The USDA grading system is a means of differentiation between the various levels of quality of beef that pass through USDA inspection. There are four primary quality grades used by USDA that are used to classify the amount of marbling in the meat: Prime, Choice, Select, and Standard (with a few more commercial grades below that). USDA Prime beef is produced from young, well-fed beef cattle and has abundant marbling (the amount of fat interspersed with lean meat). Choice beef is still high quality, but has less marbling than Prime grade beef, while Select beef is normally leaner than the higher quality grades.
The majority of beef in the U.S. falls within Choice or Select quality grades (+85%). Since the mid-2000s the U.S. has seen the percentage of Select graded beef steadily decline while both Choice and Prime have seen an increasing share. The tradeoffs between Choice and Select are highly related since cattle that fail to grade Choice typically grade Select, thereby changing the supply of both simultaneously. There are two separate but connected markets for Choice and Select beef with separate and unique supply and demand curves for each quality grade. Choice beef contains a higher degree of marbling than Select beef and can typically be attributed either to differences in genetics or to additional days on feed. These differences result in a product that is more expensive to produce, which is reflected in a supply curve for Choice beef that is different than for Select beef. Anything that shifts the supply or demand curves for either Choice or Select beef can impact the Choice-Select spread.
The Choice-Select spread is the difference between the composite values of the choice and select quality grade carcasses. The primary driver of the differences in the quality graded cutouts is the middle meats, rib and loin (this makes intuitive sense, you care more about high quality steaks, whole prime ribs, etc than you do roasts, and ground beef and the like). The figure below shows the October values for each quality grade by cutout as well as each primal. You can see that there is much more of a spread in the rib and the loin primal than the rest of the primals.
End Meat Primals Do Not Exhibit Significant Value Differences, Middle Meat Primals Do
The spread also exhibits a typical seasonality throughout the year, which is impacted by both supply fundamentals with cattle production and demand fundamentals with consumer purchasing behaviors. Fewer cattle grade choice in the spring reflecting younger cattle being placed on feedlots in the fall and dealing with winter performance issues. This contributes to the sharp increase in the spread that typically occurs during the spring months. This is occurring at the same time as the onset of the grilling season, during which time the choice cutout tends to increase at a faster pace than the select cutout, driving the spread to increase during the spring and early summer grilling months. There is usually a dip in late summer (the dog days of summer where the cutout tends to struggle prior to holiday demand, and beginning in October the spread sharply increases again as retailers secure product for the upcoming holiday demand where consumers seek out higher quality cuts of the middle meats. This demand is not shared by the select graded middle meats, driving the spread higher. The figure below illustrates these seasonal price movements (sharp increases in April/May, decline in July, increase again in October-December, sharp decline in January-March.
A widening spread incentivizes increased production of choice beef, which means cattle would need to be kept on feed longer to achieve the higher quality grade (which equates to higher cost of production, and may or may not make economic sense depending on cost of feed). The spread is a signal from packers to feeders that the marginal cost of keeping cattle on feed longer has a reward through higher fed cattle prices (in theory this should be the result). While the spread reflects packer demand for certain types of cattle quality, these incentives are not always fully communicated through price signals, depending on the pricing system used to procure fed cattle. Pricing fed cattle on a live or dressed basis makes it difficult for the packer to fully account for the quality of the animal. This may result in a lower price for the cattle producer since the packer faces uncertainty regarding carcass quality until after the animal is slaughtered. Most cattle in the U.S. are priced on a grid pricing system that provides stronger incentives, via premiums and discounts in the grid, for producers to produce high quality fed cattle. Basically, grid pricing transfers risk and uncertainty regarding the carcass quality and its value to the producer, but the producer can also be rewarded for higher quality cattle that meet demand from consumers.
