results from previous studies and the measures we developed and used to measure packer concentration. Then, we assessed these measures through the 1991-to-present cattle cycle. These measures did not indicate that increased packer concentration adversely affected cattle markets. This section includes the results from modifying our asymmetric model to test for packer concentration effects on price spreads. We end the report with a brief section containing our conclusions and some possible implications. 2 U.S. Beef Industry/TB-1874 Economic Research Sendee/USD A