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Chaunce Thompson of the Texas Southwest Cattle Raiser's Association probably best summarized the current state of the Texas cattle industry by noting that he "can't remember when so many things were out of kilter at the same time." Drought, Mexican imports, overproduction, NAFTA, poor winter grazing, the high cost of feed and alleged anti-competitive concentration in the meat packing industry all have been cited as at least contributing to the current problems faced by Texas' cattle producers since late 1995.

This litany of woe is cited by nearly every rancher involved in the industry. But what is based on facts and what on perceptions? Because of the beef industry's importance to Texas' economy, it is crucial to disentangle true trends from happenstance so that Texans can chart the best course for this industry in the state. That is the primary purpose of this Special Industry Report from Comptroller John Sharp.

Industry Production and Overproduction:
The Horns of a Dilemma

The Texas economic landscape that people imagine is one dotted with oil pumps and flaring gas wells. The truth is the state's economy is much more diversified. The cattle industry's contribution to the Texas economy is often overlooked-despite the fact that cattle production actually brings in more dollars than natural gas production.

In 1995, the total value of cash receipts for cattle and calf production in the state is estimated to have reached a record $6.3 billion (Figure 1).

This exceeds the estimated total value of natural gas produced ($5.6 billion), but is somewhat less than the total value of oil production in the state ($8.5 billion).

In addition, the beef cattle industry is by far the largest sector in the Texas agriculture industry (Figure 2).

In 1994, revenues from cattle accounted for nearly one of every two dollars received in agriculture, or more specifically, 47.8 percent of all cash receipts. This not only greatly exceeds the share of total agricultural receipts generated by cotton, the state's second largest agricultural product, which accounts for 9.2 percent of all farm receipts, but even exceeds the value of all Texas crops combined (34.5 percent of all agricultural cash receipts).

The beef cattle industry is generally comprised of several components including ranchers or cattle producers, feed lots, slaughter houses and other facilities such as auction yards. In 1995 there were 635 feedlots in Texas and 12 slaughter houses with at least 200 head capacity. The 5.5 million cattle marketed out of those feedlots in 1995 constitute the "fed beef" portion of the industry. The remaining cattle marketed for beef are predominantly "cull cows" that are no longer used or needed to increase the size of herds. Such cattle are sent directly to slaughter facilities.

The cattle industry is not immune from cycles of high and low production. As seen in Figure 3, the inventory of cattle in Texas on January 1, 1995, stood at more than 15 million head, down slightly from 1994 levels, but still among the highest inventories since 1977. Cattle herds in Texas have been building since hitting a low point of less than 13 million head in 1990.

Nearly all agricultural commodities are subject to such cycles with the length of time between peaks and troughs of production controlled largely by the speed with which additional production can be brought into the market and supply changes translated into price signals to the consumer. In the cattle industry, such cycles tend to occur over periods of eight to twelve years. By comparison, cycles in the hog industry tend to be considerably shorter, usually about four years in duration.

Although the exact timing of any particular peak or trough in the cycle often has a rationale all its own, one general rule of producer behavior underlies the cyclical process: the same behavior that is individually smart is also collectively disastrous. If prices are high, the appropriate response for any particular producer is to try to increase the amount produced. Collectively, such behavior on the part of all producers yields an oversupply of the commodity, resulting in declining prices and the "down side" of the cycle.

Such apparently is the case now. As seen in (Figure 3), the real price of cattle, adjusted for inflation, has seen three peaks since 1970. Consequently, cattle inventories have also seen three peaks during this same period. Clearly the price-driven cyclical nature of the cattle industry is apparent in Figure 3. Moreover, it seems equally clear that some of the current concerns about the cattle market in Texas are the result of economic cycles in cattle production. But, this is by no means the only influence on the state's cattle industry.

Mexican Cattle and NAFTA
One recurring concern expressed by cattle producers in Texas is that an influx of cattle from Mexico as a result of the North American Free Trade Agreement (NAFTA) has had a great deal of influence on currently low U.S. cattle prices and the level of oversupply. But, as seen in (Figure 4), the situation is somewhat more complex.

From 1970 to 1985, imports of feeder and slaughter cattle from both Mexico and Canada generally amounted to less than one percent of the U.S. cattle inventory. Beginning in 1986 through 1989, cattle imports from Mexico jumped rather substantially, roughly doubling from one half of one percent of the U.S. inventory in the first half of the decade to averaging nearly one percent in the second half.

No doubt some of the increase in imports from Mexico in 1986 and 1987 can be attributed to the devaluation of the peso. In 1988 and 1989, both Mexican and Canadian imports began to gain market share as U.S. beef prices began to rise. In addition, in 1988, the Mexican government lifted quota restrictions on exports of cattle to the U.S.

With domestic supplies limited by low U.S. cattle inventory levels from 1990-91 and strong prices during the same period, imports from both Canada and Mexico surged. From 1990 to 1993, Mexican and Canadian imports responded to the strong U.S. cattle market by nearly doubling their share relative to the U.S. inventory levels.

In 1994, the first year in which NAFTA was in effect, the share of Mexican and Canadian imports relative to the domestic market actually dipped slightly. Imports from both countries rebounded in 1995, but a continuing drought in northern Mexico caused imports from Mexico to increase at a more rapid pace than imports from Canada, as Mexican ranchers rushed to sell herds they could not afford to feed. Recently, imports from Mexico have dropped off dramatically. During the first three months of 1996, imports of feeder and slaughter cattle and calves from Mexico into the U.S. dropped to 159,000 from 608,000 during the same period of 1995.

This pattern of trade seems to indicate that NAFTA alone has had a minimal effect on the current condition of the cattle market in the U.S. or in Texas for three reasons. First, while there has been a surge in imports from both Mexico and Canada, this preceded NAFTA by several years and appears to be in response to strong market conditions in the U.S. Second, the 1995 influx of cattle from Mexico seems to be largely related to drought conditions in Mexico and aided by the December 1994 peso devaluation. Third, the tariff levels on cattle preceding the implementation of NAFTA were minor, amounting to 1.2 percent of value.

By mid-1996, the largest effects of Mexican cattle imports are likely to be over and future developments in Mexico could actually aid in ameliorating oversupply conditions in Texas. According to Jim Schwertner, a Texas livestock dealer, if drought conditions in northern Mexico subside, ranchers there could fuel a growing demand for Texas cattle to restock their herds.

Effect of the Texas Drought on Cattle Returns
A reasonable response to oversupply is to hold cattle back from market until prices rebound. In late 1995 and early 1996, this is not a viable business strategy because of drought conditions. In short, the drought in Texas has substantially driven up the costs of maintaining cattle and in some cases made it impossible.

Dr. Ernest E. Davis at the Texas Agricultural Extension Service estimated that the $1 per bushel increase in corn prices in the fall of 1995 translated into a $10 per hundredweight decline in returns to cattle feeders on 500 pound calves. In addition, because there was no winter wheat for grazing stocker calves due to the drought, the return of calf production was reduced another $6.50 per hundredweight during this period.

In early 1996, the price of corn rose an additional $1 per bushel, further lowering returns to calf feeders. Ultimately, these increased costs probably induced feedlots to cut back their inventories, increasing the supply of calves in the market in April and May of 1996. This reduced calf prices by another $5 per hundredweight. In total, based on these projections and estimated calf marketings, drought-related losses on feeder calf sales to Texas producers amounted to $329.7 million from September 1995 to May 1996.

                               Table 1		
    Estimated Drought-related Losses in Texas Calf Sales			
                      September 1995 - May 1996		
				 
                               Estimated      Estimated	
                Estimated    Drought-Induced   Average       Estimated 
                Marketings   Price Decrease    Weight         Losses 
Month          (1,000 head)     ($ cwt.)       (lbs.)        ($ mill.)
September '95      457.9         $16.50         475            $35.9 
October '95        574.6          16.50         475             45.0 
November ' 95      457.9          16.50        	475             35.9 
December ' 95      341.1          16.50        	475             26.7 
January '96        374.6          20.00        	450             33.7 
February '96       374.6          20.00        	450             33.7 
March '96          380.0          20.00        	425             32.3 
April '96          390.0          25.00        	425             41.4 
May '96            450.0          25.00        	400             45.0 
				
Total            3,800.8                                      $329.7
				
Source: Texas Agricultural Extension Service.

The effects of the drought also spilled over into other parts of the beef cattle industry. Dr. Davis estimated the additional supply from beef feeder operations would lower "cull cow" prices by $5 per hundred weight. Based on an estimated slaughter of 200,000 head through May 1996, producers lost another $90 million in this part of the market due to the drought.

Finally, the drought has required additional supplemental feeding because of the lack of range grass. From March 15 through May 31, 1996, supplemental hay and cottonseed meal cubes cost producers an estimated $373.9 million which they would not have otherwise incurred with better weather conditions. In total, the 1995-96 Texas drought had cost cattle producers an estimated $793.6 million through May 1996.

A Break for the Consumer?
One source of concern whenever one sector of an industry is affected by over- or underproduction is how quickly the situation will correct itself. Clearly, the "liquidation" of cattle stocks over time will help bring supplies back into line with demand. If consumers increase their beef purchases, the situation will improve even faster.

The prime mechanism for accelerating this adjustment is retail prices. If declines in the prices faced by ranchers mirror what shoppers see at their retail meat counters, increases in consumer demand could help alleviate oversupply problems quickly. In the case of beef prices, this adjustment appears to be underway, but price changes on the retail side do not come close to matching those incurred by producers.

According to the National Cattlemen's Beef Association, the average retail price per pound of six cuts of beef in early May 1996 are down 7.2 percent from average retail prices in 1993, the peak year for beef prices. (Figure 5) This change, however, compares poorly to the 32.5 percent drop in the price per head of cattle received by Texas ranchers from 1993 to 1996.

But even a beef price drop at the wholesale level may not always spell gains for the consumer. In the case of McDonald's Big Mac, for example, the cost of beef is only one part of the selling cost. Declines in the cost of beef could well be offset by price increases of other ingredients, or simply retained as profits.

Packer Concentration
Against this backdrop of cyclical overproduction, changing international competition and drought, it is not surprising that the cattle industry is more sensitive than ever to concerns over other market problems. Recently, there have been growing complaints that the increasing concentration of market power into the hands of a relatively few meat packers has put cattle producers at even more of a financial disadvantage.

Alleged abuses of market power by meat packers have a significant legal and regulatory history. The Sherman Antitrust Act was passed in part due to ranchers' concerns over concentration. The virtual control of the market by five packing companies in the early 1900's lead to the passage of the Packers and Stockyards Act of 1921. Indeed, one study noted that "every major antitrust law has been the result of packer concentration." 1

At the heart of this controversy lies the fact that both the cattle producers and the packers maintain logical but diametrically opposed interpretations of much of the same data. For example, as evidence of the anti-competitive gains from market concentration, producers cite the divergence of retail beef prices from those received by ranchers for cattle, the fact that the four largest packers accounted for 82 percent of steer and heifer slaughter in 1994 and that, as noted in a recent USDA report,2 packers' profits have grown in the last three years from a loss of $3 per head to a profit of from $8 to $24 per head.

On the other hand, packers note that the rush of cattle into the marketplace due to overproduction has allowed them to spread their fixed costs over a much larger volume, thereby reversing losses to gains. In addition, as noted by the U.S. Department of Agricultural (USDA) Advisory Commission on Packer Concentration, the relationship between net cattle prices and retail beef prices since October 1994 does not appear to be statistically different from the relationship that existed from 1979 to the fall of 1994.

Further complicating this controversy are other changes in the nature of the beef market. Meat packers are "vertically integrating" through arrangements known as captive supplies-agreements with producers and feed lots to obtain cattle two or more weeks prior to slaughter. Packers maintain that these types of agreements and others help them manage beef quality in a marketplace in which consumers are increasingly quality conscious. Beef producers with such contracts cite increased financial stability, reduced risk, and the ability to attract loans from financial institutions as prime benefits.

On the other hand, increased reliance on such captive supplies has called into question the ability to establish rational beef prices outside of these arrangements. In noting that today less than 2 percent of fed cattle go through the "price discovery process" of open and competitive bidding, the USDA Advisory Committee on Agricultural Concentration termed the current price reporting system "a relic." 3 Moreover, this same committee heard testimony that meat packers sometimes offer producers a higher market price on the condition that the higher price "not be reported." Not only does such behavior constitute price manipulation because it affects prices offered other sellers, but it is also very difficult to detect and verify.

Given this backdrop, it is not surprising that the USDA's Advisory Committee on Agricultural Concentration's prime recommendation is to increase the availability of data documenting cattle prices. The committee noted that captive supplies and other forms of vertical integration and coordination tend to thin market price reporting by reducing volumes on which reported prices are based and disadvantage suppliers who do not have packer arrangements. Moreover, the Committee urged Congress to increase legal and investigative resources to enforce key provisions of the Packers and Stockyards Act against anti-competitive behavior.

In Texas, recent developments in a slightly different part of the cattle slaughter business have also highlighted the packer concentration issue. All of the recent research on packer concentration by the USDA has centered on the "steer and heifer" market and the slaughter of fed beef as opposed to the smaller "bull and cow" market.

In 1996, IBP, the largest of the national beef packing companies, began steps to purchase the packing operation of the Calhoun plant in Palestine, Texas. IBP proposed to not only keep the plant in operation, but to increase it size and employment. This plant, however, did not process fed beef, the source of most of IBP's other operations, but slaughtered cows and bulls raised on area ranches.

Many local producers saw IBP's efforts in Palestine as an attempt to extend their dominance in the fed beef market into the "cow-killing" side of the cattle business. Agricultural associations sought out the help of the U.S. Justice Department to block this sale under federal anti-trust regulations, but Justice declined to pursue the matter. Subsequently, Texas Attorney General Dan Morales filed for a temporary restraining order on IBP's purchase of this plant until the state had the opportunity to examine the impacts of the sale on the Texas cattle market. Following a hearing on May 13, 1996, the request for a temporary restraining order was denied.

Findings and Summary
The cattle industry is one of Texas' major economic sectors and every effort should be made to ensure it remains a strong and vital part of our economy. Unfortunately, at the present time, the industry is in the throes of a wrenching price slide. While the industry's problems are exacerbated by the current Texas drought,4 it is unlikely that the current ill-health of the cattle industry in Texas can be fully attributed to Mexican imports or to NAFTA.

But there remains strong concern about the concentration of market power into the hands of a relatively few meat packing companies. The Comptroller's Office concurs with the USDA in their assessment that better data on price transactions are needed to monitor this problem and that Congress should allocate additional resources towards ensuring that competition remains the driving influence in the cattle industry.

To assist in moving these issues forward in a timely fashion the Comptroller calls on the Texas Agricultural Extension Service and Texas A&M University to undertake several studies to be completed before the Legislature convenes in 1997:

  • Establish value-based pricing for beef. Work completed for the USDA on beef pricing issues by the Texas Agricultural Market Research Center could serve as the starting point to establish a value-based marketing system for beef similar to the "grid" pricing structure that is currently available for some regions of the country in the pork industry.

  • Design an electronic marketing network for beef in Texas. In the early 1980s, Texas A&M established an electronic pricing system for cattle known as the "Cattlex." While this system is not currently in operation, the expertise developed at A&M in designing and operating this system would prove invaluable in developing a system appropriate for the realities of the 1990s.

In conjunction with the Texas Performance Review, the Comptroller also requests Texas A&M University review existing practices in other states which may help define the range of policy options available to Texas to ensure fair and equitable treatment of all cattle producers in pricing their stock. Moreover, this study should examine whether it is necessary to maintain arms-length relationships between the various producing, feeding and processing sectors of the cattle industry.



Cattle Industry Terminology
The cattle industry uses a variety of specialized terminology with animal terms generally referring to the age or sex of the animals and other terms defining whether the cattle are destined for breeding or feedlots, or kept on forage for feed.

Bull: Male breeding stock

Steer: Castrated male.

Heifers: Young females.

Cows: Mature females.

Replacement heifer/cow: Females that generally have not had a calf, and weigh over 500 pounds. They are usually intended to replace older cows in a herd.

Stocker cattle: Stock that gain additional weight on forage prior to placement in feedlots.

Feeder Cattle: Young stock eventually destined to finish gaining weight in commercial or on-farm feedlots. This includes feeder calves (animals mature enough to be placed in a feedlot, but less than 1 year old) and feeder yearlings (animals suitable for feedlot placement that are between one and two years old).

Fed cattle: Stock ready for slaughter that have been fed a high grain ration diet (in 1994, fed cattle made up 80 percent of all cattle slaughtered).

Nonfed cattle: Stock that do not enter feedlots prior to slaughter, but are kept on forage for feed. These cattle are generally sent to specialized slaughter houses called "cow killing" slaughter facilities.

Cull Cattle: Cattle culled from existing herds and sent directly to slaughter houses, bypassing feedlots.

Beef cow-calf production: An enterprise that breeds and maintains cows for the primary purpose of producing stocker or feeder cattle.

Cattle Cycle: A period of approximately 10 years in which the number of beef cattle in the nation is alternatively expanded and reduced for several consecutive years in response to the profitability of beef production.

Sources: John Sharp, Texas Comptroller of Public Accounts, Texas Agricultural Statistics Service, and the Economic Research Service (USDA).


Endnotes

1
Report of the USDA Advisory Committee on Agricultural Concentration, Concentration in Agriculture, U.S. Department of Agriculture, June 6, 1996.

2
Ibid.

3
Ibid.

4
In a June 1996 Special Economic Report on the Texas drought, the Comptroller's office made a number of recommendations to ameliorate the drought's impact on the state.