Tracking Feeder Cattle Basis in South Carolina: It’s More than Transportation Costs

Overview

Basis is a measure commonly used in the agricultural industry to assess space and time-specific supply and demand factors for a given commodity (e.g., location, time, quality). Basis is determined by subtracting the futures price (Chicago Mercantile Exchange [CME] market price – cmegroup.com) for that commodity from the cash price or the price producers receive from their local market. Understanding and knowing basis for a region, state, county, etc., can help producers manage risk and assist in making profitable marketing decisions. This publication describes cattle basis, how to track basis, and general trends in basis observed for feeder cattle in South Carolina. Stakeholders will understand how to use and track basis for future decision-making and on-farm analysis.

Introduction

Basis is the difference between the cash price and the futures price of a given commodity.¹ Cash price is the price that a commodity sells for in the local market, and the futures price is the price of the commodity set by the futures market or the world price.¹ When the local price is less than the futures price, basis is negative. Conversely, when the local price is greater than the futures price, basis is positive. Producers can use local basis estimates to determine whether their cattle are being sold at a discount or a premium compared to the domestic/national price. This is one reason producers should track basis rather than just prices.

Calculating and tracking feeder cattle basis in South Carolina is generally novel and relatively unexplored even though it is a tool that producers use across the country to keep track of local markets and manage risk. For a producer, first understanding some of the factors that influence basis is important. Both the local cash price and futures price are affected by several factors, with location, time, and quality being the most important.²

Location

The local price of a commodity can vary substantially based on the location of the producer. The local price of a commodity is affected by many factors, with transportation of the commodity to the market being a major driver. The distance from the producer to a market directly correlates with the amount of money that must be spent to get it there. When accounting for this, one must also consider the cost of not only shrink but also the health and management risks that are faced when cattle are transported. This can be thought about in the realm of location because these sickness and morbidity rates, which turn into costs, increase as distance to selling point increases. These transportation costs decrease the price that the producer receives and ultimately affect basis.

Example: A cattle buyer in Texas is likely to offer a higher price to a Texas cattle producer than a South Carolina cattle producer. This is true because the cattle buyer can save on costs associated with fuel, time and health risks when acquiring cattle from their own state. Efficiency in sourcing cows closer to the destination (in this case, Midwest feedlots) contributes to cost savings. It can also allow the buyer to offer more favorable prices to those in closer proximity. We must note that this is true for producers raising cattle destined for the feedlot and not the case for farms that finish and package their own product. Producers receive a price for the commodity they sell that is lower than the national price Because they have to subtract the costs of transporting the commodity to the market. If the final destination for the commodity was the only factor driving the producer’s decisions, it would result in a negative basis. However, this is not often the case. Producers make management and production decisions based on other factors (such as time and quality), not just the destination.

Time

Given that livestock are not easily storable, the anticipation of both local and national supply and demand conditions plays a role in basis movements. Seasonal supply and demand patterns in both local and national markets play a critical role in shaping price expectations. For example, feeder cattle basis often strengthens in the early part of the year when high-quality calves hit the market before weakening through the summer and fall as supply ramps up and feedlot demand fluctuates. Producers must navigate these seasonal cycles when marketing their cattle, understanding that the time of year can significantly impact both local cash prices and how those prices relate to futures contracts. Additionally, events like droughts, feed costs, and planting decisions elsewhere in the country can shift expected demand for feeder cattle, causing basis to move in anticipation. In this way, timing, not just location and quality, becomes a strategic element of market participation and risk management.

Quality

The quality of a product that producers bring to the market also affects basis and often varies across a given commodity. One example relevant to cattle would be the dressing percentage in cattle. A higher quality product can often bring a premium to the local market and drive up the price the producer receives.⁴ Increasing basis would also be called strengthening the basis.

At the most premium time of year, such as early spring, when cattle are high quality and the selling point is close by, therefore reducing transportation costs, we would expect basis to be at its strongest or least negative point. Due to the physiological limitations of beef cattle, such as a 9-month gestation period and feed efficiency, producers cannot always plan to fall within that scope.

These three factors all play into the reason for volatility in the market (see Figure 1 and Figure 2 as an example). Figure 1 and Figure 2 show trends in the South Carolina feeder steer and heifer basis from January 2021 to December 2023. Steer and heifer basis follow the same general pattern regardless of weight, both strengthening and weakening at similar times within the year, such as early spring, but at different price levels.

Figure 1. Feeder steer basis, January 2021–December 2023 (USDA – Agricultural Marketing Service (AMS) and Livestock Marketing Information Center (LMIC).

Figure 2. Feeder heifer basis, January 2021–December 2023 (USDA – Agricultural Marketing Service (AMS) and Livestock Marketing Information Center (LMIC).

How To Calculate Basis

Basis can be calculated using cash prices from a producer’s local market and futures market data. Sources of cash price figures may vary by location but might be auction prices posted online from local sale barns, found in person, or found in the local newspaper. The United States Department of Agriculture (USDA) Agricultural Marketing Service (AMS) publishes the South Carolina Weekly Livestock Auction Summary (https://mymarketnews.ams.usda.gov/viewReport/1963), and this weekly report summarizes auction prices for livestock from sale barns across the state. Futures market data is available on the Barchart.com website and the Livestock Marketing Information Center (LMIC) (a subscription is available through the website limc.info). Futures contracts are traded on the Chicago Mercantile Exchange (CME), cmegroup.com, which is an exchange for trading futures and options across multiple commodities, including agricultural products. In this report, we use feeder cattle futures prices to calculate basis. As explained above, futures market prices used to calculate basis in this publication is the nearby Wednesday close of each week. The Wednesday closing price is used to avoid basis calculations that consider the more volatile movements associated with the beginning and end of the week.

To calculate basis, average prices for 400–499 lb, 500–599 lb, and 600–699 lb steers and heifers were collected from the USDA South Carolina Weekly Livestock Auction Summary report. Subtract the weekly average price for each weight class from the nearby feeder cattle futures contract to calculate the South Carolina local basis for the week. For the purposes of this study, medium and large frame ½’s were used from January 2021 until June 2023. However, in July 2023, USDA adjusted reporting procedures for cattle prices and now medium and large frame 2’s are reported.

The nearby futures contract (closest feeder cattle futures contract to expiration) is used to attempt to eliminate speculation and create a measure that is meaningful to the current time dimension. Feeder cattle futures contracts are available and expire every month except February, June, and July.² So, if we were calculating the basis in January 2021, we would use the underlying January 2021 contract. In February of the same year, the underlying futures contract we would use is March 2021 since a contract with a February expiration is not offered. “As the nearby futures contract approaches expiration, the local cash prices and futures prices should converge and differ by only a small amount.”³ For example, when calculating basis in the month of January, we use the futures contract that expires in January to leverage the convergence of the local price and the futures price together. Calculating basis in the month of January using the September futures contract would include a high level of speculation and would not be helpful.

Example: Consider the following example where basis is calculated under different scenarios with cattle and futures prices varying (Table 1). Each row of the “Futures Price” column was subtracted from the “Cash Price” column to calculate basis. In this example, it is clear that both cash price and futures price are important in determining the basis. For the same cash price of $220/cwt, basis can be both positive and negative depending on futures market conditions. Further, even with depressed cash prices of $184/cwt, basis may not fall markedly if futures prices also fall.

Table 1. Example basis calculations showing both positive and negative basis under various cattle and futures prices: cash price minus futures price equals basis.

Cattle Basis and General Trends

Steers versus Heifers

The reason steers and heifers are tracked separately is that heifers are discounted for reasons including, but not limited to, size and feed efficiency. Basis for different weight classes tend to be similar, with the exception of bigger cattle due to trucking logistics. Trucking logistics are bound by the amount of weight they can carry in a single load rather than the number of animals.⁵ Depending on the market structure we see, which is ever dynamic, buyers may prefer the composition of the truck to be made up of lighter or heavier calves even if the number of pounds adds up the same. Feed costs, and therefore, cost of gain, drives this preference and movement. Similar price patterns are observed for both steers and heifers for 2021-2023, just at different price levels (Tigure 3). Feeder heifers destined for the feedlot will generally command a lower price relative to steers due to the physiological limitations they exhibit, being their inability to finish at the weight of a steer. As seen in figure 1 and figure 2, the average price of 5-weight feeder steers (500–599 lb are 5-weight steers) in South Carolina over the three-year period was $175.23, while the average 5-weight feeder heifer price was $151.84. The comparison of these two averages can give a crude estimate of the average discount given to heifers over the last three years. Since feeder steer are a larger market share, feeder steer basis will be used as the example to further discuss basis in the remainder of this article.

Figure 3. 2021–2023 5-weight steer and heifer basis movements (USDA- Agricultural Marketing Service (AMS).

Supply and Demand Shifters

Changes in supply and demand over time have driven the increases in prices and movements in basis observed in figure 1, Figure 2 and Figure 3. Price increases observed over the last two years can be attributed to herd liquidation, which began in 2019. Also, weather and geopolitical conflicts worldwide drove up input costs and impacted domestic cattle inventory. According to Drought.gov, the Midwest entered extreme drought in July of 2022. Due to drought, yield for feedstuffs used by the cattle industry, such as corn, soybeans, and hay, decreased substantially.⁶ This constrained supply and increased the cost. Due to the war in Ukraine starting in February of 2022, fertilizer prices approximately doubled due to the world supply tightening. Marked rises in input costs expedited herd liquidation in the Midwest and quickly tightened cattle supply nationally, driving higher cattle prices.⁷

The Southeast experienced similar effects of increasing input costs, but at a lower magnitude, and only saw a short period of herd liquidation and quickly bounced back. Through herd liquidation, cattle were bought and placed by backgrounders (operators who bring calves up to desired feedlot weight) and feedlots at low prices, but the supply of cattle was not projected to be significantly lower moving forward. Prices increased due to the sharp drop in supply of cattle in the Midwest. Southeast producers (including those in South Carolina) had a high supply of cattle relative to the rest of the country due to the low magnitude of the region’s herd liquidation and lack of local drought threatening forage. Given the low national supply but stable South Carolina supply, increased demand for South Carolina cattle increased prices.

Seasonality

Price seasonality is defined as regular cattle price patterns occurring within the year.⁸ Basis may strengthen or weaken in a fairly predictable seasonal pattern (figure 4). Figure 4 below shows 5-weight feeder steer basis year-over-year from 2021 to 2023. Basis for 500–599 lb steers is strengthening and positive through the first quarter each year until it begins to weaken starting in late spring and into the summer, where it stays depressed through the fall. This seasonal price pattern is influenced by both the supply and demand for cattle to feedlots and beef for consumers. On the demand side, every year, demand for beef increases during the warmer months of the year, specifically around the 4th of July.⁹ The increase in consumer demand drives cattle prices up resulting in a negative basis. More cattle are needed to keep up with the high volume of beef that is demanded and consumed in this season. This example focuses on fed cattle markets and prices, but it also impacts feeder cattle markets, as feedlots respond by purchasing more feeder cattle to meet the increased demand for finished cattle.

Figure 4. 500 lb.–599 lb. steer basis year over year for 2021–2023 (USDA – Agricultural Marketing Service (AMS) and Livestock Marketing Information Center (LMIC).

On the supply side, cattle prices are also heavily influenced by market seasonality. Like price seasonality, there are cattle price patterns occurring within the year that are expected due to management and production decisions of cattle producers rather than beef consumers.^3,10 In most parts of the country and especially in the Southeast, most calves are spring calved and raised to be feeder calves. These feeder calves will be raised to between 500 lb. to 700 lb. over six to eight months and then marketed to backgrounding or feedlot operations in the fall, resulting in supply of feeder cattle being high in the fall. This leads to a drop in prices as all the fall-marketed calves get placed. Demand for feeder cattle remains constant, but the feeder cattle supply curve shifts out, and price falls. Inversely, backgrounding and feedlot operations prefer to run at full capacity throughout the year. For this reason, cattle prices rise during other times of the year when feeder cattle supplies are low. These shifts in supply, both from South Carolina producers meeting consistent demand and from shifts in demand for feeder calves, contribute to substantial swings in local prices and, subsequently, basis.

Futures Market

In addition to basis fluctuating due to high volatility of both the local and futures markets (Figure 1 and Figure 2), basis patterns remain relatively consistent as local prices increase (Figure 5. The solid orange line in Figure 5 represents 500-599 lb. steer prices, with the orange dotted line added to show the linear plotted trend over the last three years. The solid blue line with the blue dotted linear trend line shows basis. The orange trend line shows an overall increase in prices over the last three years, while the blue trendline, representing basis, remains relatively constant. As futures market price rises, local cash price also rises and maintains basis margins.¹ For this reason, basis tends to stay more stable than prices in cattle (figure 5). This contributes to the intuition behind why basis risk is less variable and predictable compared to price risk, making it one tool for producers to use when determining and managing risk.

Figure 5. 500 lb.–599 lb. steer local prices and futures price for 2021-2023. (USDA – Agricultural Marketing Service (AMS) and Livestock Marketing Information Center (LMIC).

Storability

When analyzing basis, commodity specific attributes also determine price and basis patterns. Unlike grains, livestock are not easily storable. Although it is possible to store livestock, it is cost prohibitive. Attempting to store cattle requires paying a daily cost to maintain their physiological state, such as feed, water, cost of pasture and other uncontrollable variables. Unlike grain markets that are often geographically close to the producer, most feeder cattle are trucked to feedlots in the Midwest of the United States. The cost associated with transportation is often passed to the producer. Cattle also face limitations within the processing sector of the market due to the concentration and dominance of the few meat packers.¹¹

Cattle Cycle

In discussing feeder cattle basis, a question often asked is how often and why cattle prices fluctuate in the local and future markets. As discussed above, cattle prices fluctuate every day for many different reasons. These factors drive the cyclical behavior of the cattle business, also known as the “cattle cycle.”³ The cattle cycle is driven by the supply and demand of cattle, as discussed above, and its effect on cattle prices. Due to the drought in the Midwest and increased prices of inputs, the cattle industry entered a liquidation phase. Producers began flooding the market with cattle that weren’t profitable to feed and maintain, ultimately increasing supply and dropping the price. Due to the swift exit of many cattle producers, supply dropped severely, and prices increased. High prices are an incentive to enter the market, but given that cattle must be obtained, bred, birthed, and raised before they can be sold, it usually takes many years to reverse a liquidation phase. Once supply is back to normal, prices will fall back down. Again, this is known as the cattle cycle.¹²

How to Use Basis in Marketing Decisions

Understanding feeder cattle basis can help producers in three key areas of their livestock marketing plan. Specifically, basis can be one tool to (1) evaluate hedging or floor pricing opportunities, (2) evaluate cash contract opportunities, and (3) cash market timing.¹

Managing basis risk rather than price risk may provide opportunities for producers to anticipate market movement and time decisions. In the short term, the expected value to producers is to use the historical basis and the nearby contract to infer local price movement. Also, producers can alter marketing strategies to capture more revenue potential.

Conclusions and Cautions

Price volatility in cattle markets is important and understanding basis and how prices react in the local market when they do fluctuate can help producers make more profitable marketing decisions. Basis is just one tool in a producer’s toolbox when thinking about the larger risk management and marketing plan that facilitates management decisions. Other risk management tools and marketing strategies a producer could also use in conjunction with basis tracking are hedging and options trading, contract and forward pricing for inputs and cattle, diversification, and insurance.¹³

Limitations of this analysis revolve around the novelty of tracking livestock basis in South Carolina. Up to this point, three years of data to determine basis is available. Larger and more complex trends may not be visible at this small-time scale, and thus, more complex modeling is not yet possible. In addition, every farm is different, and every year is different, requiring farm site-specific management and marketing strategies. What might work for one farm might not apply to another.

References Cited

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