INTRODUCTION:  Captive supplies are livestock inventories “captured” by packers without a price bid, at least 14 days before delivery.  Contracted and packer owned livestock are captive supplies.  Two bills at issue in the Senate farm bill debate will reduce the market harm of captive supplies, improve free markets in agriculture, and preserve most producer choices in selling livestock.  The rationale is the same as in the stock markets, where some stock selling/buying methods have been prohibited because of the risk of market harm, including insider trading or off-board stock sales.

BILLS: The captive supply bills include:

• Packer Ownership Prohibition (S. 305) to prohibit the recent phenomena of packers owning livestock.  The bill only affects the largest packers.  Packers did not own livestock before the 1980’s, and several state laws have, or currently, prohibit packer ownership.  This item was included in the Senate Ag Committee version of the Farm Bill, approved October 25, 2007.
• Captive Supply Reform Act (S. 1017) to eliminate unpriced-forward contracted cattle while not affecting priced-forward contracts, hedging, or sales of cattle live, in-the-meat, or grade and yield.  Senator Enzi filed this bill, which is co-sponsored by Senators Dorgan, Conrad, Thomas and Grassley.

FACTS AND PRINCIPLES

• Captive supply volume/current numbers.

• Hogs: According to the USDA/Research Triangle Institute report of January 2007 (RTI study), hog marketing volumes by type from October 2002 to March 2005 were:
• Spot market hog = 8.9%;
• All contracts without packer owned hogs = 57.75%;
• Packer owned hogs = 19.61%

• Hogs: According to an analysis of Livestock Mandatory Price Reporting data for 2006, hog marketing volumes by type were:
• Spot market hog = 8.9%;
• All contracts without packer owned hogs = 57.8%;
• Packer owned hogs = 26.3%

• Cattle:  According to the RTI study, cattle marketing volume by type were:
• Spot market cattle = 61.7%;
• All contracts without packer owned cattle = 33.3%;
• Packer owned cattle = 5%.

• Captive supplies cause lower prices for livestock, $69/head lower for cattle and at least $32 per head lower for hogs.  Low prices put many producers out of business.

• Captive Supplies lower prices for cattle producers by approximately $69 per head:  Every study addressing the issue has found that more captive supplies are associated with lower cattle prices.  In cattle, studies by Azzam, Schroeder, Schroeter, Taylor, Sexton and Ward have found cattle prices decrease by anywhere from .145% to .25% when captives supplies increase by 1%.  Assuming 38.3% captive supplies in cattle (which OCM believes is too low), the price decline (using a .15 to 1 correlation ration) is $5.75 per hundred weight, or $69 per 1200 pound animal.

• Captive supplies substantially lower prices for hog producers by at least $32 per head: Every credible study has shown that more captive supplies are associated with lower hog prices.  The recent USDA study by Research Triangle Institute confirmed that captive supplies cause lower hog prices:

“At the sample means, a 1% increase in contract hogs sold causes the spot price to decline by 0.75%. A 1% increase in packer-owned hogs sold causes the cash/spot price to decline by 0.24%.” GIPSA Livestock and Meat Marketing Study, Volume 4, p 2-41.

• Assuming 20% of hogs marketed are packer owned, the negative price impact is $4.80/cwt live, or $13.44 per hog.  Then adding the contract effect, we get another $43.28/cwt price depression (58% x .75) for a total of $48.30/cwt.  This is probably too high, likely because the marginal effect of the captive supply causation is not a linear effect.
• If we assume a .24 to 1% relationship across all captive supplies (which is the lower packer owned impact), the result is a $18.56/cwt price depression from captive supplies.
• If we assume the lower cattle correlation of .15 to 1% relationship across all hog captive supplies, then the price depression effect is $11.65/cwt or $32.62 per head for a 280 pound hog.

• Economic theory predicts that when buyers can procure supply without bidding, and need only bid for residual supply, their bids will be lower and less aggressive under the same consumer demand conditions as in competitive markets.  The facts bear out the theory in this case.

• Captive supplies cause market access risk and losses.  Market access risk puts many producers out of business.

• Cattle:  Because of captive supplies, these problems occur each week.
• Cattle feeders have a “bid window” of 15 to 60 minutes per week.  They have no available bids during at least thirty nine of the forty hours in a business week.  Packers have such a large volume of captive supplies that they do not bid at other times.
• Only in one out of four to six weeks do packers provide competitive bids to cattle sellers.  During the other weeks, the bids are not competitive.  This is known as “bid not to buy.”  Captive supplies cause these long “out of the market” time periods.
• When producers cannot sell cattle, they must pay to feed them another week, the cattle lose feed efficiency and become lower quality, and overfat cattle can be discounted by $150 to $200 per head.
• Hogs:  Many producers do not receive price bids.  Instead they receive dates to bring their hogs to the packing plant, with a price to be determined at the time of delivery.  Captive supplies allow packers to control this scenario.  Producers often have no choice.

• Captive supplies cause market volatility risk and losses.

• Economic theory predicts that low volume in markets causes high market volatility. 
• Hog price volatility has increased as the number of spot market hogs has decreased.
• The RTI study found tremendous intra-day volatility in the hog markets that they could not explain.
• High market volatility causes increased risk for livestock producers.  A producer receiving $3 per hundredweight (cwt) less on the same day loses $8.40 per hog as compared to the high end of that day’s market.  For 1,000 hogs, this is $8,400.

• Packers have been, and are, making money, with a far greater return on investment than producers.  

• Tyson’s (formerly IBP) slaughter division profit over 9 years from 1994 to 2002 was 30%, far more than producer profit.  Tyson’s processing division profit was 9-10% from 1994 to 2002.  Livestock producers’ average profit margin has been far less, and often a loss.
• This data comes from Tyson internal documents disclosed in the Pickett vs. Tyson suit (which went to verdict in 2004), and was not disputed by Tyson.  SEC reports do not breakdown this data, and no other public studies that we are aware of have this data.
• Joseph W. Luter III, the former CEO of Smithfield Foods, received a fiscal year 2007 compensation package worth nearly $20 million according to Forbes.
• Smithfield had at least 20 percent returns each year for over 20 years.
• Joel Johnson, CEO of Hormel Foods, received pay of $12.06 million in 2006.
• Conversely, producers have not fared as well.
• 200,000 cattle operations have closed in the U.S. since the mid-1990’s, according to data from Auburn University.
• At least 50% of the production years from 1990 have been loss years for cattlemen.
• In the hog industry, approximately half of the last 10 years have not been profitable. 

• Producers deterred from speaking out.  Producers are afraid to come forward and complain publicly because of market retaliation fears.  These fears, whether justified or not, are real.