Profit Margins with Projected Prices: What’s Your Game Plan?
Jul 19, 2013
Even with a positive dairy outlook, it’s important to maintain risk management strategies to decrease volatility, secure a margin or capture an upside surprise.
By Kristen Schulte, Iowa State University
Currently the Corn Belt has adequate moisture to grow an average to bumper crop while other parts of the U.S. are still waiting for rain to relieve ongoing drought.
This is a different picture from a year ago when a large portion of the U.S. was entering a drought, causing producers to evaluate feed sources and cow inventory.
Weather is just one cause of increased price volatility that dairy producers have experienced over the past years. Export markets for dairy products have been over $3.5 billion dollars since 2011, with this trend continuing in 2013. Product exports are expected to be level or grow in coming years. New Zealand, Australia and the EU-27 are key producing countries to watch; however, China, Southeast Asia, and developing countries are important to watch for demand growth, new opportunities, and internal supply growth, which all may impact the global dairy supply/demand balance.
There a lot of factors to consider when projecting prices in the coming months. However, futures markets should reflect the most current market data, and that information, alongside historical data, tells where the dairy industry has been and what is expected in the future.
A year ago, I looked at a price index that uses 1980 as the base year. Corn and milk prices trended in the same general direction until 2010, when the corn price index increased up to above 3.0, while the milk price index stayed variable just above 1.50. While both commodities experienced price variances, corn prices increased at a greater rate. While this has been reality of the last few years, what does the future hold? According to the futures market for new crop corn and milk, the spread between corn and milk price narrows down closer to historical trends.
The graph below shows these price indices--the historical Class III Announced Milk price, U.S. Corn Price, and U.S. Alfalfa Hay Price up to June 2014.
The futures market is used to project prices into 2014 and is displayed with dashed lines on the graph at right.
Corn and milk are projected to track more closely over the coming year, similar to the pre-2010 period. However, hay prices are expected to remain high due to stable hay acres, below average first-cutting tonnage, and continued demand. While decreased corn prices may help feed costs, milk prices are expected to remain consistent into 2014 due to increasing production, rising product stocks and global supply and demand levels.
For 2014, USDA projects in its latest supply/demand report that the expected average price for corn is $4.80/bu. (range of $4.40 to $5.20) and for Class III Milk is $17.10/cwt. Using these prices adjusted for basis, in addition to $200/ton for hay, we can estimate projected profitability for an average dairy producer. Typical other revenue, production costs, labor costs, and fixed costs are factored into dairy budgets.
The projected results based on these prices for mid-year 2014 look promising for a dairy producer. At 22,000 RHA, the estimated profitability is above $2 per hundredweight. This projection is representative of a conventional operation in the Midwest. Different production systems and different regions across the U.S. will see different profitability levels based on cost structure and commodity price basis levels.
As producers continue to learn about risk management options and increase their comfort level with marketing concepts and practices, will strategies change with changing margins? Improved profit projections do not mean producers can breathe a sigh of relief and do nothing. Even with these better projections, it is important to maintain risk management strategies to decrease volatility, secure a margin, or capture an upside surprise.
Based on your operation’s risk management plan, future milk margin estimates, and knowledge or comfort level, will you participate in the futures and options markets, forward contract milk or feed, or purchase margin insurance? Each marketing tool has its own advantage. Each tool must fit the producer’s situation and operation. Finally, with changing commodity prices, it is important to recalculate cost of production on a regular basis to evaluate any change in prices and the impact of different marketing options on the profit margin.
Kristen Schulte is Iowa State University Extension and Outreach Farm Business Management Field Specialist. Contact her at firstname.lastname@example.org.
Additional comments from Ron Mortensen, Dairy Gross Margin, LLC:
The comments above highlight the improved potential margins in 2014. The data regarding LGM-Dairy insurance supports this. The projected margins are actually pretty good compared to the last 10 years. If you look at January, February, March and April using 1,560 cwt. of milk, 20.5 tons of corn and 6 tons of meal, the margins rank very high. Margins that can be locked in via LGM-Dairy insurance for January and February are the second best. Only 2008 was better. March margins were better in 2008 and 2011. April margins were better in 2004 and 2007.