CME CME Group Inc

By Kelsey Gee 

Unruly trading of cattle futures is leading to a revival of live auctions, as ranchers look to bring robust pricing data to the market and guide understanding of supply and demand in their industry.

Cattlemen trade futures, or contracts to buy or sell cattle at a given price on a future date, as a form of insurance on their borrowings to feed hundreds or thousands of animals at a time. In the past year, values of cattle futures contracts have swung wildly, from near-record highs to six-year lows.

A nearly one-third drop in the price of cattle futures through the fall of 2016 has slashed ranch incomes and prompted investigations into the source of the volatility.

The Chicago Mercantile Exchange is considering drastic changes to how those contracts are settled. The world's largest futures exchange has been working with cattlemen to address the apparent breakdown in the $13 billion market, proposing among other measures a new index to guide pricing of futures contracts.

CME Group Inc. says an index could help align futures contracts with real trade data. The index could be built on cattle purchase prices that meatpackers are required by law to disclose to the U.S. Department of Agriculture.

Some ranchers say such a price index would make volatility in the futures market worse. USDA price reports can lag behind actual deals by hours or even days, meaning the index might not represent current sales.

Nonetheless, the reports "do provide transparency to the market," says Dave Lehman, CME's managing director of commodity research.

The lack of public bartering and price transparency in the cattle industry is one major source of the market's problems, CME says. At present, the predominant way of selling cattle is via private production contracts between feedyards and the four big U.S. meatpackers. So-called formula contracts price cattle ahead of sale based on the benchmark price independent cattlemen will get in the cash market, plus or minus premiums and discounts.

Some feedyard operators now are experimenting with live auctions, returning to doing business in an open cash market. They want to generate new public price information and slow the supply of previously committed cattle to slaughter each week.

"We would rather be a part of the solution than have the Mercantile Exchange make the decision for us," says Surcy Peoples, director of customer service at Cactus Feeders, a large cattle producer in Amarillo, Texas, which before this fall sold most of its more than a million cattle annually using formula contracts.

Cactus Feeders is one of nearly 100 producers using Superior Livestock Auction LLC's Fed Cattle Exchange. In its live-streamed online auctions, similar to eBay, cattlemen haggle with meatpackers over fractions of pennies a pound.

Ranchers worry that such auctions still won't generate robust price data and CME might decide to settle cattle futures prices to an index anyway. An index system is already in use in the hog market, which has few remaining independent farmers actively negotiating for cash.

A cattle index also would eliminate the ranchers' option of settling futures contracts by delivering cattle -- thus removing actual animals almost entirely from a financial market created to assess their value.

"We believe moving to this form of contract settlement drastically increases the incentive for price manipulation," Craig Uden, of the National Cattlemen's Beef Association, wrote to CME in November.

CME says any cash index would be vetted for the reliability of its data.

The chicken industry also is confronting pricing concerns. An index called the Georgia Dock has consistently reflected higher prices than other benchmarks. Georgia's Agriculture Department last month suspended the index, amid recent scrutiny.

Online cattle auctions have already led to an uptick in cash sales. The share of steers and heifers sold in cash markets rose to 26% through November this year, up slightly from 21% a year earlier but still well below a decade ago, when more than half of cattle were sold in cash markets.

The structure of the industry has changed, and having just a handful of cash transactions once or twice a week doesn't provide a good benchmark for the industry, CME says. Negotiations for cash sales used to take place daily in raucous livestock auction barns; traders got a sense of fair value at any given moment.

Now, every Wednesday morning, the Fed Cattle Exchange streams a spreadsheet showing seller, weight and location as each animal comes up for sale. Bidding starts at a floor set by the producer. Pictures of the feedyard pops up on screen; prices flash yellow as bids increase.

"It's important that the public is able to see the transactions take place on their computer, right in front of their eyes," says Sam Hughes, manager of the Oklahoma City exchange.

Write to Kelsey Gee at kelsey.gee@wsj.com

(END) Dow Jones Newswires

December 17, 2016 07:14 ET (12:14 GMT)

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