Dairy Farmers Need to Study Risk Management Options for 2017

Dairy farmers are experiencing another cyclic downturn in prices, and this usually brings another look at what tools farmers could use to absorb some of the risk in price volatility.

Dairy farmers face a unique situation in the market. Milk is produced 365 days per year, has limited storability and must be kept at low temperatures. Farmers can’t stockpile their product in hopes of higher prices.

Milk is also unique in the complicated marketing rules in place to protect the farmer as well as ensure a safe product for consumers.

There are only a few games in town to protect prices: the Margin Protection Program, Livestock Gross Margin, forward pricing through a cooperative or forward pricing on your own through the Chicago Merchantile Exchange.

Another option is self-insuring by not participating in any market program. Farmers who do not take any insurance programs are nearly guaranteed to get the average milk price for the year, assuming fairly constant milk production.

By taking part in any insurance program, the farm is incurring additional costs, which guarantees they will not get the average milk price for the year.

This may seem to be the smart move, but what if milk prices drop to the point where insurance programs kick in?

One insight that came out of the effort to pass the current Farm Bill is Congress’ reluctance to provide agriculture with handouts just for producing.

Crop insurance requires involvement on the part of producers — if you want more coverage, you pay more of the costs.

However, crop insurance is accepted by crop farmers and is part of the requirements set by lenders when loaning operating funds.

Smaller scale dairy producers, on the other hand, are for the first time experiencing a crop insurance type of program in MPP.

Congress does not seem to be interested in these programs anymore, so there is little chance the current Farm Bill’s dairy program will be changed.

That leaves smaller scale producers, those producing less than 4 million pounds a year, with two practical options for managing price risk — MPP or doing nothing.

MPP takes into account changing feed prices by basing coverage on the estimated returns over feed costs.

There are valid complaints that the MPP does not reflect true feed costs in the Northeast. Generally a grain-deficit area, the Northeast pays extra transportation costs by importing corn and soy meal from the Midwest.

Now it’s decision time. Dairy farmers have to choose a level of coverage for 2017. What do we know now that we didn’t know last year?

First, few were predicting Class III milk prices would drop below $13 as they did in May, which lowered the estimated return over feed costs to $5.76 and triggered an MPP insurance payment to those farmers whose coverage was above $5.50.

The predictions for 2017, according to the MPP decision tool, show expected prices at $9.73 to $10.29, well above the highest insurable level of $8 per hundredweight. This is the expected price based on predicted feed and milk prices.

At this time, there is only a 10 to 15 percent chance that return over feed costs will drop below $8 and only a 1 to 2 percent chance that it will drop below $6.50.

These probabilities do not encourage participation in the MPP program for 2017, but last year we saw similar projections before milk prices dropped below what had been projected.

If not for concurrent falling feed prices, we would have seen lower returns over feed costs this year.

Coverage in 2017 will range from $100 at $4 coverage to $17,799 at the $8 coverage level.

The expected returns are negative for all levels at $5.50 or below, with some positive returns at the $8, $7.50 and $6.50 coverage levels.

But would you be willing to spend $17,799 for the $8 coverage level with only a 10 to 15 percent chance the expected price will drop below $8?

Under the extended deadline, Dairy farmers have until Dec. 16 to sign up at their Farm Service Agency office for the 2017 MPP program.

As you consider the options, think about what could happen next year.

Milk prices could go up due to booming exports with returns over feed costs ballooning to levels we only dream about. Or surging production in Europe and New Zealand could drive U.S. exports down and collapse prices.

Mix in a dry year in the Midwest, and we could see surging corn and soybean prices.

Which outcome is most probable? Which outcomes should be insured against? These are decisions the dairy farmer needs to make.

Source: Bob Parsons, Lancaster Farming

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