With strong milk futures prices, dairy producers are facing increased pressure from lenders and others to protect milk prices or income margins far out into the future. Protecting profits is important, as long as it is done with sound reasoning and understanding of all options, according to Travis Glaser, certified crop insurance agent and owner of ARM Services LLC.
Glaser, who partners with FarmFirst Dairy Cooperative on dairy risk management strategies, warns that some of the pressure applied to producers to lock in long-term price or margin protection will come at a cost of high premiums or margin calls, negatively impacting the producer’s risk strategy.
Glaser described several options available to dairy producers to protect milk revenue. He warns producers to analyze costs with each of the strategies listed.
“In some instances, it’s opportunity cost; in other instances, it’s premium cost,” he said.
Locking in prices with forward contracts with a milk processor may be inexpensive at 10-15 cents per hundredweight (cwt) but may prevent you from taking advantage of rising milk prices. Additionally, since cooperatives are not required to pay Federal Milk Marketing Order (FMMO) minimum prices, negative producer price differentials (PPDs) or other deductions may mean you receive less than the contracted price, Glaser said.
Options trading, buying puts and selling calls on the Chicago Mercantile Exchange (CME), allows you to build a fence around a desired milk price. But while allowing you to protect the bottom, it may also set a limit to the topside, Glaser said. For producers who locked in prices several months ago, the margin calls add another layer of costs. Making multiple moves with a broker may also increase transaction costs.
- Dairy Revenue Protection (Dairy-RP) helps provide a federally subsidized floor under milk revenue. However, some components of the program can prove costly, especially as they relate to premiums for far-out months, Glaser said. Quarterly averaging on both price and milk production also limits the ability to manage risk when month-to-month price or production changes occur.
At any one time, sales are open for as many as five future quarters. Sales close 15 days before the beginning of the quarter. For example, the period to purchase Dairy-RP coverage for the third quarter of 2022 closes on June 15. The market changes daily, and Dairy-RP endorsements must be purchased between the CME market closing and the next CME opening.
Dairy-RP coverage cannot be purchased on days when major USDA dairy reports that could impact markets are released, including Milk Production, Cold Storage and Dairy Product reports (see Calendar). Dairy-RP is also not available on days when applicable futures contracts move limit-up or limit-down, or on days when Chicago Mercantile Exchange trading is closed due to holidays.
Indemnity payments are determined by calculating the difference between expected revenue and actual revenue according to market prices, adjusted on a state or regional basis to account for differences between expected and actual milk production. Premiums do not become due until the month following the end of the quarter.
- Livestock Gross Margin for Dairy (LGM-Dairy) also establishes a federally subsidized floor on your margin, covering both the price of milk and feed. Gross margin is milk price minus feed (corn and soybean meal) prices. Dairy producer can purchase a $0 deductible policy or up to a $1 deductible in 10-cent increments. Coverage under LGM-Dairy is available for up to 10 months. To be eligible for a subsidy, at least two months of coverage must be purchased. LGM-Dairy pays the difference between the gross margin guarantee and the actual gross margin, as defined in the policy provisions, for milk covered.
Sales periods for the LGM-Dairy program are open on a weekly basis. Unlike Dairy-RP, LGM-Dairy is available even if a sales period falls on the day of a USDA report.
The milk prices for LGM-Dairy are three-day averages of Class III futures prices. Three-day averages for corn and soybean meal futures prices are used for the feed side of the policy. LGM-Dairy has flexibility in how much feed is included in the policy they purchase.
Under current market conditions, Glaser prefers LGM-Dairy because the producer is eligible to protect margins on a monthly basis, avoiding the quarterly averaging under Dairy-RP. In some states, premium costs for LGM-Dairy are cheaper than Dairy-RP.
Escalating feed costs ate into milk income margins in February but not enough to trigger indemnity payments under the Dairy Margin Coverage (DMC) program. Read: February DMC margin dips but no indemnity payments triggered.
The February 2022 announced U.S. average milk price rose 50 cents from January to $24.70 per cwt, the highest monthly average price since October 2014.
However, offsetting the gain in the average milk price were higher average costs for alfalfa hay, corn and soybean meal. February feedstuff prices yielded an average DMC total feed cost of $13.72 per cwt of milk sold, up $1.09 from January and the highest since the inception of the DMC program or its predecessor, the Margin Protection Program for Dairy (MPP-Dairy), dating back to March 2014.
That left the February DMC margin at $10.98 per cwt, 56 cents less than January‘s margin, which hit a 14-month high of $11.54 per cwt. Despite the decline, the margin remained above the top DMC Tier I insurable level of $9.50 per cwt.
A lot of milk price comparisons are being made with those prices received in 2014. The two years provides a substantial contrast in milk income margins, however.
While the February 2022 milk income over feed cost margin under DMC was $10.98 per cwt, the September-October 2014 average all-milk milk price under the MPP-Dairy program was slightly higher at $25.30 per cwt but yielded a much larger margin at $15.51 per cwt. Average feed costs in September-October 2014 averaged $9.79 per cwt, with the hay price averaging $195.50 per ton, corn averaging $3.52 per bushel and soybean meal averaging $453.61 per ton.
USDA milk production report, outlook
February 2022 milk production was down 1% from the same month a year earlier, but an eight-month decline in cow numbers came to a halt, bolstered by higher milk prices. U.S cow numbers were up 3,000 from the revised January 2022 estimates but still down 96,000 head from a year earlier and were 137,000 head lower than the peak in May 2021.
The USDA’s March preliminary milk production estimate will be released on April 20. Check back with Progressive Dairy for numbers and analysis.
The USDA’s monthly World Ag Supply and Demand Estimates (WASDE) report, released April 8, revised the 2022 U.S. milk production estimate upward, citing expected growth in cow numbers. Despite the production increase, the outlook for farm-level milk prices improved.
Compared to the previous month, the USDA raised the milk production forecast by 300 million pounds to 226.3 billion pounds. If realized, 2022 production would be unchanged from 2021.
The projected annual average Class III price was raised $1.10 from last month to $22.75 per cwt. The projected Class IV price was raised 35 cents to $24.05 per cwt. The 2022 all-milk price forecast was increased to $25.80 per cwt, up 75 cents from last month.
- Next "Protecting Your Profits" webinar is April 27. A special edition of the Pennsylvania Center for Dairy Excellence (CDE) Protecting Your Profits webinar will focus on rising interest rates and the potential impact on dairy profitability. Zach Myers, risk education manager with CDE, will host the monthly webinar, April 27, 12-1 p.m. (Eastern time). The program will feature Sam Miller, managing director of agriculture banking at BMO Harris Bank, who will discuss increasing interest rates, inflation and how these could impact dairy producers and the industry as a whole. Myers will also highlight Class III and IV futures milk price forecasts, as well as DMC margins.
Advance registration is not necessary. Each webinar is available via podcast or phone. To participate, click here or phone: (646) 558-8656. When prompted, enter meeting ID 848 3416 1708 and passcode 474057.
- FMMO uniform price and producer price differentials for March milk marketings were released, April 11-13. FMMO statistically uniform milk prices were up in March, while the spread between milk class prices again impacted handler pooling and the “Class I mover.” Read: FMMO uniform prices, Class IV depooling march on.
- Progressive Dairy
- Email Dave Natzke