Retained OwnershipValue Added
John Marsh
Professor
Department of Agricultural Economics and Economics
Montana State University
July 2006
Montana Branded
Beef Association
1
Preface
The following analysis illustrates the potential to hedge the base
price in value-based or grid pricing of fed slaughter cattle. Producers
face numerous risks when retaining ownership of calves for finishing
purposes. Producers with high quality fed cattle can improve their
returns using grid pricing because of premiums paid, which, on
balance, may provide higher returns than those based on average
pricing of fed cattle.
As live (fed) cattle prices vary, so do base prices in the grid
formula. The following demonstrates the potential to cross hedge the
grid base price using the live cattle futures contract. The prices and
costs used in the analysis are based on those observed in the cash
markets and futures markets in July 2006. As of November 2006 these
prices have substantially changed. Producers should be able to
substitute their own prices/costs in the worksheet formulas for personal
evaluation of retained ownership decisions. Assumptions used in the
analysis could describe a typical operation, but they will vary
according to individual producers.
2
Alternatives Cow-Calf
Producers
• Sell-calves (weaning)
• Retain-background (lighter calves)
• Retain-finish (heavier calves)
Sell fed cattle liveweight or on the grid
(value based)
3
Breakeven Analysis
• Breakeven (BE) sale price of feds, liveweight basis:
BE sale ($ / cwt ) 
Feeder calf cost ($/head)  Cost of gain ($/head)
Ending Weight
• Futures hedge price greater than BE sale price is return
to ownership including risk.
• Breakeven (BE) buy price of feeder calves:
BE buy ($/cwt) 
Fed cattle revenue ($/head)  Cost of gain ($/head)
Beginning Weight
• Market feeder calf price less than BE buy price indicates
potential returns to retained ownership.
4
Risk Factors
• Occur because of changes in market
demand, supply, and stochastic
factors.
• Variance in prices of fed cattle, feeder
cattle, and feed (Figures 1 & 2).
• Feedlot rate of gain.
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Figure 1: Fed Cattle Price, 2000-2006
$/cwt
120
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Year/Month
Fed Steer
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Figure 2: Corn Price, 2000-2006
$/bu
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Year/Month
Corn
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Risk Factors, cont.
• Quality and yield grade performance
• Variance in carcass and boxed beef
prices—relationship to grid base.
Manage risk through contracting and
futures/options.
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Hedging Sale Price
• Use live cattle futures to directly hedge
liveweight sale of feds.
• Use live cattle futures to cross hedge
grid base price of carcasses (if possible).
• Requires high correlation between live
cattle futures price and beef carcass
price.
• Correlation coefficient of 0.90 (Figure 3).
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Figure 3: Boxed Beef Price and Live Cattle Futures, 2000-2006
$/cw t
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Year/Month
Boxed Beef
Futures
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Example of Cross Hedge
• Wean calves November 2006,
background/finish calves until following
June 2007 (205 days)
• Beginning weight = 575 lbs.
Ending weight
= 1,200 lbs.
Rate of gain/day = 3.05 lbs.
• Cost of gain = $0.54 lb x 625 lbs gain =
$338/hd (background and finish)
• Use live cattle futures contract, choice
grade cattle.
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Example of Cross Hedge,
cont.
• Projected grid base sale price:
Pfutures June 2007 = $84.00/cwt
+ expected basis
= - 2.50/cwt
$81.50/cwt (liveweight)
Carcass base price = $81.50/cwt ÷ 0.64 dress yield
= $127.35/cwt
• Your basis and dress yield may differ.
12
Example of Cross Hedge,
cont.
• Projected grid revenue:
$127.35/cwt (base) + $5.00/cwt premiums =
$132.35/cwt
$132.35/cwt x 7.68 cwt (weight of carcass) =
$1,016.45/hd or carcass
• Your expected premiums may differ.
13
Example of Cross Hedge,
cont.
• Breakeven Analysis: feeder calf price
TR = TC (total revenue = total costs)
$1,016(TR) = Pfeeder x 575 lbs (feeder calf
cost) + $338 (cost of gain)
Solve for breakeven feeder price:
$1,016  $338
$678
Pfeeder 

 $118.00 / cwt
575 lbs .  100.0
5.75 cwt
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Example of Cross Hedge,
cont.
• Thus, if market price of calves in November is
less than $118.00/cwt, consider retained
ownership.
• For example, if market price was $110.00/cwt,
then retained ownership return is $118.00/cwt $110.00/cwt = $8.00/cwt.
$8.00/cwt x 5.75 cwt (weaning weight) =
$46/head expected return to ownership and risk
• Would like to protect this $46/head through cross
hedge, if selling on the grid.
15
Hedge the Base Price
• In November 2006, sell June 2007
live cattle futures (JF `07)
= $84.00/cwt
• Early June 2007 offset (JF `07) = $79.00/cwt
$ 5.00/cwt profit
• Futures cattle price declined $5.00/cwt in this
example. Perfect correlation says carcass base price
declined $5.00/cwt ÷ 0.64 = $7.80/cwt. Imperfect
correlation results in a spread difference, however.
• Assume constant basis. Ignoring hedge costs here
(commission and interest on margin).
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Hedge the Base Price, cont.
• This $5.00/cwt profit on futures amounts to a $7.80/cwt
protection on the grid.
• That is, with near futures price:
$79.00 JF `07 - $2.50 basis = $76.50/cwt local fed price
$76.50 ÷ 0.64 dress = $119.50/cwt carcass
grid
$119.50/cwt carcass grid + $7.80/cwt protection =
$127.30/cwt hedged carcass base price.
• If $5.00/cwt premiums, then hedged $46/head.
17
Summary
• If futures price increases still lock in the $127.30
carcass base price with near perfect correlation.
• Problems occur with weak correlation between live
cattle futures and beef carcass price since
spreads can work against you.
• Because of possible price increases, some might
buy put options (hence, establish a floor with
potential upside price gain).
• Value to producer of feedlot performance and
carcass data information.
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