Dairy Talk: Skewed to the right

November 17, 2010 04:07 AM
 

 

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 “Low Milk Prices are Your Own Fault”Presented by Carl Babler at the Elite Producer Business Conference in Las Vegas 

No, this is not a column about the Republican takeover of the U.S. House of Representatives or the Tea Party’s takeover of the Republican Party.

It’s about something far more important: Protecting your milk price from devastating declines.
Carl Babler, senior hedge specialist and principal owner of First Capitol Ag, says Class III prices are “skewed to the right.” Babler spoke at Dairy Today’s 2010 Elite Producer Business Conference in Las Vegas, Nev., last month.

Since 1997, 80% of Class III prices have fallen below $13.80/cwt. When put on a price distribution chart, the bulk of Class III prices are to the left side and above $13.80/cwt. just 20% of the time.
In economic terms, the curve is skewed to the right. In bleak terms, Class III prices will likely be at or below cost of production 80% of the time. (That depends, of course, on your farm’s basis—the difference between your net mailbox milk price and the Class III price.)

The solution to this seeming dilemma is quite simple, Babler says. If you don’t have the liquidity to withstand Class III prices below $14/cwt., you need to floor the price at $14/cwt. by using options or other hedging tools. By doing so, you can eliminate—yes, eliminate—all those ugly cash-flow-draining prices that keep you from sleeping at night, Babler explains.

Yes, this price protection comes with a cost. But so does losing $2, $3 or $4/cwt. when prices collapse. If you plan ahead, put options can often be had for 40¢/cwt. to 50¢/cwt., Babler says. And use of more sophisticated hedging strategies, such as fences that lock in both minimum and maximum prices, can reduce that cost further.

Ron Gibson, one of the contributors to our Dollars and Sense column, offers this bit of advice: You can’t get interested in marketing your milk only when the price outlook is unfavorable. By paying attention 12 to 18 months out, you often can find marketing opportunities when option prices are reasonable.

When you do, it’s up to you to pull the trigger so you aren’t skewed to the left.

 

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