The Road to Risk Management

November 28, 2011 10:20 AM
 
dairy risk management

A producer’s journey toward a solid marketing program

In 2000, when he was still doing most of his dairy’s day-to-day work and contemplating an expansion, Wisconsin’s John Ruedinger had a revelation.

"This is crazy," he remembers thinking. "I should be doing more with a pencil instead of my back."

That first year, he began dabbling in the commodity markets. He would lose $120,000 before finally, in 2003, making $30,000 on his trades. That year’s earnings allowed him to pay the salary of the employee who fed his 400 cows, reducing Ruedinger’s daily physical workload.

"That showed the value of pushing a pencil to be more productive," Ruedinger says.

Bonus Content



Web resources:

Eleven years later, Ruedinger’s marketing savvy has grown along with his operation. His herd size has increased to 1,000 cows and his farm to 1,350 acres of corn, alfalfa and winter wheat. And he is regularly making marketing decisions to protect his milk prices and feed costs, "two areas that change and move quite a bit," he says.

"As your business grows, you have to change," Ruedinger adds.

Ruedinger, who spends at least 30 minutes each night educating himself on marketing, believes risk management means managing his dairy’s margins rather than only the milk price. "That’s where we need to look in the future," he says.

He credits his marketing and hedging program with helping him maintain adequate cash flows and profit margins. Forward contracting has also allowed Ruedinger to plan for growth, as he did in 2003, when he expanded his operation, and again in 2009, when he built a six-row, drive-through freestall barn. He plans to grow his milking string to 1,200 cows over the next three to four years.

In creating his marketing strategies, Ruedinger seeks to maximize the separation between the average price he receives and the final price. "We look to build a solid average price," he says. "It’s not about picking the tops and bottoms. It’s about protecting your bottom line from the risk of low prices."

Following that strategy, Ruedinger says, it’s possible to consistently make a profit. "You position yourself to capitalize on higher prices and to minimize lower prices," he says. "I try for middle ground."

His goal is to manage the margins between his milk price and his input costs and to mitigate the
times of volatility that seem to come all too often. "Sometimes we’ve even contracted below our cost of production," Ruedinger says. "You have to do that sometimes."

Ruedinger’s marketing history also reflects that strategy. Yearly results for his milk marketing don’t always reveal lucrative gains, but they do show that he avoided major losses.
 

john ruedinger
"You get out of a marketing program what you put into it," says Wisconsin dairy producer John Ruedinger. "It does take time."

In 2008, Ruedinger sold 16.68 million pounds of milk and hedged 66% of it. The Class III price averaged $17.44 per cwt. His final average price reached $17.40 per cwt., reflecting a loss of $0.04 per cwt. His options costs through the CME Group totaled $6,696. (To pay the cash requirements of his trading costs, Ruedinger relies on a separate line of credit that he dedicates exclusively to milk hedging. From that, margin calls are automatically deducted at the end of each trading day.)

His 2008 milk price amounted to a loss of $6,672. Adding in the $8,500 in fees to his marketing firm, Ruedinger saw a loss of $21,868, or negative $0.13 per cwt., for his total milk marketing program.

The next year, however, brought substantial profits to Ruedinger’s operation. In 2009, he sold 23.84 million pounds of milk, more than 7 million pounds over the previous year. He hedged 60% of that year’s milk output. The Class III price fell to $11.36 per cwt., while his final price averaged $13.99, reflecting a profit of $2.63 per cwt. Ruedinger paid $4,731 in option costs. His milk futures profit soared that year to $626,992. Deducting the $9,000 he paid in marketing fees, Ruedinger realized a profit of $613,260, or $2.57 per cwt., for the total program.

Ruedinger’s 2009 gains were especially significant to him in the year that hit U.S. dairies so hard. "We had borrowed a lot to expand our dairy that year," he says. "Overall, we lost only $20 per cow versus the $800 that many people lost."

In 2010, Ruedinger hedged 43% of his dairy’s milk production, which had increased over the previous year by nearly 3 million pounds to 26.2 million pounds. The Class III price climbed to $14.39 per cwt. that year. Ruedinger’s final price reached $14.45, for a small profit of $0.06 per cwt. He paid out $6,118 in options expenses, while realizing $13,100 in milk futures profits. That left an overall loss of $2,018, or negative $.007 per cwt.

By controlling risk, Ruedinger says he has been able to focus on other dairy essentials, such as employee training and management, reproduction, genetics, manure management and milking. The result is a rolling herd average of 30,216 lb. and a somatic cell count of just 130,000 cells/ml. His components include 3.5% fat and 3.02% protein, with a cheese yield of 2,956 lb.

"Farming by nature is a risky business," Ruedinger says. "If you try to take all the risk out, you take out all the profit opportunity as well. The best thing you can do is manage the risk and position yourself to capitalize on opportunities the market presents.

"The key is staying with it," he adds. "You’ve got to do a lot of reading. There’s a lot of time and effort along the way. I’m not an expert by any means. I’ve got a lot yet to learn."


Control Feed Cost Risk

In addition to controlling the risk of milk price volatility,Wisconsin dairy producer John Ruedinger also works to protect his feed purchases.

Ruedinger has worked with the marketing firm of Stewart-Peterson Inc. since 2003. Matt Mattke, one of the firm’s market advisers, describes its strategy for minimizing Ruedinger’s feed risk during 2008–10.

To supplement his own corn production, Ruedinger annually procures corn feed from neighboring grain farmer Steve Willis. In 2008, Willis booked his corn with Ruedinger in the $6.50 per-bushel range. Stewart-Peterson offset that purchase by selling futures. This allowed Ruedinger to have the physical contract, but re-opened his price to the market so that he could capitalize on lower corn prices.

"That, as well as the put options, worked well as corn fell to $3 per bushel," Mattke says.

"In 2009, the corn market traded largely sideways," he says."We took a largely hand-to-mouth approach on booking John’s feed corn. The hand-to-mouth approach spilled over into most of 2010 as well, as the sideways-to-lower trend continued."

In the summer of 2010, as Ruedinger and his marketing team watched the price action on the charts, the trend for feed corn, which had been declining, reversed and began rising. "When we closed over downtrend line resistance, signifying that the downtrend was changing to an uptrend, we started recommending locking in corn for the year ahead," Mattke says.

Both Ruedinger and Mattke believe their marketing efforts during those three years accomplished their goals. "John was protected from corn’s highs of $5 to $8 a bushel," Mattke says. "We also kept his downside flexibility for when the price downturns came."


Break Market Barriers

Marketing firms like Stewart-Peterson Inc. prefer a systematic approach to risk management for one simple reason.

"It helps take the emotion out of marketing decisions," says Mark Ludtke, dairy business development manager for Stewart-Peterson.

great marketing



The firm develops a marketing strategy based on an individual client’s financial position, business goals, risk tolerance and lender relationship.

Ludtke believes only 15% to 20% of U.S. dairies are marketing their milk consistently. He understands the hesitation many producers have in starting a risk management program. Ludtke points out the barriers to successful marketing:

  • A bad previous experience
  • Fear of volatility
  • Concerns over the proposition that risk equals reward
  • Time
  • Knowledge
  • Cash flow
  • Fear of the unknown
  • Fear that there won’t be a return on the investment
  • Cost
  • Trusting someone to do it


But there are ways to break those barriers, Ludtke adds. They include:

  • Investing time for marketing
  • Finding a resource
  • Expecting reasonable performance
  • Communicating with your team, which includes key people on your dairy, your lender and your brokerage firm
  • Expecting that there will be customization to your situation
  • Using discipline and strategy


"It’s our job to keep producers out of the price troughs," Ludtke says, "but, at the same time, as the price goes up, to take advantage of the opportunity that presents itself."

Back to news

Comments

 

Rate this News Article:

Spell Check

No comments have been posted to this News Article

Close