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CME: Live Versus Carcass Pricing for Cattle, Hogs

by 5m Editor
3 June 2010, at 12:29am

US - When we asked readers for some terms to define or explain a few months back, several of the responses asked about live versus carcass pricing, write Steve Meyer and Len Steiner.

Why do we have both? Why is the CME Group futures contract for cattle Live Cattle using, quite logically, a live weight price and the futures contract for hogs called Lean Hogs using a carcass weight price? Why wouldn’t the contract be called “Carcass Hogs” or the price be a “lean weight” price? Very confusing to the noninitiated and, since we do not have a secret handshake or initiation ceremony into the fraternal order of livestock market analysts and traders, we thought we would use today to address these questions.

First for cattle. Live weight prices were, for many, many years the only prices quoted at auction markets and by packers and are still the most widely used — thus we still have a Live Cattle futures contract. This began to change a few years back for a very practical reason: Cattle fed in northern-state feedyards tended to carry a great deal of mud to the slaughter house in the winter. This mud would be weighed — and thus paid for — along with the animal when live weight prices were used. Therefore, packers either had to guess at how much to discount the live price to account for varying degrees of mud or use a price that was not affected by the degree of mud being carried. The answer, of course, was using a carcass price.

Another reason has been added in recent years as more and more cattle are sold “on the grid” meaning prices include premiums and discounts for quality and yield grade. It is quite logical that carcass prices be the basis of these carcass merit grid systems.

The chart below shows monthly, 5-market average live and carcass steer prices and the dressing percentage these prices imply. Assume that a 1400-lb live market steer or heifer is worth $1370 to a packer (how that value is determined is a topic for another issue!). The animal is thus worth $97.86/cwt. (cwt = centiweight = 100 pounds) live. If the animal yields a carcass weighing 880 lbs, its carcass-weight value is $1370/8.80 cwt. = $155.68/cwt. The animal’s “yield” is 880/1400 = 62.9 per cent — a very normal yield for cattle. The relationship between carcass and live prices will always be tied to carcass yield: $155.68 x 62.9 per cent = $97.92/cwt live. The discrepancy is due to rounding. The seasonal variation in yields is clearly discernible in the chart.

But the hog relationship is not quite so simple. First, the industry began moving to carcass weight pricing in the 1990s when carcass merit pricing began to be widely used. Carcass merit pricing starts with a base price determined by supply and demand conditions and then adds premiums/deducts discounts depending on the leanness/fatness of the carcass and whether it falls within a desired weight range. CME changed its Live Hog contract to a carcass-weight Lean Hog contract (the name was chosen to reflect the improvement of hogs and to keep the LH abbreviation) beginning with the February 1997 contract. USDA reported only carcass weight prices as part of the mandatory price reporting system beginning in mid-2001. But a small number of hogs were still being sold on a live-weight basis direct to packers so USDA added those animals to its reports in January 2004. As can be seen from the implied yields in the second chart, the live-carcass price relationship for hogs is not nearly as predictable as that of cattle. Live prices fall relative to carcass prices when hog supplies are plentiful, implying that live-weight purchases are “at the margin”. Live prices increase relative to carcass prices when supplies are tight for the same reason plus, in the minds of some observers, another one: Live prices are not included in the base prices for hogs purchased through marketing contracts. Some observers suspect that packers buy more hogs on a live weight basis when prices are high to keep these high-priced pigs out of the average carcass price and thus out of the prices of contract-purchased pigs. True or not, high live prices so far in 2010 tend to support the theory.