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Change your risk management mindset

Zach Myers for Progressive Dairy Published on 07 October 2021

The COVID-19 pandemic taught and continues to teach numerous lessons to those of us in the dairy industry. We found out in March 2020 that the processing and packaging part of the industry could adapt but was not very nimble in doing so.

It took several weeks for the U.S. dairy industry to adapt to a huge shift from food service demand to retail demand. The adaptation period led to empty dairy cases while dairy farmers were having to dump milk.

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The government stepped in and provided some much-needed monetary relief to those dairy farmers who chose to receive it. The Farmers to Families Food Box Program provided a route to help clear the market – but in doing so exposed another issue where the market is just now starting to get back to more normal dynamics.

Prior to the implementation of the Food Box program, Class III and IV milk prices dropped to their lowest since the dairy market crash of 2009. Once USDA cheese buying started, the Class III price soared to its highest point since 2014. This occurred in just one-and-a-half months’ time, from mid-May to the end of June 2020.

Unfortunately, the Food Box program did not create the same demand for Class IV products, so the Class IV price stayed low, sometimes more than $10 per hundredweight (cwt) lower than the Class III price. This spread, along with the subsequent depooling of Class III milk, created historically low negative producer price differentials (PPDs) that persisted most of 2020 and into 2021. Federal Milk Marketing Orders’ (FMMO) PPDs finally returned to positive territory in June of 2021.

Milk prices: Volatile and hard to manage

I do not have to tell you milk prices are volatile and perhaps much more difficult to manage than ever before. However, more risk management options are currently available compared to just a few years ago to help you more successfully manage that volatility.

In my opinion, these programs are underutilized by U.S. dairy farms. I’m sure part of the reason is: Some of the programs are difficult to understand, and farmers fear making the wrong decision when participating in risk management.

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Working for Pennsylvania’s Center for Dairy Excellence (CDE) in my current role, I have talked to numerous dairy farmers over the course of the last three years. There are a combination of answers I hear most frequently when I ask them why they do not use risk management. I certainly understand that, as some of the options do take some work to learn and understand.

Another common reason I hear is, “If I invest my money in something, I expect a return on that investment. I’m not guaranteed a return using risk management and may actually lose money if I make the wrong decision.”

I understand that statement as well. However, having a risk management plan should be looked at differently than an investment. Risk management should be considered a cost of doing business.

A risk management plan is an insurance plan that should help protect against unforeseen drops in milk or feed commodity prices. Just like other insurance policies, you hope you never need them. Think about liability insurance, fire insurance, automobile insurance, worker’s compensation and life insurance. You hope you never have to file a claim against any of these, but if you ever need to, you will be glad you had it.

This is the same as your risk management plan. The adage goes “practice makes perfect.” You may never be able to reach a perfect risk management plan, but with experience and help from advisers who know your dairy operation and understand the programs, it will certainly help you get closer.

A common mistake

One of the biggest mistakes I see is trying to guess the market. You may get lucky sometimes and guess it correctly, but most of the time you will likely miss it and end up making a wrong decision. Consistency is the best plan of action. The goal of risk management is to cover your cost of production, and if you can lock in a profit, even better.

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A consistent risk management strategy will lead to a more consistent milk price with less volatility compared to relying on market prices alone. Depending on how your plan is designed, you may not always get the top of the market, but you probably will not get the bottom of the market either. Newer programs allow you to set a milk price floor while not capping the top side of the market if milk price moves higher than your floor.

Dairy Margin Coverage program

One program that allows dairy farmers to set a milk price floor while not giving up the top side of the market is the Dairy Margin Coverage (DMC) program. DMC sets a margin over feed cost chosen by the dairy farmer. The margin is determined each month based on subtracting the corn, soybean meal and alfalfa hay prices from the U.S. all-milk price – thus setting a milk price floor that does not restrict your milk price if the margin ends up better than the margin you elect to cover.

The DMC program is in its third year and has so far provided a net benefit to those enrolled in the program every year including 2021, even though there are five months still yet to be determined. At the maximum $9.50-per-cwt margin coverage at the Tier 1 5-million-pound production history cap, 2019 DMC provided a net benefit of 39 cents per cwt after premiums and fees were subtracted. 2020 DMC provided a net benefit of 54 cents per cwt. So far for 2021, DMC has triggered an indemnity each month through July and has provided a net benefit of $1.49 per cwt, or roughly $15,600 per 1 million pounds of production history up to the 5-million-pound production history cap. If you apply the DMC rules for each year back to 2000, there are only two years that would not have provided a net benefit.

Hay price calculations changing

The 2020 and 2021 net benefit will increase once new changes to the program are finalized. In August 2021, the USDA announced a change in how the alfalfa hay price would be calculated. Currently, the alfalfa hay price is the average price of mid- and high-quality alfalfa hay. This will be changed to the high-quality alfalfa hay price, reflecting a more accurate price that dairy farmers pay for dairy-quality hay. This change will be retroactive to Jan. 1, 2020. Only five months in 2020 had margins low enough to result in a change in the indemnity payment at the $9.50-per-cwt margin coverage. For these five months, the average indemnity payment will be about 19 cents per cwt. For 2021 through July, the average indemnity, at the $9.50- per-cwt coverage, will increase by an average of 21 cents per cwt. The retroactive payment for the feed cost change will be automatic once the change is finalized.

Producers who were/are enrolled in DMC in 2020 and/or 2021 will not need to apply for the payment. This change will be in effect for the remainder of the 2018 Farm Bill cycle (through Dec. 31, 2023).

This program really is a no-brainer for any dairy that has 5 million pounds of annual production or less. With the option to update your production history coming soon, which will be retroactive to Jan. 1, 2021, and continue through the 2023 program year, this program is a great tool to have in your risk management toolbox. At the maximum 95% production history and $9.50-per-cwt margin coverage option, it currently looks to be the cheapest option to provide some financial protection for up to 5 million pounds of production history in 2022.  end mark

PHOTO: Getty images.

Zach Myers
  • Zach Myers

  • Risk Education Manager
  • Center for Dairy Excellence
  • Email Zach Myers

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