Canada’s beef industry plays a major role in our day to day lives: Last year Canadians consumed 39.1 lbs of beef per person, which is 0.8 percent higher than the year before¹. The process to get all of those roasts, burgers, steaks, and stir-frys from farm to table contributed $18 billion CAD to total GDP²; a figure on par with our automotive industry. Our 59,784³ beef producing ranches make sure we are well employed and well fed. But the industry is not without its challenges. 75 percent of our exports head to the US, which creates a difficult situation where Canadian ranchers are essentially beholden to US market conditions.

In this piece, we take a quick tour of the dynamics of the Canadian beef export landscape with a particular focus on how strategic foreign exchange (FX) planning can help industry leaders effectively handle their inherent exposure to the value of the US dollar.

Alberta’s beef export landscape

Canada’s Western Provinces are the epicentre of the beef industry with 71 percent of total head residing in Alberta and Saskatchewan. Alberta has the largest share overall with forty-one percent, or 1.5m head of cattle⁴. Most of that activity is centered in Southern Alberta which is home to three large packing operations.

On a global scale, Canada only has a 2 percent share of the total 996 million cattle, well behind the largest player’s like the US and Brazil. That being said, we are the world’s seventh largest cattle exporter moving over $2 billion USD in product to global markets in 2019 alone. While that pales in comparison to the $7.5 billion USD⁵ Australia shipped, it is significant as it represents almost 40 percent of total Canadian production.

Exhibit 1: Global Beef Exports by Country 2017-2019 US$B

The vast majority of those exports head south of the border to the US; in 2018 Canada sent 75 percent of our shipments to the US. In a similar dynamic to our energy exports, which trade at a discount to US products, our beef can also suffer from lower prices relative to US products. This is due to two main drivers:

1. A quality differential, and
2. A locational discount to cover the cost of shipments to US markets.

This price differential, or basis, means that the US can fetch much better average prices for similar products in aggregate than our Canadian producers.

Another reason for Canadian prices to trade at a discount compared to those in the US is because Canada has less favourable trade and tariff agreements with major buyers in Asian markets⁶. As a result we don’t have the same historically strong relationships with Asian buyers. Canada has recently entered into a trade agreement with Korea that will see average tariffs start to fall this year, but the US will still have a 7-8 percent tariff advantage⁷. The recent US-China trade deal and continuing frictions between Beijing and Ottawa will impact Canada’s ability to increase Chinese exports, which reached 22.8 million lbs in 2018.

Developing strategic foreign exchange strategies

All of this leaves Canadian producers beholden to the US market, and thus to the value of the Canadian dollar relative the US dollar amid difficult market conditions. That means producers have to maximize every dollar they earn from sales to US buyers. So, what is the most optimal foreign exchange strategy?

We have crunched the numbers over the past five years and compared two similar and relatively simple hedging strategies that producers may want to consider. The parameters are as follows:

We took the monthly closing rate for USD/CAD over the last five years.

We then assumed the producer followed either:

• A rolling three-month forward strategy in which at the close of every month they booked the fair valued forward, which was then settled against the closing rate three months later. Or,
• A rolling three-month Participating Option Strategy booked and settled in the same fashion.

We then compared the results using actual market data from the last five years.

A forward contract locks the hedger in and insulates them against further market fluctuations: they have 100 percent cost certainty, but no ability to participate in favourable market movement. The Participating option addresses this concern. Like the forward contract, it offers 100 percent downside protection so producers can plan ahead will full confidence, but it allows for 50 percent participation in favourable US dollar appreciation. For that added benefit, the initial strike rate for the Participating option will be less favourable than the comparable fair value forward.

Exhibit 2: Participating and Forward Contract Payoffs for a US Dollar Seller

The results of our study were interesting: Pursuing a hedging strategy with participating forwards over the last 5 years would have yielded an additional 24bps in realised FX revenue compared with the forward strategy. That translates to an average of $144,000 CAD in annual savings assuming $5 million USD in monthly sales. Those savings are not immaterial and given that the participating strategy still affords 100 percent downside protection from US dollar depreciation, the producer can accurately forecast future cash flows while benefiting from potential US dollar appreciation.

Exhibit 3: Participating and Forward Hedges Analysis - Participating Wins Over the Long Haul

This is a small example of how working closely with your financial markets partner can help to introduce small efficiencies that can lead to large benefits over time. Canada as a whole benefits from Alberta’s beef producers, and the right partner will work to ensure you are set up to take advantage of every opportunity available to maximize export value.