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A SOLID FLOOR: Risk management for mid-sized herds

LISBON, N.D. -- Mike Schaefer says cattle producers worried about volatile feeder cattle markets should take a second look at the Livestock Risk Protection program.

LISBON, N.D. -- Mike Schaefer says cattle producers worried about volatile feeder cattle markets should take a second look at the Livestock Risk Protection program.

The LRP program had been available as a pilot project in limited areas around the country and became available in North Dakota in January 2004.

"I think it's probably more important now because of what's happening in the industry," Schafer says. "With what the grain complex is doing because of the energy bill, and other factors, the livestock end of it is going to continue to get pressured. Corn prices are twice what they were two years ago and that's a major component in the cost structure of feeding out a feeder calf."

Simply put, there's more downside risk.

Know the break-even

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The first step in using an LRP -- or any risk protection plan -- is to know the break-even.

"There are a lot of producers that do know their break-evens, but to put together a risk management plan you have to know that -- it's a starting point for making money. If you don't know your break-even, it's going to be increasingly difficult to make money," he says.

Producers also need to develop a solid understanding of the grain industry in general and the impact feeder prices.

Grain producers can market a crop anytime through a year, or even across marketing years. Beef cattle -- particularly feeder calves -- typically are marketed one calf crop at a time.

"In my opinion, that puts more pressure on making a decision," he says.

The LRP is a way to offset risk.

LRP is run by the Risk Management Agency and sold through crop insurance providers.

It's available for other species, but people in North Dakota who use it primarily are interested in the beef program. It's available for both market-ready cattle and feeder cattle, but people here primarily are interested in the feeder cattle side of it.

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Classes and weights

There is a 600- to 900-pound weight class and then a 600-pounds-or-less class.

"The majority of what we've written has been for the 600- to 900-pound market," Schaefer says. "That's typically what our cattle get sold at when marketing into the cash market."

The program runs July 1 to June 30. Contracts are sold in week-length policies, ranging from 13 weeks to 52 weeks in advance. Typically, the longer the policy length, the higher the premium.

"Predominantly we sell 13- to 34-week policies," he says, referring to the period between when the policy is written and when it expires. "The 13-, 17- and 21-week polices are most common." Most of these are sold in August and September.

Premiums are based on the Feeder Cattle Futures Board of the Chicago Mercantile Exchange.

The settlement payment is established from the Feeder Cattle Cash Index. This is the actual cash sales of cattle from 20 states across the United States. Feeder steer prices are based on marketings from the 600- to 850-pound range. The numbers are derived in the seven days before the contract expiration.

"Coverage percentages range from 75 percent to 100 percent," Schaefer says. "We sell predominantly to 95 percent to 100 percent of the coverage level."

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Subsidized at 13 percent

A separate policy is called the Livestock Gross Margin program.

This first was introduced in North Dakota in 2006 and is only available for finished cattle. This policy pulls information from corn futures, feeder cattle futures and fed cattle futures.

"You're insuring against movement on corn, feeder cattle and live cattle," he says.

An important feature of the LRPs is that government offers a 13 percent subsidy on the premium. The RMA limits the number of cattle it'll write in a particular year, and in a particular state, but the program isn't approaching its capacity, Schaefer says.

Schaefer guesses that fewer than 10 percent of qualified producers are using it.

Some people, of course, already are using the futures market to hedge their cattle. But a feeder cattle futures contract covers 50,000 pounds, he says. On 600-pound feeder calves, that would be 80-some head.

"If you're a producer and have 40 head, you have to buy the whole contract," he says. "With the LRP, we've had producers buy policies for as few as 25 head of heifers and 25 head of steers. The smaller you are, the less you can use futures and option, because of the head count."

Schaefer acknowledges that one advantage options have over LRPs is you can lift a futures position and get out.

"With the LRP, you own the policy until it expires," he says. "I see that as both an advantage and a disadvantage. People who lift their positions on options -- that's speculation. The LRP reduces the temptation to speculate," he says. "You bought a policy -- hopefully at a profit level -- and you can't remove it."

Schaefer says the policies require that a producer can't market more than 25 percent of the head count from the policy more than 30 days before the expiration of the policy.

Once the policy expires, of course, the producer is paid any indemnity they're entitled to, regardless if the cattle are sold.

"If you don't sell, then you're taking on a new risk," he says. "The key is to try and customize the LRP policy so the expiration ties in with when you're going to sell cattle."Producers need to develop some type of risk management program -- the LRP, futures and options or plain forward-cash sales with sale barns and feedlots are some of them. People need to establish a floor on their cash price, and this is just one tool to do it."

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