In 2014, live cattle basis — the difference in the commodity’s cash price and futures contracts — experienced extreme volatility in the marketplace. This volatility has led to increased risk for cattle producers and greater uncertainty about profit margins.
University of Idaho student Brett Wilder set out to learn more about this issue to help producers. He will receive a master’s of applied economics degree from U of I’s College of Agricultural and Life Sciences in May 2019 and his research will provide valuable insight to stakeholders.
A Structural Break
Most agricultural commodities are traded on the cash market — taking feeder cattle to auction or corn to grain elevators — and traded on the Chicago Mercantile Exchange (CME) in the form of futures contracts — what traders think today that a commodity will be worth at a specific future time. By selling futures contracts, commodity producers are able to lock in a predictable profit margin. If producers think prices will be higher down the road they may opt to wait and sell on the cash market. If they think prices will stay the same or decrease, they may opt to lock in prices through futures contracts.
“What a cattle producer can do is look at the current price of live cattle and the futures contracts and they can sell futures contracts to offset falling prices in cattle,” Wilder said. “What happens is, if the price goes up, the value of the cash commodity increases so the cattle are worth more but they lost money on the futures side. If prices fall, yes, their cattle aren’t worth as much but they’ve gained a relatively equal or offsetting amount in the futures contracts.”
When the market is extremely volatile, as it has been since 2014 for live cattle, it is difficult for producers to make decisions on futures contracts. Wilder wanted to know what caused the volatility and what producers could do to minimize their risk.
“The whole reason that futures contracts exist is so that actual producers can manage their price risk and if instead of managing it, it makes it worse or doesn’t help manage it at all, then the futures contract is no longer worth having,” Wilder said. “So, we wanted to statistically determine whether there’s been a significant break in how cash and futures prices interact.”
Wilder’s research found there has been a structural change in the way basis moves. He looked at an array of supply factors, which seem to have influenced how basis moves. For example, there is a larger percentage of cattle grading choice or better. The quality of beef is higher, which had a different effect on basis pre-2014 than it does now.
“A few futures related variables and a few cattle supply related variables have changed significantly in the way they’ve impacted how basis moves,” Wilder said. “Knowing that information doesn’t solve the problem, but it does do is allows a cattle feeder to look at the results of my research and make more informed risk management decisions.
Wilder’s research will be made available to stakeholders to help them change the way they conduct business. He will also use his research as a financial analyst for Rabo AgriFinance in Billings, Montana, beginning in January 2019.
Wilder will be working with producers, providing loans, doing market analysis and underwriting. He hopes to one day move up to relationship manager where he will be able to work more closely with individual clients to help them be more successful.
“The knowledge I’ve learned from this commodity marketing program and from my thesis and my understanding of the business these people are in should help me help these producers be even more successful at what they are doing and that to me is fulfilling,” Wilder said.
A native of Meridian, Wilder initially chose to attend U of I because of the faculty in CALS.
“I had lots of different options that I was looking at and the University of Idaho was the only place I was looking at that had professors that really showed that they cared,” Wilder said.
The opportunity to conduct research on a current, real-world issue is what convinced him to stay for his master’s degree after graduating from CALS in 2017 with his bachelor’s in agricultural economics.
“The reason I stayed for graduate school, even though I was looking at other places, was because of the commodity risk management program and because I knew the University of Idaho would let me push the forefront of research rather than taking on a project that was already established,” Wilder said. “They let me take a big topic that was important to industry, and even though it was a little more complex than an average thesis and there wasn’t necessarily funding for it, they let me run with it and helped me find funding.
“I’m excited to move forward and apply this information in the real world and have an impact on what happens in the industry.”
Article by Amy Calabretta, College of Agricultural and Life Sciences
Published in December 2018