Managing risk in feed prices directly

Newsletter No. 62 - Item 4

There are an increasing number of reports and articles written to advise producers on how to manage the effects of the increasing feed prices as they represent the highest single input cost. When prices are under pressure, it is always tempting to work with feed ingredients that do not have adequate nutrients to support optimum health and commercial levels of production. The top producers in mainstream livestock know that certain ingredients must be included in their diets, or they risk production dropping to uneconomic levels. These current conditions are putting increasing pressure on establishing the right balance.

One of the major problems with Ostrich production was the belief that ostrich can obtain energy from fibre and thus poor quality ingredients can be used. During a conference in 1998 the delegates were taken to a very large breeder farm. The farm was new and boasting to be the largest breeder farm in the country. The manager of the farm correctly stated that they see their breeders as production units and went onto tell us that their rations contained 50% straw. I do not know how many years the farm lasted, but it was not many. There are very few nutrients in straw, so the rations simply could not provide commercial levels of production and possible no production at all with 50% straw in a ration. With ostrich, because the daily intake of feed is low in proportion to their body weight, the ingredients used need to provide as many nutrients as possible within their class (e.g. forage, protein, grains) and those nutrients need to be available (digestible). The aim of commercial production units is to identify the ingredients that are essential to support commercial levels of production and then securing the supply and purchasing those ingredients at the best prices possible.

The following quote is from a document published this month (April 2008) for our British Pig producers entitled “Global Feed Commodities Market - Its Impact on the British Pig Industry and Risk Management Strategies to Mitigate This”. This quotation is discussing using forward buying as one mechanism for gaining better control over feed prices. This is the way larger producers manage their ingredient sourcing and provides an indication of the challenges facing Ostrich production while operations are small, fragmented and failing to work in collaboration. The right ingredients are essential for commercial production, but very expensive when purchased in low volume and on the open market.

Managing risk in feed prices directly
Buying forward cover

• This is a common practice among intensive livestock farmers, although it is not without its risks. To buy forward at a time when the value of the finished product is static or rising may well make good sense since it locks a major element of total costs at a known level which will leave a profit or at least limit any short term losses.
• Equally, if a short term contract has been taken, when it comes up for renewal at a time when cereal and protein prices have been rising while output values have not improved, there could be a sudden jump in costs against static output values resulting once again in reduced profit or a shift to trading losses. It is this last combination of circumstances in which the industry now finds itself at the beginning of 2008.

Using forward grain markets and Options
• Buyers of feed can buy an Option to buy wheat at a given price. If the market goes up, they exercise the option to buy at the lower price, thus effectively locking in to a maximum feed price. Should the market fall, they ‘tear up’ their Option contract, write off the cost of it, and buy at the lower price in the market.
• In the case of livestock feed, the business which buys the Option to buy feed ingredients could be either the pig farmer or his feed compounder. In the latter case the feed manufacturer will pass on the costs of the arrangement, no doubt including administration, to their customer, but at least both parties know that they can trade with each other for the duration of the arrangement without worrying about what the grain market is doing.

Managing risk through collaboration in the supply chain
• Fixed price contracts. These involve negotiating a price based on known feed costs and other costs in the chain which leave a modest margin for efficient operators and offer the opportunity for the more efficient to prosper further.
• Sale contracts linked to commodity prices. To reduce the risk of either or both parties to a fixed price contract being locked in to an unfavourable arrangement for any length of time, they may wish to consider a contractual arrangement with flexibility built in. An example of this would be linking finished pigs to wheat prices, for example the HGCA spot price on a given day, or the London International Financial Futures Exchange (Liffe) futures price for wheat..

Leave a Reply