Know Your Market
Farm Bill Dairy Program: Profit Center or Risk Management?
Apr 17, 2014
What's known—and not known—about the new Margin Protection Program.
By Ken Hartzell, Dairy Gross Margin, LLC
The most frequently asked question centers around high milk prices and how long will they stick around. After all, the expression "the cure for high prices is high prices" should be coming into play. And dairies have certainly seen some of the highest milk prices ever.
The futures market continues to show discounts (lower prices) in the farther out months. As each contract nears expiration, the tendency has been for the nearby prices to rally. This seems to tell dairymen not to worry about risk management. However, increases in supply are worrying the market and should provide a tipping point eventually. Add in the toppy look of a farther out futures chart (July or later), and some alarm bells should be going off.
The next question concerns the new farm bill and its effect on the dairy industry. Familiar programs such as MILC and the export provision are gone. A new provision called MPP, or Margin Protection Program, is introduced and demands everyone’s attention. Its purpose is to protect dairies in the event of low milk prices and higher corn/soybean meal/hay prices.
- A producer can choose to insure a margin of $4 per cwt. minimum up to $8 in $.50 increments.
- There are different premium levels for producers below 4 million pounds of annual production (as determined by the HIGHEST of their production in the calendar years 2010, 2011, 2012) and those above 4 million pounds.
- The premiums are fixed by law and will be based on the producers highest Annual Production History in the years 2011, 2012, and 2013.
- A producer may insure, in 5% increments, from 25% to 90% of his production history.
- Production can be increase each year by multiplying production history times 1.02.
- Losses will be calculated in two-month increments. Example: January and February will be calculated together, March and April together, and payments made, based on those two months.
- Producers will be able to change their percentage of milk insured and their level of margin coverage at yearly sign-up time.
- Producers choose one percentage and coverage level for the entire year.
- This program is "absolute." It is not about the markets comparing to what is predicted. It is about the markets performing against absolute values.
- This program is highly subsidized by the government.
We DON’T know:
- When you will be able to sign up for 2014, or when you will have to sign up for 2015.
- If a producer signs up for the program, whether he is "locked" into the program until it expires in December 2018 or if he can opt out on a yearly basis.
- For SURE, if it is on a calendar year basis or fiscal year basis. We assume it is a calendar year basis.
- When the sign-up period will be in relation to the coverage period (how long in advance of coverage will you decide?)
Other things we know:
- Premiums are fixed and do not reflect true risk. When futures markets give indications that MPP should pay out, premiums do not increase. In insurance, this is called "adverse selection." The closer the sign-up period is to the coverage protection period, the more is known and producers can vary their coverage accordingly.
- It has been said given the "absolute" nature of MPP, this program is "a profit center" rather than risk management.
- Several economists believe this program, by the nature of support it brings when prices are low, will extend the length of these periods because it will continue to encourage production.
LGM Dairy (Livestock Gross Margin-Dairy) is unaffected in the farm bill in subsidy amounts for producers or overall subsidy amounts. The one stipulation is that if you are involved in MPP, you may not be involved in LGM. Because it is not known if enrollment in MPP is continuous and annual changes are allowed, or if once enrolled, producers must stay enrolled until December 2018, it is hard to gauge the impact on LGM-Dairy.
Many of the fine points of the MPP program are yet to be determined by USDA and FSA. As one producer stated, it’s kind of like a guy being asked to go on a blind date and not knowing what rules the young lady’s father might impose.
But perhaps more importantly, this provides an alternative, or addition, to current risk management programs. There will be so many choices, it will be harder for a dairy producer to not use some form of risk management.
Ken Hartzell is an agent with Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products. Reach him at email@example.com or visit www.dairygrossmargin.com.