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Navigating the new safety net

Alan Zepp Published on 06 November 2014

Every five years, dairy producers and others in agriculture brace themselves for the latest farm bill, which is a bundle of legislation Congress passes to set national policies for agriculture, forestry and nutrition programs carried out by the government.

The Dairy Price Support Program, Federal Milk Marketing Orders and the Milk Income Loss Contract program were all enacted through farm bill legislation.

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However, this year’s farm bill – the Agricultural Act of 2014 – probably brought more change to national dairy policy than our industry has seen in more than half a century. The new Dairy Margin Protection Program (MPP) replaces existing dairy programs to put the responsibility of dairy price risk management solely in the hands of each individual dairy farm family.

By now, most producers should have heard about the Dairy MPP program and be aware that they must register at their local Farm Service Agency by Nov. 28 if they wish to participate for 2014 or 2015. When you reach your local FSA office, you’ll have to choose the percentage of milk you want to cover.

You’ll also have to choose which year of production – 2011, 2012 or 2013 – you’ll want to use as your base production. And you’ll have to decide whether you simply want to pay $100 to protect your business against what the government calls catastrophic loss at a $4 margin or pay an additional premium for a higher level of margin protection.

The choices dairy producers will make will be as different as the diverse dairies from Maine to California. However, to find the solution that works for you and your risk management strategy, most farms will simply need to ask themselves five questions.

1. Should I register for the Margin Protection Program?

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2. Do I own a Livestock Gross Margin for Dairy policy?

3. What is my milk production history?

4. What margin level is correct for my farm?

5. Is my goal to maximize income or supplement cash flow during periods of narrow margins?

So let’s drill down into each of those questions.

Should I register for the Margin Protection Program? Some will say, “I will not take help from the government” or “I don’t have time to fool with this paperwork.” The program is voluntary, so no one will force a farm to sign up, although a bank may be more willing to negotiate lower interest rates for a dairy that has MPP assuring the payments.

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But before you dismiss MPP, think about your corn-growing neighbor. He could have sold corn for delivery this fall at $6 per bushel around Christmas of 2012. Last May, he still could have sold corn for $5, but he was thinking about how far prices had fallen, not about how far they could still fall, so he did nothing. It looks like he could be marketing corn for $3 this Christmas. Could milk prices replay this scenario?

What if MPP covers half of the county’s milk the next time milk prices plummet? The milk covered under MPP will receive payments, reducing the cash-flow pain on those dairy farms. Could this extra cash prolong the low-price portion of the cycle?

Your business may face even more risk due to thin margins if you are not enrolled in MPP going forward. Even if your principles prevent you from signing up for MPP, developing a marketing plan with futures and options contracts might be wise to protect your business from plunging milk prices.

Do I own a Livestock Gross Margin for Dairy policy? The Agricultural Act of 2014 states that “Farmers already participating in the Livestock Gross Margin program may register for the Margin Protection Program, but the new margin program will only begin once their Livestock Gross Margin coverage has ended.” Does this eliminate LGM-Dairy from your marketing plan? Not really.

Current futures markets for Class III milk, corn and soybean meal are generating expected margins that correspond to MPP margins above $9.50 for all of 2015. These are well above the fixed $4 to $8 levels that MPP provides.

Today’s exceptional margins and this farm bill language create an opportunity for dairies to secure these elevated margins for 2015 with LGM-Dairy today. Then, during the next MPP sign-up period (July 1 through Sept. 30, 2015), producers can re-evaluate their position.

Next summer, they could choose to enroll in the Margin Protection Program or extend their LGM-Dairy coverage into 2016. They would forfeit the annual “bump” in production history (+0.87 percent for 2014) in 2015 if sign-up is deferred until 2016.

This strategy offers all producers, but especially those farms with a base in excess of four million pounds, the opportunity to raise their safety net level with LGM-Dairy at a similar or lower cost when compared to the MPP.

What is my production history? Existing dairies simply choose whether they sold the most milk in 2011, 2012 or 2013. Dairies who began operating after Jan. 1, 2013, should talk to their local Farm Service Agency office as soon as possible to clarify which of the new producer options best fit that farm’s situation.

What margin level is correct for my farm? The simplest strategy for producers who just want catastrophic coverage from the Margin Protection Program is the “free” $4 margin coverage level. This option automatically covers 90 percent of the farm’s production history and requires the yearly $100 administrative fee.

This will be the choice for all-size farms that do not utilize LGM-Dairy and are merely looking for catastrophic coverage. MILC coverage in 2009 would roughly convert to a $5.25 MPP margin, so the “free” coverage safety net is lower than MILC was.

All-sized farms can build their marketing plan around today’s strong milk futures prices and low feed costs. Cooperative or brokerage contracts can generate a higher safety net than MPP can deliver. In this situation, MPP can still provide calamitous coverage for minimal cost.

Producers choosing “buy up” margin coverage between $4.50 and $8 will need to evaluate their marketing plan as they determine the correct MPP coverage level for their business.

A related question would be: “Is my goal to maximize income or to supplement cash flow during periods of narrow margins?” Consider whether your business is prepared to endure periods of narrow and even non-existent margins. Making sure you’re protected and prepared will be critical to your dairy’s future success.

The new farm bill legislation states that education around the Dairy MPP program will be provided by land-grant universities in each state. In many regions, milk cooperatives, lenders and other institutions are providing MPP trainings. Contact your local extension office or your milk buyer to find out if there are trainings planned near you.

For more basic information about the Dairy MPP and links to online tools available, visit the Center for Dairy Excellence website. PD

Alan Zepp is a risk management program manager with Center for Dairy Excellence. Contact him by email.

alan zepp

Alan Zepp
Risk Management Program Manager
Center for Dairy Excellence

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