Over the last three weeks, I’ve seen some significant moves in how some countries plan to manage price volatility in their dairy industry.
Just last week, Fonterra in New Zealand decided to call an end to its recently launched guaranteed milk price scheme, citing inequality and mixed reaction from farmers. More importantly, it announced that a new tool in terms of managing volatility was being finalised and would be available to New Zealand dairy farmers very soon.
Recently in the US, I experienced at first hand how some farmers manage volatility and what it means to their system. Yes, the uptake might be relatively low, but maybe the uptake is always going to be small and those that need to use volatility management tools can pick and choose when they need it.
I certainly know some Irish dairy farmers now that would lock in at a price today if they had the chance as it would allow them plan with some degree of certainty.
The Wisconsin dairy farm I visited last week had forward-sold milk for 2016. The farmer was also insuring his margin as per the Dairy Margin Protection Program, had forward-purchased grains and, maybe more importantly, had huge stocks of forage on farm (almost two years worth). Now that’s what you call volatility management.
Yes the system of milk production was high-cost, intensive, low-margin, and on a huge scale, but the operators were using the business tools available to US dairy farmers to ensure they managed the farm margin as best they could.
In the US, the 2014 farm bill included a new dairy safety net known as the Dairy Margin Protection Program, or MPP. The MPP provides dairy producers with payments when margins are below the coverage levels the producer chooses each year. Its focus is to protect farm equity by guarding against destructively low margins, not to guarantee a profit to individual producers.
How it will work
All dairy operations producing milk commercially are eligible to participate. Coverage is based on a producer’s production history. In the first year, production history is defined as the highest level of milk production during 2011, 2012, or 2013. In subsequent years, adjustments will be made based on the national average growth in overall US milk production as estimated by the US Department of Agriculture (USDA).
Any growth beyond the national average increase will not be protected by the programme. Producers will be able to protect from 25% to 90% of their production history, in 5% increments. They will select margin protection coverage from $4 per hundredweight (€0.08/l) to $8 per hundredweight (€0.16/l), in 50c increments.
The programme supports producer margins, not milk prices, and is designed to address both catastrophic conditions as well as prolonged periods of low margins. Under this programme, the margin will be calculated monthly by USDA. Simply defined, it is the all-milk price minus the average feed cost.
Average feed cost is determined using a national feed ration that has been developed to more realistically reflect those costs associated with feeding all dairy animals on a farm on a hundredweight basis.
All producers pay a $100 (€90) annual registration fee. Basic margin coverage of $4 per hundredweight is free. Above the $4 margin level, coverage is available for varying premiums.
Sign-up
During the three-month 2015 sign-up period, producers could enrol for any year between 2015 and 2018. Once a producer enrols, he or she is committed to be in the programme each year until the expiration of the 2014 farm bill.
However, producers can adjust their coverage.
Payments to producers are based on the percentage of production history they choose to protect (25% to 90%) and the level of margin coverage selected (8c/litre to 16c/litre).
Payments are distributed when margins fall below $4 per hundredweight (or below the margin level selected by the producer above $4 per cwt.), averaged over any of these consecutive two-month periods: January-February, March-April, May-June, July-August, September-October, or November-December.
How are payments
calculated?
The margin is calculated by the USDA. It is defined as the US all-milk price, minus national average feed costs, computed by a formula using the prices of corn, soybean meal, and alfalfa hay. The formula reflects the cost of feeding all the dairy animals on a farm, including heifers and dry cows.
The programme pays on one-sixth of a producer’s annual production history, multiplied by the percentage of coverage selected by the producer. The programme pays when the national average margin for any one of the six consecutive two-month periods is below the level of coverage selected by the producer.
It is likely producers will receive payments a little more than a month after a payment is triggered. For example, if a payment is triggered for January-February, the margin for that period will be announced at the end of March and payments will be sent out in early April.
Why margin, not price?
The financial stability of dairy operations depends on margins, rather than milk prices alone. The economic hardship experienced by dairy farmers in 2009, and again in 2012, testifies that high milk prices don’t guarantee profitability when teamed with high input costs.
Visiting the Chicago Mercantile exchange
While in the US last week, I also had the opportunity to visit the Chicago Mercantile Exchange, or the Chicago Board of Trade (CBOT) as it is now known. This is effectively the livestock mart for all commodities.
In the CBOT, similar to Ennis mart, when a heifer walks into the ring, farmers and dealers raise their hand and bid. In Chicago, there are flashing screens up around the ring showing prices of products instead of the heifer. The Chicago sale starts at 8.30am and finishes at 1.30pm and there is a separate ring for soyabeans, wheat, etc.
You have buyers all rigged up with earpieces taking direction from other staff in offices around the CBOT or sitting in seats around the ring. In total, there are 1,400 registered dealers and each has a yellow badge with a number that they flash up so the teller can identify who has made the purchase.
Soon, it is likely the rings, or the pits as they are known in Chicago, will disappear and all will be replaced by internet bidding, but for the moment the Chicago Mart-type scenario still exists.
Needless to say buyers get to know each other very well because they are standing beside each other for hours every day bidding on product for clients.
The farm I visited in Wisconsin last week had forward-sold milk that would be produced between January and June 2016 the day before I arrived on the farm. How did this happen? The farmer picked up the phone to his broker, explained he wanted to forward sell a certain number of contracts (a volume of milk) and the broker would then have offered the contracts for sale in Chicago.
In the US, Class III milk price futures contracts and options for each calendar month are available 24 months into the future. Class III price is the Federal Milk Marketing Order-defined minimum farm price of milk used for cheese (and whey) and is the primary driver of farm milk prices in the US.
Class III is the primary driver of farm prices because cheese is the single largest class use of milk. Class III futures and options traded on the CBOT are 200,000lb monthly contracts (contract is 90,000 litres each) that cash settle when the Class III price is announced for each month.
The farmer I visited in Wisconsin had made a decision to sell a number of contracts for January to June 2016. Yes he agreed that potentially the business would lose out if milk price went up, but he was willing to forego that upside because he felt the market was going to get worse before it got better.
The open interest and volume in Class III contracts has increased dramatically in the past decade, reflecting the desire of both sellers (farmers and co-operatives) and buyers (eg, cheese processors) of milk to mitigate milk price risk. Farmers are paid a mailbox milk price that includes the average milk marketing order blend price (where applicable) as well as farm-specific premiums.
Risk
When farmers use Class III milk futures or options contracts to manage risk, basis risk (mailbox less Class III price) remains.
Milk price volatility isn’t really new, but it was more predictable before. Cashflow has always been a challenge but as stocking rates have increased and businesses purchase more feed, the problem is different today.
Volatility in margin or net income or profitability is the challenge today, because milk prices are volatile but so are prices of inputs, especially, but not only, feeds. This isn’t likely to change soon.
Economic instability in the world, political instability in parts of the world and climate issues (whether they are short-term or long-term) have an effect. Increasing milk and feed price volatility in recent years has led to frequent calls in the US for dairy farm adoption of forward pricing tools by policymakers and industry leaders.
A recent research paper examined the extent to which forward pricing tools had been used by dairy farmers in California, Florida, Indiana, Michigan, and Wisconsin. In summary, the research found farm managers who had used these tools were more educated, younger, operated larger herds, had more acreage, produced more milk per cow, and were not organised as sole proprietorships. The farm I visited in Wisconsin last week ticked all those boxes.
The most common reason that farm managers had not used forward pricing was lack of knowledge about the tools. I do think some national scheme needs to be developed for the Irish dairy industry. I definitely think it would ease the concerns of some farmers who are in the process of changing their dairy system or those farmers who have invested heavily recently and know they have large repayments for a number of years, even at current low interest rates.
The Irish Department of Agriculture should gather a small group of experts on the matter to decide the best route forward. Yes it won’t change the core profitability of a dairy business but it can help determine a certain level of output for the future and allow more definitive planning. It might not be for everyone and will of course be voluntary, but options and flexibility are better than failed debt repayments and forced asset selling.
Key points
Onus on the Department of Agriculture to initiate an Irish group of experts to discuss volatility management tools for Irish dairy farmers. US dairy farmers managing volatility in many different ways – forward selling milk, forward purchasing grain and fuel etc. Volatility management tools don’t mean margins increase but they improve planning and can allow low margin businesses survive during periods of change.
Over the last three weeks, I’ve seen some significant moves in how some countries plan to manage price volatility in their dairy industry.
Just last week, Fonterra in New Zealand decided to call an end to its recently launched guaranteed milk price scheme, citing inequality and mixed reaction from farmers. More importantly, it announced that a new tool in terms of managing volatility was being finalised and would be available to New Zealand dairy farmers very soon.
Recently in the US, I experienced at first hand how some farmers manage volatility and what it means to their system. Yes, the uptake might be relatively low, but maybe the uptake is always going to be small and those that need to use volatility management tools can pick and choose when they need it.
I certainly know some Irish dairy farmers now that would lock in at a price today if they had the chance as it would allow them plan with some degree of certainty.
The Wisconsin dairy farm I visited last week had forward-sold milk for 2016. The farmer was also insuring his margin as per the Dairy Margin Protection Program, had forward-purchased grains and, maybe more importantly, had huge stocks of forage on farm (almost two years worth). Now that’s what you call volatility management.
Yes the system of milk production was high-cost, intensive, low-margin, and on a huge scale, but the operators were using the business tools available to US dairy farmers to ensure they managed the farm margin as best they could.
In the US, the 2014 farm bill included a new dairy safety net known as the Dairy Margin Protection Program, or MPP. The MPP provides dairy producers with payments when margins are below the coverage levels the producer chooses each year. Its focus is to protect farm equity by guarding against destructively low margins, not to guarantee a profit to individual producers.
How it will work
All dairy operations producing milk commercially are eligible to participate. Coverage is based on a producer’s production history. In the first year, production history is defined as the highest level of milk production during 2011, 2012, or 2013. In subsequent years, adjustments will be made based on the national average growth in overall US milk production as estimated by the US Department of Agriculture (USDA).
Any growth beyond the national average increase will not be protected by the programme. Producers will be able to protect from 25% to 90% of their production history, in 5% increments. They will select margin protection coverage from $4 per hundredweight (€0.08/l) to $8 per hundredweight (€0.16/l), in 50c increments.
The programme supports producer margins, not milk prices, and is designed to address both catastrophic conditions as well as prolonged periods of low margins. Under this programme, the margin will be calculated monthly by USDA. Simply defined, it is the all-milk price minus the average feed cost.
Average feed cost is determined using a national feed ration that has been developed to more realistically reflect those costs associated with feeding all dairy animals on a farm on a hundredweight basis.
All producers pay a $100 (€90) annual registration fee. Basic margin coverage of $4 per hundredweight is free. Above the $4 margin level, coverage is available for varying premiums.
Sign-up
During the three-month 2015 sign-up period, producers could enrol for any year between 2015 and 2018. Once a producer enrols, he or she is committed to be in the programme each year until the expiration of the 2014 farm bill.
However, producers can adjust their coverage.
Payments to producers are based on the percentage of production history they choose to protect (25% to 90%) and the level of margin coverage selected (8c/litre to 16c/litre).
Payments are distributed when margins fall below $4 per hundredweight (or below the margin level selected by the producer above $4 per cwt.), averaged over any of these consecutive two-month periods: January-February, March-April, May-June, July-August, September-October, or November-December.
How are payments
calculated?
The margin is calculated by the USDA. It is defined as the US all-milk price, minus national average feed costs, computed by a formula using the prices of corn, soybean meal, and alfalfa hay. The formula reflects the cost of feeding all the dairy animals on a farm, including heifers and dry cows.
The programme pays on one-sixth of a producer’s annual production history, multiplied by the percentage of coverage selected by the producer. The programme pays when the national average margin for any one of the six consecutive two-month periods is below the level of coverage selected by the producer.
It is likely producers will receive payments a little more than a month after a payment is triggered. For example, if a payment is triggered for January-February, the margin for that period will be announced at the end of March and payments will be sent out in early April.
Why margin, not price?
The financial stability of dairy operations depends on margins, rather than milk prices alone. The economic hardship experienced by dairy farmers in 2009, and again in 2012, testifies that high milk prices don’t guarantee profitability when teamed with high input costs.
Visiting the Chicago Mercantile exchange
While in the US last week, I also had the opportunity to visit the Chicago Mercantile Exchange, or the Chicago Board of Trade (CBOT) as it is now known. This is effectively the livestock mart for all commodities.
In the CBOT, similar to Ennis mart, when a heifer walks into the ring, farmers and dealers raise their hand and bid. In Chicago, there are flashing screens up around the ring showing prices of products instead of the heifer. The Chicago sale starts at 8.30am and finishes at 1.30pm and there is a separate ring for soyabeans, wheat, etc.
You have buyers all rigged up with earpieces taking direction from other staff in offices around the CBOT or sitting in seats around the ring. In total, there are 1,400 registered dealers and each has a yellow badge with a number that they flash up so the teller can identify who has made the purchase.
Soon, it is likely the rings, or the pits as they are known in Chicago, will disappear and all will be replaced by internet bidding, but for the moment the Chicago Mart-type scenario still exists.
Needless to say buyers get to know each other very well because they are standing beside each other for hours every day bidding on product for clients.
The farm I visited in Wisconsin last week had forward-sold milk that would be produced between January and June 2016 the day before I arrived on the farm. How did this happen? The farmer picked up the phone to his broker, explained he wanted to forward sell a certain number of contracts (a volume of milk) and the broker would then have offered the contracts for sale in Chicago.
In the US, Class III milk price futures contracts and options for each calendar month are available 24 months into the future. Class III price is the Federal Milk Marketing Order-defined minimum farm price of milk used for cheese (and whey) and is the primary driver of farm milk prices in the US.
Class III is the primary driver of farm prices because cheese is the single largest class use of milk. Class III futures and options traded on the CBOT are 200,000lb monthly contracts (contract is 90,000 litres each) that cash settle when the Class III price is announced for each month.
The farmer I visited in Wisconsin had made a decision to sell a number of contracts for January to June 2016. Yes he agreed that potentially the business would lose out if milk price went up, but he was willing to forego that upside because he felt the market was going to get worse before it got better.
The open interest and volume in Class III contracts has increased dramatically in the past decade, reflecting the desire of both sellers (farmers and co-operatives) and buyers (eg, cheese processors) of milk to mitigate milk price risk. Farmers are paid a mailbox milk price that includes the average milk marketing order blend price (where applicable) as well as farm-specific premiums.
Risk
When farmers use Class III milk futures or options contracts to manage risk, basis risk (mailbox less Class III price) remains.
Milk price volatility isn’t really new, but it was more predictable before. Cashflow has always been a challenge but as stocking rates have increased and businesses purchase more feed, the problem is different today.
Volatility in margin or net income or profitability is the challenge today, because milk prices are volatile but so are prices of inputs, especially, but not only, feeds. This isn’t likely to change soon.
Economic instability in the world, political instability in parts of the world and climate issues (whether they are short-term or long-term) have an effect. Increasing milk and feed price volatility in recent years has led to frequent calls in the US for dairy farm adoption of forward pricing tools by policymakers and industry leaders.
A recent research paper examined the extent to which forward pricing tools had been used by dairy farmers in California, Florida, Indiana, Michigan, and Wisconsin. In summary, the research found farm managers who had used these tools were more educated, younger, operated larger herds, had more acreage, produced more milk per cow, and were not organised as sole proprietorships. The farm I visited in Wisconsin last week ticked all those boxes.
The most common reason that farm managers had not used forward pricing was lack of knowledge about the tools. I do think some national scheme needs to be developed for the Irish dairy industry. I definitely think it would ease the concerns of some farmers who are in the process of changing their dairy system or those farmers who have invested heavily recently and know they have large repayments for a number of years, even at current low interest rates.
The Irish Department of Agriculture should gather a small group of experts on the matter to decide the best route forward. Yes it won’t change the core profitability of a dairy business but it can help determine a certain level of output for the future and allow more definitive planning. It might not be for everyone and will of course be voluntary, but options and flexibility are better than failed debt repayments and forced asset selling.
Key points
Onus on the Department of Agriculture to initiate an Irish group of experts to discuss volatility management tools for Irish dairy farmers. US dairy farmers managing volatility in many different ways – forward selling milk, forward purchasing grain and fuel etc. Volatility management tools don’t mean margins increase but they improve planning and can allow low margin businesses survive during periods of change. 
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