Rewind your clock to December 4, 2011. The prior week the USDA released its preliminary Agricultural Prices report for November. According to this report, the preliminary milk-feed ratio for November was 1.80. Following the headline “November milk-feed ratio a disappointing 1.80,” an eminent dairy economist commented, “The milk-feed profitability index for November is none too rosy. It’s not until the ratio reaches 3.0 that it is considered profitable to buy feed and produce milk.”
For most dairy producers, however, November 2011 was a very profitable month – in fact, November was one of the most profitable months of 2011. So what’s going on? Is there a problem with the USDA’s milk-feed ratio?
There are in fact multiple issues with the USDA’s milk-feed ratio as a benchmark of dairy profitability.
1. It is expressed as a ratio of income over cost as opposed to a difference. Profits are made from differences, not ratios. In November, the milk price was $19.90 per hundredweight (cwt) and feed costs were $11.05, yielding a gross margin of $8.85 per cwt.
A few years ago, milk price was at $13.00 per cwt and feed costs were at $4.25 per cwt, resulting in a milk-feed ratio of 3.05 (69 percent greater than last November), but a gross margin of $8.75 per cwt, a figure that is in fact less than that of last November.
2. It is based solely on corn, whole soybeans and alfalfa hay prices. In many regions, producers make extensive use of regional feeds and byproducts whose prices are greatly seasonal and not perfectly aligned to the corn and soybean markets.
In addition, the price relationships between feeds have changed over time. One only has to think of corn distillers dried grains, a feed ingredient that was selling at a 30 to 40 percent premium over corn 10 years ago but is now selling at a discount compared to corn.
3. The USDA “ration” is fixed. It assumes that it takes 51 lbs of corn, 8 lbs of raw soybeans and 41 lbs of alfalfa hay to produce 100 lbs of milk. This “ration” never changes regardless of prices. How many dairymen have kept using the same ration over the last 25 years?
4. The USDA “ration” is not updated for changes in animal productivity. In fact, I have not found any documentation regarding what animal productivity was assumed with this ration. Fortunately, we know that in the 100 lbs of feeds used in the USDA calculation we have about 88 lbs of dry matter and 80.2 Mcals of net energy for lactation (NEL).
We also know that it takes 10.6 Mcals to maintain a cow for one day and 0.32 Mcals to produce one pound of milk at 3.7 percent fat and 3.0 percent protein. Using a bit of algebra, one calculates that the USDA production is that of four cows, each producing 25 lbs per day (9,125 lbs per year).
So the index is for a 1970 cow. Currently, the average cow in the U.S. is producing about 60 lbs of milk per day, or 22,000 lbs per year. Simply put, the index is based on an obsolete cow, the one that our grandfathers used to milk.
5. The milk-feed ratio does not account for regional differences. Considering the significant production shift towards Western states that has occurred over the last few decades, it is probably important to have an index that properly accounts for where milk is being produced as opposed to maintaining the USDA’s Midwestern myopic fixation.
A few years ago we started working on an index of dairy profitability for the U.S. We facetiously called this index the Cow-Jones, indirectly coat-tailing the ubiquitous Dow-Jones index used by investors.
The original Cow-Jones index was based on Midwest prices. Since the introduction of this index in 2006, we have worked on building an improved index of dairy profitability that would:
1. Tract regional difference in productivity
2. Tract seasonal change in productivity
3. Be based on the whole feed market in each dairy regions as opposed to just a national average for corn, soybean and alfalfa hay markets
4. Be expressed as the difference between gross income from milk and the cost of supplying the nutrients required to achieve the average production in a dairy region
5. Be physically and biologically coherent. That is, the index should be consistent with the current knowledge in dairy nutrition.
In this issue of Progressive Dairyman we are introducing the Cow-Jones II. The assumptions and calculations underlying this index are fully disclosed. More specifically,
• Each month, milk production and composition are estimated using the prior two-year historical pattern for each of the top 25 milk-producing states.
• Six regions are tracked: Northeast (New York, Pennsylvania, Vermont), Southeast (Florida, Missouri), Midwest (Minnesota, Wisconsin), Southwest (New Mexico, Texas), West (California) and Northwest (Idaho, Oregon, Washington).
Altogether, these states account for over 75 percent of the U.S. annual milk production. Of course we realize that we have left out a few important states, but considering the size of our budget ($0) and support staff (0), this is as good as it is going to be for a while. Send us a big enough check and the fixing may be done faster …
• Milk price per region is calculated as the weighed average at actual butterfat, protein and other solids of Class III milk under the Federal Order system, plus the average Class I differential in a region multiplied by the average percentage Class I utilization in the region for the month in question.
We are treating California as if it belonged to its own Federal Order. We realize that milk pricing in California is different, but considering the size of our budget … Still, we intend to fix this aberration shortly.
• The cost of feeding is the cost of providing the basic nutrients to lactating and dry cows. The index does not factor the cost of feeding the replacement herd.
• Requirements for NEL, metabolizable protein (MP), effective neutral detergent fiber (eNDF) and non-effective NDF (neNDF) are calculated according to NRC (2001) for cows weighing 1,500 lbs and at weighed averages of milk production and composition for each of the six regions.
• Unit prices of nutrients are calculated separately for each region using the Sesame software. This method incorporates the composition and prices of all feeds being traded in a given region. This approach has been used for some time in our feed market analysis column that appears monthly in Progressive Dairyman .
The Cow-Jones II will be refined through time. Readers will be alerted whenever we make changes in our methods of calculation. Our hope is that the clarity and precision of the Cow-Jones II will make it more relevant than the current USDA milk-feed ratio. PD