By Russ Euken, ISU Extension beef program specialist, and Lee Schulz, ISU Extension livestock economist
Cattle producers face a great deal of risk, not only in production but also in pricing. The last couple of months have served as a reminder of the need for price risk management in a cattle marketing plan. Price risk management, although related to marketing, has a different goal. Managing price risk is not the same as getting the highest market price.
There are several reasons why a producer would be interested in taking steps to reduce price risk and uncertainty. These reasons are influenced by the enterprise combination, cash flow needs and financial situation, as well as one’s personality and attitude toward risk.
The first is to reduce the variability of income over time. This allows more accurate planning for items such as debt payment, family living expenses and operation growth.
Second, there may be a need to ensure some minimum income level to meet family living expenses and other fixed expenses.
A third reason for minimizing price risk is to enhance the survival of the operation. Making a business judgment on how much loss a business can withstand is key to putting a price risk management plan in place.
One way to establish price risk management objectives is to start with the cost of production and the amount of risk the operation can withstand. With this knowledge, producers can use the futures markets more effectively by finding hedging strategies to lock in a price above (or close to) the cost of production.
Alternatively, the options markets or Livestock Risk Protection (LRP) or Livestock Gross Margin (LGM) -- http://www.rma.usda.gov/livestock/ -- allow for the benefit from rising (falling) prices because prices are not locked in if the market trends favorably. When comparing price risk management alternatives, producers need to consider all the costs involved with each and what the most optimistic and pessimistic prices may be.
A good place to learn more about price risk management is Iowa State University’s Ag Decision Maker website (Livestock – Markets – https://www.extension.iastate.edu/agdm/ldmarkets.html). You also can contact your ISU Extension farm management or beef field specialist.