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Production and risk management: Is the tail wagging the dog?

Angie Molkentin Published on 28 June 2012

More and more dairy producers are learning about their risk management tools and strategies. However, the industry is “a long way from maturity” when it comes to consistent use, says John VanSickle of the Food and Resource Economics Department at the University of Florida.

Maybe that’s because producers are finding a lot more success producing milk these days. Record production is predicted for 2012 and, while educators are doing their best to increase use of available tools, barriers to price risk management still remain.

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Producers who have participated in VanSickle’s risk management education report the following deterrents:

• Feeling that hedging is not needed when milk prices are low
• Lack of cash flow for margin requirements and lack of informed bankers who understand how hedging has helped manage risk
• Family generational disagreements
• Fear of the futures market, margin calls, etc.

VanSickle’s department has taken on markets education in a very hands-on way. Earlier this year at the Southern Dairy Conference, VanSickle reported that focused markets education, along with trading simulation, has had some impact on removing barriers to using risk management.

The University of Florida’s trade simulator is called FACTSim – Financial and Agricultural Commodity Trading Simulation. It is used in classrooms all over the U.S. as well as in dairy producer outreach education. (In 2010-2011, Progressive Dairyman encouraged interested readers to join peer groups that used the simulator as an education tool and wrote about their experiences.)

According to VanSickle, adding the simulator to risk management education helps make the concepts real.

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“Meetings and conversations are important,” VanSickle says. “But decision-making in the moment is still at the heart of all of it, and the participants could practice that on the simulator.”

An Ohio dairy producer who joined a FACTSim peer group this spring (username “Buckeye”) says she signed up because she wanted to learn how the tools work and to see if there is an application to their dairy operation. She has used the simulator to practice purchasing options.

“I would like to be able to see what 40 percent of my milk sold for six months looks like and how I should manage it month-to-month,” she says. “That takes active participation.”

In addition to the simulator, Buckeye has learned from the peer interaction. “The conversations with our coach and the group of dairy producers have been very valuable. We discussed how different strategies are working for each of us and how to get optimal results.”

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Where are they now?
Forecasts of record-breaking production for 2012 prompted Progressive Dairyman to check in with the producers who joined the trading peer groups in 2011.

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Click here or on the image at right to view at full size in a new window.

Producer perspectives reveal perhaps the biggest deterrent to applying risk management strategies long term – the time investment it takes to watch the markets and make good decisions.

Here is the “where are they now” survey indicating to what degree each has implemented what they learned a year ago – see table on right.

From among this sampling of producers, it’s clear to see that risk management is rising up on the priority list, but is still a step away from being consistently implemented.

“When pressured for time, dairy producers are like most business owners – they revert to what they do best,” says Mark Ludtke of Stewart-Peterson Inc., who coached two groups of FACTSim users in 2011. “Dairy producers are already masterful at production. I fear that the real issue – protecting what they work so hard to earn – is being overlooked.”

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So is this a case of the tail wagging the dog? While we produce, volatile credit markets are creating uncertain and skittish investors and consumers. The fundamental situation is becoming more and more tenuous.

The government could step in and throw the industry a bone in the form of renewed funding for LGM. But that too is uncertain, VanSickle says. “The government is signaling that it wants to move more responsibility for risk management to farmers. So the bottom line is that we will have to step up.”

“Stepping up” may not only help producers weather the market lows … it could also help producers differentiate their operations in the future. Ludtke explains the macroeconomics of the situation: “In a world of efficient producers, there will be more and more pressure to be better and more efficient.

That’s because, in a production environment, prices will always seek and eventually settle at breakeven. As prices seek the breakeven, there is a lot of volatility that must be tolerated. How well you manage that can become a differentiating factor.”

For Joe from Idaho, the only one of the peer group of producers who is consistently applying risk management at this time, the strategies are helping him stay competitive without adding more cows. “We would like to stay at this herd size,” he says. “That’s why I decided to get better at marketing.”

Despite the gradual adoption, Buckeye believes dairy producers will indeed need to learn how to apply marketing strategies. “Each producer can tolerate different levels of volatility. We all have to learn how to manage through it to be successful for the long run.”

Education offerings continue
VanSickle’s educational outreach at the University of Florida will continue, including the development of a new smart phone app for FACTSim coming this summer. And Ludtke will continue to coach peer groups of producers interested in learning how to make risk management decisions.

You can check out the University of Florida’s FACTSim program at www.factsim.org or join a trading peer group forming this fall. PD

Angie Molkentin is a writer from Oconomowoc, Wisconsin. She has special access from Stewart-Peterson to observe FACTSim dairy trading groups and the interactions of producers in the program.

DISCLAIMER: Futures and options trading involves significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The views and opinions expressed in this article are those of the author. The information provided is designed to assist in your analysis and evaluation of the futures and options markets. However, any marketing decisions you may make based on such research are entirely your own and not deemed to be endorsed by or attributed to Stewart-Peterson.

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