By Jim Dickrell
, editor Dairy Today
Woulda, coulda, shoulda. That pretty much sums up Dennis Haubenschild's milk and grain marketing plans before he decided to contract with a professional firm to handle his dairy's risk management.
Dennis dairies with his wife, Marsha, and their two sons, Tom and Bryan. Together they farm 1,000 acres of alfalfa and corn near Prince-ton, Minn., an hour north of Minneapolis, have 900-plus cows and market some 23 million pounds of milk each year.
The Haubenschilds' break-even milk price hovers at $16/cwt. Their March mailbox price came in at $12.41. So even though they have dairied for 36 years, risk management is still critical to their operation.
"When I first started hedging years ago, I had a marketing plan. But it changed weekly,” Haubenschild says. "It was the woulda, coulda, shoulda approach. Sometimes I got things covered, sometimes I didn't.”
His first experience with forward pricing came with grain. "I went to a few classes, I knew our break-even cost for growing corn and I thought I knew what I was doing.
"So I locked in a contract, and then the market started moving up. It ate up my margin account in no time, and I was borrowing money on tractors, my Corvette, even my boat, to make those margin calls,” Haubenschild chuckles.
"I learned pretty quickly I needed a much more sophisticated approach to marketing.”
He started working with professional marketers at Stewart-Peterson, based in West Bend, Wis., in May 2006.
"You can only do so much yourself,” he says. "Turning over the marketing lets me focus on keeping our people happy, our cows happy and on making milk.” Now he lets his consultant, Matt Mattke, make the marketing decisions.
"You're hiring them to do a job, so you have to turn them loose,” Marsha explains. "We hire people to drive expensive tractors here too, and we trust them to make the right turns when they're supposed to. It's the same with marketing.”
Stewart-Peterson provides weekly market updates and trading strategies. The Haubenschilds can still pull in the reins if the brokers get too aggressive.
The Haubenschilds are most comfortable when 40% to 50% of their milk production is protected. This year, they have about 45% of their milk protected at an average price of $17.36.
and her husband, Jarred Searls, started dairying in October 2005. Both are nutritionists by training. Jarred maintains a full-time job as beef specialist with Vita Plus; Laura still balances rations for a number of clients as well as managing their 390-cow Jersey herd near Cobb, Wis., an hour west of Madison.
It's a lot of ground to cover, since they also are a partial grazing herd. They rotationally graze 110 acres split into 25 paddocks. Laura estimates the cows get about 30% of their dry matter from grass and the balance from total mixed ration.
Juggling all of that, plus marketing milk from a highly leveraged start-up dairy, is not for the meek. "When we started, we considered forward-pricing our milk with the co-op for a one-year contract,” Laura says. "But we never actually did it. Thinking back, it scares me that we considered contracting, which would have meant a loss of flexibility.”
Instead, they rode the market for their first 2½ years. Their dairy consultant, Steve Bodart, of Lookout Ridge Consulting, suggested they work with a marketing service with the goal of minimizing risk. "Jarred and I know we're not going to top the market doing this; that's not a realistic expectation,” Laura says.
"Our lenders at M&I Bank definitely urged us to explore marketing our milk professionally, but they didn't require us to do it. We did it to stop worrying about it,” she says.
In December 2008, they had 60% of their 2009 milk production protected at a $17.77 floor. But they were also wanting to add 90 cows to the operation.
So they rolled out of sold positions to capture gains to help finance the cows. Then, they went to more options and fence positions (varying combinations of put and call options) to protect their 2009 milk. With that strategy, they're running $1.40/cwt. to $1.50/cwt. better than the Class III average.
The other factor, which complicates things a bit, is their Jersey herd. Jerseys have a cost of production that can run 20% higher on a hundredweight basis than Holsteins. But Jersey herds can also compensate for it with higher butter-fat and protein premiums.
In Daniels' herd, butterfat averages 5% and protein 3.55%. So her basis—the difference between the Class III price and the mailbox price—can range from $3.75/cwt. to more than $7/cwt. Her average basis for last year was $5.66/cwt. Protecting the Class III portion of her mailbox price is often straightforward, but protecting the basis can be more problematic.
"Laura gets quite a large components premium and the butter price is more of a factor for her,” says Matt Mattke, her Market360 adviser with Stewart-Peterson. Butter trading volume and liquidity are lower than they are in milk futures, he adds, but Jersey herds can look to Chicago Mercantile Exchange butter futures contracts to partially hedge their basis.
Whether you work
with a professional to manage risk depends on a number of factors, including your liquidity, debt level and comfort level with your own ability to pull the trigger on trades.
The Haubenschilds and Daniels do it for peace of mind. "It's a tool, and when times are tough, you have to use all the tools available,” Haubenschild says.
"Marketing is something you have to be willing to manage every day,” Daniels adds. "We're not, so we turn it over to someone who will manage it for us.”
For many large operators, formalized risk management often becomes a condition of their loan requirements when borrowers don't meet core underwriting standards, says Greg Steele, vice president of agricultural business capital for AgStar Financial Services.
For AgStar, that means 50% equity in the operation and $200/cow working capital. "More than 90% of borrowers don't meet those requirements when they undertake a major expansion,” Steele says. Plus, large expansions will expose borrowers to levels of risk that they have never experienced.
Knowing they have a formalized risk management plan in place lets both borrowers and their lenders sleep a little better, Steele says.
This year, however,
has proven to be one endless sleepless night. Bodart, with Lookout Ridge Consulting, says the percentage of his clients that are forward priced on milk is the lowest in a long time.
Typically, 75% of his clients will have 50% of their milk contracted. This year, the percentage is closer to 60% of clients with only about 30% of their milk covered.
Bodart says clients backed off on booking this year because they left a lot of dollars on the table during the price run-ups of 2007 and 2008. And even when milk-pricing opportunities presented themselves last summer, the corn futures were trading at $6/bu. and even $7/bu.
"The margins over feed costs weren't there,” he says. "And people were reluctant to lock in losses.”
The lesson of 2009, according to Stewart-Peterson's Mattke, is that the market does not always provide a margin. "Sometimes you have to make sales in order to reduce the red ink,” he says.
The key for dairy operators this year is to manage risk in a disciplined, systematic way. "We try to be very methodical in our approach, pricing production in 10% to 20% increments,” Mattke says. "That way, if we're wrong and the market moves up, we haven't committed everything. It leaves room to take advantage of new opportunities.”
"COST” OF TRADING
One of the biggest "costs” of risk management is margin accounts or hedge lines. They're a necessary evil—you can't trade without them.
One way to view them is as a substitute for working capital. If you're not managing risk of input cost and output price volatility, you'll need more working capital to cover price swings. In a year like 2009, working capital requirements can be as much as 50% of your cost of production.
How much you need in your hedge line depends on how active you are in futures and options trading. "A pretty good starting number is $200 per cow,” says AgStar's Greg Steele. That amount rarely impedes a dairy's access to operating money. The only time it can become a problem is when milk production drops or there are other production problems.
"The key with hedge lines is to have an understanding between the borrower and the lender as to what it's there for, and then get the hedge line repaid as those contracts settle,” Steele says.
The $200/cow level probably suffices if you are at a medium level of risk management and protecting no more than 50% of your milk production. If you're doing a lot of contracts and sophisticated trades, you'll need more margin money, says Matt Mattke of Stewart-Peterson. At the highest level of risk management, $300/cow may be required.