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An Initial Look At The Cattle Price Insurance Program

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Once the program is available, even if unused, the government is off the hook.

Aversion to risk is not a characteristic many would confer on the feedlot business here in Alberta. Consider how many cattle feeders “buy cattle on the come in the market.” In other words, market price needs to go up in order to break even or make money.

As the name states, Cattle Price Insurance Program (CPIP) is an insurance program. Feedlots and their clients can now purchase insurance to protect against some of the downside risk attached to either the Alberta fed cattle price or the basis component of this price. It will operate entirely on producer premiums. There will be no government support as the payments to producers must equal premiums paid by producers over time.

ANALYZING THE BASIS

Alberta fed cattle prices are related to fed cattle prices in Nebraska. The difference or basis is made up of transport, inspections, documentation, and grading costs. Basis now reflects the increased cost to segregate meat from Canadian cattle in order to meet the Country-of-Origin-Labelling laws.

When U.S. supplies become onerous, the demand for Canadian cattle is reduced. Local packers respond quickly by reducing their prices. The basis has become weaker, or “widened.” The effect when all other factors remain unchanged is a reduced Alberta price.

The effect of an adverse change in basis due to lower U.S. packer participation in the Canadian market can be greater than the combined effects of changes in U.S. futures and currency changes. The extreme case was during the BSE crisis when the difference between western Canadian prices and those south of the border became weaker by $50/cwt or $700 per head. There was no program to offset this basis risk and the Alberta government quickly pumped out cheques to keep the industry up and running.

NO GOVERNMENT MONEY

The province of Alberta has undertaken to provide insurance coverage that allows fed cattle producers to protect themselves from changes in the fed cattle price or its basis component. The government may also be sending a message that the responsibility to manage these risks rests with the producer, not the government. Once the program is available, even if unused, the government is off the hook. It will be reluctant to provide ad hoc programs to offset adverse changes in price and basis when this program is available

The program was developed for cattle fed in Alberta. Producers owning and feeding cattle in other provinces must have them fed in Alberta for a period prior to marketing to be eligible. Other Canadians owing and feeding cattle in Alberta will be eligible if they pay taxes on that activity in Alberta.

Individuals can purchase insurance coverage on the Alberta price or its basis component. Individuals who currently use futures and options to manage changes in futures price and currency, can now add protection against adverse changes in the basis to their marketing strategies.

PICK YOUR PROTECTION

Individuals who have relied on local cash markets to price their fed cattle can now purchase insurance to protect themselves against adverse changes in the local cash price. Purchasing insurance on the Alberta price essentially covers adverse changes in futures prices, in currency and in basis. Cattle producers seeking some coverage will have to choose among the different costs (premiums) attached to the different types and different levels of coverage. Generally higher levels of support (for price or basis) will have higher premiums.

Individuals with knowledge and skills in using options will be familiar with the choices required when there are different levels of support available at different premium levels. Generally they will seek the level of coverage that they can afford balanced with the level of coverage they feel they need to participate, or to at least to sleep nights. Individuals with limited experience may be tempted to purchase the low-priced coverage and save on premiums. There is no right or wrong coverage. But often the reduction in coverage is greater than the savings due to paying a lower premium.

HOW TO PLAY THIS ONE

1) Get registered and set up an account: Find and bookmark the website www.afsc.ca. Premiums are posted every Tuesday, Wednesday and Thursday.

2) Establish just how risk-receptive you are. How much can you afford to lose is a key issue as to what level, of either basis support or price level support you will choose.

If your wallet is thick, out of the money/cheap options may be what you want.

If your business is on the thin edge, you may have little choice but to buy the best insurance available. If you can’t afford the premiums you may have to reconsider the feeding project.

Does it make sense to buy cheap insurance just so you can sleep at night?

If you are a traditional spot cash marketer that lets the market of the day determine your margin, are you comfortable with that approach to marketing?

What do your strategic partners think?

3) If necessary, seek guidance from a market advisor or even a broker. They may have spreadsheets to help choose the right coverage for what the buyer either wants or needs. However, insurance coverage is an individual decision. Beware of advisors who do not take the time to understand your attitude toward risk.

4) You will need to have your costs down pat and know the time at which your cattle will be ready for market before stepping up either to do your own option buying or getting help from your marketing advisor.

These two insurance products should be viewed as welcome additions to existing producer toolboxes. These tools can provide value to cattle feeders. The greatest value will be realized by those cattle feeders that recognize their exposure to the possibility of harmful effects due changes in markets and are prepared to take action to manage these threats.

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