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Deal is in the details: A look at new Margin Protection Program

Kevin Hernandez Published on 23 May 2014

There has been a lot of talk about the Margin Protection Program (MPP) introduced in the new farm bill. As the saying goes, “Out with the old and in with the new.” The MPP replaces the Milk Income Loss Contract (MILC), Dairy Product Price Support and the Dairy Export Incentive Program.

These programs were considered mostly ineffective because they focused solely on prices and not the costs. As most dairymen know, this logic is flawed. The industry has seen drastic volatility in the feed marketplace with breakeven prices rocketing higher for most producers in the last 10 years.

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Is the new program the solution to the dairy industry’s problems or is it another so-called “safety net” with one too many holes? Let’s take a look into it. I will let you decide for yourself.

What is the Margin Protection Program?

It is a risk management tool meant to protect farm income over feed cost margins. The margin is determined monthly by the USDA using the national all-milk price minus the national average feed cost.

Feed cost is based on a realistic feed ration to feed an entire dairy farm with 1,000 mature cows producing 69 pounds per day and an 80 percent replacement ratio (i.e., 800 replacement heifers).

The margin calculation will average two consecutive months beginning with January and February. In the first year of operation, coverage is based on the operation’s highest level of annual milk for 2011, 2012 and 2013, and in subsequent years annual adjustments to the producer’s production will be based on the national average growth in overall U.S. milk production.

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In 5 percent increments, producers will be able to protect 25 percent to 90 percent of their production. Margin protection will start at $4 and go up to $8 per hundredweight (cwt) in $0.50 increments.

Dairy operations will pay no premium for $4 margin coverage and up to $0.475 per cwt for $8 coverage on the first four million pounds and $1.36 per cwt for $8 margin coverage on production in excess of four million pounds.

What is the bright side of the MPP?

  • For starters, it takes both feed cost and milk price into consideration, which is where the previous programs fell short. You cannot look at one without the other.
  • It only costs $100 to sign up for the free $4 margin coverage. That is market-crash conditions, but the national average margins over the last 13 years have fluctuated from a low of $2.25 to a high of $14.65 per cwt.

    Had the program been in place during those years, participating producers would have received payouts for most months in 2009, and some in 2012, for even the lowest margin coverage of $4 and therefore recovering at least some of their cash deficits for those years.

  • All dairies are able to participate. The program does not have the adjusted gross income limitations we had with the MILC program, nor does it have a production limitation.
  • The program allows producers to “test the waters.” Producers are able to “bounce in and bounce out” on an annual basis. Signing up does not lock a producer in for the life of the program. Also, you can choose to cover as little as 25 percent of production.
  • It is more accommodating to smaller dairies, as there exists a substantial discount for coverage on the first four million pounds.
  • The premiums schedule is fixed for the life of the program, but a discount of 25 percent is planned for 2014 and 2015, except for the $8 level and only for marketing under four million pounds.
  • Producers share the cost of the program with the government.

Where does it fall short?

  • The national all-milk price and national feed costs do not correlate with some states. In particular, here in California, milk price is closest to Class 4B, which is historically lower than the national milk price, and feed costs in California are historically higher than feed costs in other parts of the country. Therefore, many operators in states like California will not be protecting their “true margins” with the program.
  • The program provides better coverage on a cwt basis to smaller dairies because the premiums are considerably more expensive for medium to large dairies with production over four million pounds.
  • For larger operations, buying up margin coverage for $7 and up would likely only pay off under market crash conditions like we saw in 2009.
  • The program has the potential to be very expensive under market-crash conditions, which could make it controversial with the public.

Overall, the consensus is that the program is a step in the right direction from past support systems. However, there are still plenty of unknowns yet to be addressed. For example, how far in advance must you sign up for the desired coverage period?

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Will it be three or six months? Some critics believe six months is ideal so that there is no “adverse gaming” – hence less ability to forecast margins over the coverage period.

How long is enrollment? Will the program premiums be assigned from the milk checks? These are just a few of the questions the policymakers will need to address before the program goes live. PD

kevin hernandez

Kevin Hernandez
Manager
Frazer, LLP

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