You could not have had a more stark contrast. One dairy producer pleading for passage of dairy reforms including growth management, aka supply management; the other vehemently opposed even if he were guaranteed the plan would remain voluntary.

 

Also stunning was the contrast in geography. The dairy producer pleading for growth/supply management (GSM) was from Southern California. The producer saying “no way” was from central Wisconsin.

 

Twenty five years ago, California was unloading pot bellies of cheap heifers and feasting on even cheaper feed from the Midwest. Wisconsin, losing dairy farms by the hundreds, was almost happy California was buying its heifers even if they represented its lost future. California’s mantra was “Let the market rule.” Wisconsin was asking the last processor in the state to turn out the lights. No more.

 

Today, the shoe is on the other foot. Wisconsin has the comparative advantage. It wants to keep that edge, even build on it.

 

California is cutting production because its plants are in awash in milk. Feed costs are $11/cwt. of milk produced. Over-base milk is $13.50. Margins are barely enough to keep the milking machines running.

 

In Wisconsin, competitive milk markets and homegrown feeds mean most producers are weathering the current margin meltdown. In fact, the state recently announced plans to grow milk production 3% annually to 30 billion pounds/year by 2020.

 

Geoff Vanden Heuvel and Jerry Meissner reflect these contrasting milk making environments. Vanden Heuvel has a total of 1,650 cows on two dairies in Chino, Calif. He is vice president of the California Milk Producers Council. Meissner, with his brother, son and nephew, milk 2,400 cows, raise 2,300 replacements and farm 4,600 acres near Chili, Wis. Meissner is also president of the Dairy Business Association in Wisconsin. Both participated in a producer panel at the National Dairy Workshop in Salt Lake City, Utah, a few weeks ago.

 

“I can’t pay everything else on $2.50 margin,” says Vanden Heuvel. “How long am I expected to subsidize this market? I lost $1.2 million in 2009, some months I was losing $5,000 per day. I burned through 25 years of accumulated equity in one year.”

 

Vanden Heuvel says the industry needs some means to rein in milk production in times of surplus. “No one could have designed a more benign supply management program than Dairy Security Act (DSA),” he says. “The only time it kicks in is where there is a surplus.

 

“We need a mechanism to take out 1% or 2% of surplus milk. I can’t do it anymore. If this market doesn’t do me in this time, the next down turn will,” he says.

 

And Vanden Heuvel is not alone. “Are we willing to sacrifice 30% of California dairy producers?” he asks.

 

Meissner says supply management, even a voluntary program where producers opt in, is the wrong direction for a national industry beginning to export to the world. “It’s a red flag for processors. Export buyers will require assurance of supplies. And market share will be lost to more aggressive countries,” he says. “We should not punish success.”

 

He says Wisconsin is 10% to 12% milk deficit in current processing capacity, and the states 30X20 plan will build even more. “I feel there is so much potential – why inhibit our ability to compete in global markets? Our biggest impediment in the producer sector is our lack of the use of risk management tools,” he says.

 

Risk management is really the crux of the issue. Too few producers use the tools currently available—some out of ignorance, some out of fear, some because the tools don’t work for them because of their size or their markets.

 

DSA attempts to fix that, offering one-size-fits-all margin insurance at no premium for the basic program and at ridiculously low cost for moderate levels supplemental coverage. The price of these cost savings is the growth management program. If you sign up for the insurance, you must also agree to cut back production in periods of low margins.

 

And therein lies the rub. Western producers are desperate for relief, willing to succumb to government supply controls to bring their margins back to breakeven. In the Midwest, where there is strong competition for milk, over-order premiums and cheaper feed, government supply control is akin to moving to Canada.

 

You’d think producers of good faith could come to a reasonable compromise. But memories run deep. Twenty five years deep. Too deep.

Modifications to the Dairy Security Act (DSA) included in the Senate Farm Bill may prove less onerous and odorous to opponents of supply management in the dairy industry. Or not.
 
New analysis suggests that the dairy market stabilization program, aka supply management, is not triggered nearly as often with the new provisions. That’s confirmed by both the Universities of Missouri and Wisconsin.
 
Recall that the Wisconsin analysis of the original provisions of Foundation for the Future, the framework for DSA, suggested the supply management program would have been triggered up to 45% of the time. Missouri analysis suggested supply management might be triggered up to 20% of the time.
 
The new analysis cuts those estimates of supply management triggers substantially. The reason for the reduction in the Wisconsin analysis is a change in feed formulas: “The formula for calculating feed ration costs was changed by lowering the feed parameters to 90% of the DSA levels. This seemingly small change increases the value of the margin calculation by a bit more than $1/cwt. when feed prices are at levels that have prevailed over the last four years,” says Mark Stephenson, a University of Wisconsin dairy economist.
 
As a result, he says, it’s harder to hit the $6 two-month trigger and $4 one-month trigger for supply management. In this new Wisconsin analysis, which is a retrospective going back to January 2006 through January 2013, supply management would have been triggered for 16 months. But two of those months would have been suspended because U.S. dairy prices would still have been higher than international prices. In the end, supply management would have been in effect about 20% of the months over the last six years. 
 
The Missouri analysis, done by dairy economist Scott Brown, suggests the Senate dairy bill would trigger the supply management program only 7.5% of the months from 2012 through 2022. The higher feed calculation is part of that, but much higher milk prices are also key. Brown’s analysis suggests the All-Milk price will average $19/cwt. throughout that period, which is midway between the Congressional Budget Office projection ($18.70/cwt.) and the USDA projection ($19.30).
 
The Missouri analysis suggests milk production will only be 0.1% lower during the period due to the supply management program, but milk prices will be a nickel higher. Exports of non-fat dry milk will fall a miniscule 4 million pounds over the period, or 0.3%.
 
While much of the debate has been over the dairy stabilization provision, little has been said about what the actual net return will be for dairy producers. The Senate dairy bill throws a whole new wrinkle into the equation. It offers one set of insurance rates for the first 4 million pounds of annual milk production, and another, higher set of rates for production above 4 million pounds.
 
The Wisconsin analysis incorporates all these rates to estimate what the final net payout would be. For supplemental coverage, producers can choose a margin level they wish to protect and the percentage of their production they wish to protect (from 25% to 90% of annual production history). And they can do this annually.
 
The Wisconsin spreadsheet takes into account premiums paid, indemnities received, milk losses from milk not sold and feed savings from that milk not produced to come up with a net total per farm and per hundredweight. It also looks at four farm sizes: small, 100 cows; medium, 250 cows; large, 500 cows, and extra-large, 1,000. And it looks at supplemental insurance coverage of either 25% or 90% of annual production, and assumes producers buy supplemental insurance throughout the six-year period.
 
“Because the premium levels are so high, it is unlikely that farms will purchase supplemental insurance at the $7, $7.50 or $8 levels of margin protection,” says Stephenson. “The $6 to $6.50 levels of protection probably represent the ‘sweet spot’ for participating producers—the best combination of cost and benefit.”
 
At 25% supplemental coverage at the $6.50/cwt. level, the net total return over the six years ranged from 10¢/cwt. for small farms to 8¢/cwt. for the extra-large farms. At 90% coverage, the net total return was 30¢ for small farms to 17¢/cwt. for the extra-large farms. 
 
The analysis also shows that margin insurance would have provided the most relief during the depths of the 2009 crisis—February through November. At a $6.50 supplement coverage, the indemnity payment would have averaged $2.10/month (from which premiums and milk withholds must still be deducted).
 
“In 2012, which is shaping up to the second worst year of the young century, the magnitude of the net benefit for farmers who buy up to the $6.50 level is more subtle,” says Stephenson.
 
This year, the $6.50 margin would have been triggered from April through October, with an average indemnity payment of $1.41 (less premiums and milk withholds).
 
The Wisconsin analysis can be read here. http://dairy.wisc.edu/PubPod/Pubs/BP12-05.pdf

 

After nearly two years of discussion and argument on future dairy policy among dairy farmers and processors, the real debate that matters begins in Congress this week.

 

The Senate will begin mark-up of its version tomorrow, and the Dairy Security Act (DSA) of 2012 as we all know (and love or hate) it, will likely be tweaked. That’s almost a certainty on the House side, where Speaker John Boehner has been quoted as saying DSA is dead on arrival if it contains supply management provisions. The House of Representatives’ Agriculture Subcommittee on Livestock, Dairy and Poultry will hold hearings on dairy policy Thursday.

 

In dairy country, the rhetoric has already ratcheted up. A few weeks ago, the Dairy Business Association in Wisconsin claimed that had DSA already been in effect, dairy stabilization provisions would already be requiring participating producers to cut production or forfeit a portion of their milk checks due to low margins.

 

“Not true,” counters Jim Tillison, National Milk Producers Federation Senior Vice President of Marketing and Economic Research. “Based on the numbers as DSA is currently proposed, the dairy stabilization program would go into effect in May. But it’s also true producers would be receiving margin payments for the previous two months, depending on the level of supplemental margin insurance they signed up for.”

 

Dairy programs actually in place, the Milk Income Loss Contract program (MILC) and Livestock Gross Margin-Dairy (LGM-Dairy), are currently sending real dollars to producers who have signed up for these programs. The MILC program is paying producers 39¢/cwt. for February milk production, the first time MILC payments have been made since April 2010. Projections, based on current futures prices, are that MILC will make significant payments—$1/cwt. or more in June and July—through August.

 

LGM-Dairy is also paying indemnities, reports Ron Mortensen, with Dairy Gross Margin, LLC. If producers had signed up for the insurance for January, February and March with zero deductible, the indemnity would be 81¢/cwt. less the 63¢ premium, netting 18¢/cwt.

 

And then there’s localized supply management. Last week, California Dairies, Inc., issued a press release that it might have to impose penalties for members who ship more than their assigned baseline limits. It has not done so since May 2009, but increasing milk volumes might necessitate the reactivation of the program.

 

Land O’Lakes has already activated its base plan in California, noting the huge increase in daily deliveries that is overwhelming processing capacity and the prohibitive cost of hauling surplus milk to other plants.

 

The point of all this is that Congress will be debating new dairy policy in the midst of tightening margins and rapidly expanding production. Note: February milk production was up 4.3%, March production was up another 4.2%.

 

Existing programs are attempting to deal with this conundrum. Opponents of DSA would like to gut supply management from the program. But that throws budget savings and control out the window as well.

 

Some are already girding for failure. Sen. Patrick Leahy, D-Vt.), Sen. Bernie Sanders, (Indep., Vt.) and Rep. Peter Welch (D-Vt.)  introduced legislation that would continue the MILC program at current levels until Sept. 30, 2013. (Current legislation expires Sept. 30, 2012. )

 

But in order to enact that legislation, the Vermont Congressional delegation will have to find offsetting budget savings. And that would be on top of the $3.32 billion in annual savings agriculture must contribute to budget reconciliation after the so-called “Super Committee” failed to reach agreement last fall.

 

No one can predict how any of this will turn out, of course. What is clear, given the tenor of the times and the debate so far, is that we’re in for a long, hot, nasty summer.

Back in December, we dutifully reported  an analysis by Chuck Nicholson and Mark Stephenson. Chuck Nicholson is a dairy economist at Cal Poly; Stephenson is a dairy economist at the University of Wisconsin.

 

Their economic model shows that the Dairy Security Act of 2011 (DSA) could significantly reduce milk price volatility, but that reduction would come at a price of nearly $1/cwt. reduction in the all-milk price. The Stephenson/Nicholson model also suggests the dairy stabilization program would be in effect 40% to 45% of the time, and net farm operating income would be reduced by 32% to 48%.

 

Opponents of DSA immediately grabbed onto those numbers. And frankly, who wouldn’t? These are some unsettling outcomes, to say the least.

 

But proponents of DSA point out, rightly, the Stephenson/Nicholson model does not include any correlation between feed prices and milk prices. In other words, there is no mechanism in the model that says as feed prices rise, less milk is produced, which in turn eventually drives milk prices higher. DSA proponents say this is a critically missing link in any analysis of DSA because the program hinges on the margin between feed and milk prices.

 

Scott Brown, a dairy economist with the University of Missouri, completed work on the feed-milk correlation this winter. His results confirm there is a fairly strong correlation between feed and milk prices—in the neighborhood of 0.45. (No correlation would be 0.00; a perfect correlation would be 1.00.)

 

“I was surprised at how strong the correlation is, even in the shorter term,” he says. “But feed is a big driver to milk production costs—65% of production costs are wrapped up in feed.”

 

And so the correlation between feed costs and milk prices becomes important, especially if you’re receiving government payments based on the marginal difference between the two. “The chances of high feed costs and low milk prices are lower than the chances of low feed costs and low milk prices,” he says.

 

“As a result, margin payments may not trigger as often as you might think. There certainly is a lower probability,” he says. And if there’s a lower probability of margin payments, there is also a lower probability of the dairy stabilization program kicking in.

 

Brown’s model suggests all-milk prices would have also been about $2/cwt. better in 2009—not dipping nearly as low as they did, and rebounding more sharply—had the DSA been in place.

 

Brown ran 500 iterations of his economic model for each year from 2012 through 2020. His results show that there is very little difference in the all-milk price between the current dairy program and the Dairy Security Act of 2011 as originally proposed by U.S. Rep. Collin Peterson, D-Minn., last fall. In fact, there is not a nickel’s worth of difference in any of those years.

 

If you look at 2015, for example, there’s only a 10% chance of a margin payment at the base program rate of $4/cwt. margin. And even at the $6.50/cwt. supplemental margin, there’s a probability of a payment only a third of the time.

 

All of this, of course, depends on what the final details of the reform package are, if it passes and how many dairy producers then opt in.

 

Opponents of DSA will cling to the Nicholson/Stephenson results as to what DSA could bring. Brown acknowledges the Nicholson/Stephenson scenario is a possible outcome even in his model. But it’s only one of 500 possible outcomes.

 

 

Win #1: The plant, with ground breaking likely to come by early summer, will require 2 million pounds of milk per day when it’s operational in late summer 2013. That will require Fallon dairy producers to essentially double cow numbers, or recruit other producers to the region. Already, some producers in the area are making expansion plans. Their greatest hurdle (more on this later) will be to convince local lenders to supply the capital.

 

Win #2: Fallon producers will no longer be required to truck their milk to California plants. The savings will come not only in hauling costs saved but peace of mind. Moving Nevada milk into California’s state-controlled order has always been a point of friction. Nevada producers live in constant fear that that access to market will be cut off, and with it their livelihood. Other than Reno, the next closest processing plant is 500 miles away. To get some sense of that distance, that’s like moving milk from Sacramento to San Diego or from Madison, Wis., to Fargo, N.D.

 

Win #3: The Fallon plant frees up California processing capacity. After 2009 and 2010, the California industry has rebounded to pre-recession levels. So the Fallon plant announcement should be welcomed news on both sides of the state border, particularly by DFA members from both states. And it should help boost California’s Class I utilization—at least until California producers make up the manufacturing milk losses to the Fallon plant.

 

Win #4: And probably the biggest win of all: DFA is showing global customers it is willing to invest in processing capacity specifically designed to meet their unique ingredient needs. Yes, the plant will be capable of producing domestic skim milk powder if world demand for whole milk powder evaporates. But the mission of the Fallon plant, first and foremost, is to supply products to meet international customer needs.

 

This is precisely the point of the Bain Study, which shows a latent supply gap of some 7 billion pounds of milk over the next few years. To meet this need, the U.S. must produce products that the global market needs—not products we produce for U.S. markets that we happen to have in surplus every now and then.

 

With this commitment comes market risk. The Fallon milk price is being targeted at Class IV plus 25¢ to 30¢/cwt. Year in, year out, this is essentially our basic manufacturing price. Few dairy producers have gotten rich at these levels. It’s one reason some bankers are already showing reluctance to finance new, $2 million milking parlors in Fallon. (See Win #1.)

 

In the end, the Fallon plant is not an automatic home run. It shows that while some will benefit by its mere existence, others will take the risk that it will be successful.

DFA and the local Fallon producers who are willing to step up to the plate should be commended. Kudos to these guys for slapping on their batting helmets against world-class competition.