Understanding the seasonal and long-term effects of the Choice-Select spread
by Lance Zimmerman, M.S., Analyst – CattleFax
Supply and demand fundamentals work in tandem to produce the seasonal variation of the Choice-Select price spread.
Economic uncertainty and relatively large supplies of high quality beef have weakened the Choice-Select spread in recent years.
Demand for high quality beef received a boost this fall when a major retailer transitioned store meat cases nationwide to include premium Choice beef.
Supplies of high quality beef will likely decline with a smaller fed cattle supply and steady quality grades, resulting in a wider Choice-Select spread.
A wider spread will likely increase incentives for high quality beef production and significantly change the market premiums for value-added production in all sectors.
Supply and demand fundamentals for high quality beef have a dramatic seasonal and long-term effect on the Choice-Select price spread. A recovering domestic economy, slower restaurant business and dramatically improving quality grade led to a historically low spread in January and February. The dynamics that created the low price spread early in the year changed considerably by fall. Furthermore, a major retailer transitioned store meat cases nationwide to include premium Choice beef and production of high quality beef declined seasonally as fed cattle supplies fell and quality grade moved lower. Increased demand and smaller supplies of Choice beef pushed the weekly Choice-Select spread beyond $17 per hundredweight (cwt.) multiple times during the fall – its widest margin since summer 2006 when it averaged $23 per cwt. For the first time in five years, farmers and ranchers could receive a noticeable price increase for cattle with Choice grading potential. The incentives for high quality beef production have the potential to significantly change the rewards available for value-added production in all sectors.
Every year carcass quality improves going into the late fall and winter months as the proportion of yearlings marketed as fed cattle increases. The colder weather also discourages grilling and restaurant business declines. Seasonally increasing supplies of Choice beef meets declining middle-meat demand, and the price spread between Choice and Select beef narrows.
Grade data in February showed one of the more impressive runs of Choice grading carcasses we have seen in recent history. During that time, Choice grading carcasses were as much as 67 percent of the weekly steer and heifer slaughter. For every pound of Select beef produced, the industry was producing nearly 2.8 pounds of Choice. It was the largest production difference between grades going back to the mid-1990s, and it produced one of the lowest price spreads during that same time.
Quality grade steadily declined from February to October. The Choice grading percentage reached its lowest point of the year in October at 59 percent, while Select-grading cattle improved from 24 to 32 percent of all fed slaughter.
Choice beef production is also affected by seasonally changing fed cattle supplies. Fed slaughter typically peaks in the summer and declines steadily into the winter. Specifically, fed steer and heifer slaughter averaged 562,000 head per week in June and averaged 510,000 head by October.
These seasonal aspects of beef supply – quality grade and fed cattle slaughter – result in Choice beef production peaking at 74 percent of the Choice-Select product mix in late winter and adjustment closer to 66 percent this fall. With the net supply loss from seasonal grade change alone, Choice beef production falls 35 million pounds and Select beef gains 33 million pounds.
The seasonal changes in Choice and Select product supply due to grading and slaughter rate create a Choice-Select spread that is generally the narrowest in the late winter months, but widens through the summer.
Middle meat values generate the largest seasonal demand impact on the spread. In the fall, the Choice-Select spread moves closely with Choice rib prices, reflecting holiday demand for prime rib. Choice rib value has increased significantly since September and is at its highest level since 2003.
Prices for Choice ribs typically peak around Thanksgiving, and decline into the spring as loins gain preference for summer grilling. In the spring, Choice loin prices tend to dictate the spring highs in the spread and the loin’s influence continues throughout the summer.
Demand effects have been more muted in recent years due to the U.S. recession. When the first signs of an economic recession surfaced in fall 2007, the Choice-Select spread broke below $5 per cwt. during the following seasonal decline.
Significant year-over-year improvements in quality grade began at nearly the same time. It created an improving supply situation for high quality beef when consumers were not in the market for a premium product. Restaurant business lagged, and consumers were trading down to lower quality cuts at the meat case.
Since that time, the marketplace has adjusted to a larger supply of high quality beef and demand at the retail and restaurant sectors has been steady to improving.
Another demand factor has become noticeable lately with Wal-Mart including premium Choice beef, in what used to be a mostly Select meat case. With 3,800 retail stores, this represents a major shift from low- to high-quality beef demand. There is a chance the retailer could revert back to more Select product at some point in 2012, but let’s assume the transition to Choice is long-term.
Regardless of the additional Choice demand from Wal-Mart, smaller forecasted cattle supplies for 2012 will likely result in declining Choice product next year and a wider than normal spread. The demand implications of this change could be a game changer for the entire beef industry.
The daily Choice-Select spread has reached a high of more than $19 per cwt. this fall. Even if the Choice-Select spread moves to an annual average around $10 per cwt., a feedyard selling on a formula or grid could earn $85 per head more for a Choice carcass than its Select-grading counterpart.
That extra margin creates an incentive to produce Choice cattle that has not existed in recent years. A wider Choice-Select spread in the long run would likely signal cattle producers to change production and management practices to benefit from the increased spread and more significant premiums for grid-marketed cattle.
Fed cattle pricing could fundamentally change between the North and South since the northern region tends to produce a higher percentage of Choice grading cattle relative to the southern region. There is a possibility the price difference between higher and lower quality cattle will widen and a two-tier cash market could develop.
It could also result in more buyers looking for calves and feeder cattle with documented carcass performance – or at least the potential to grade Choice or better. Cow-calf producers who can meet the demand for higher quality cattle should receive a premium for their investment in genetics and management.
Auction markets likely will see increased incentives to encourage participation in value-added programs, ensuring farmers and ranchers receive the maximum return for those calves. Also, retained ownership will be more profitable for cattlemen who understand the feedyard and carcass performance of their calves.
It appears that there will be a push for more Choice beef in the coming years, and CattleFax estimates that the Choice-Select spread will average around $10.25 per cwt next year due to this increase in demand. Renewed market incentives for Choice-grading cattle may create stronger market signals for genetic and management practices that are known to improve quality grade. Management practices and genetic selection that producers can use to increase the quality grade potential of their cattle will be an added benefit if the spread continues to widen.