Will the Farm Bill Replace Risk Management?

08:05AM Nov 26, 2014
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Marketing experts answer our questions about how the farm bill’s new dairy Margin Protection Program will work

AgDairy Market’s Robin Schmahl, Dairy Farmers of America’s Ed Gallagher and Stewart-Peterson’s Bob Devenport discuss why the Margin Protection Program (MPP) and Livestock Gross Margin for Dairy
(LGM-Dairy) Program may—or may not—be important to you.

Why should I sign up for MPP?

Gallagher: Recent history has shown that events beyond any dairy farmers’ control can cause significant harm to milk prices or push livestock feed prices higher. Just remember the global financial crisis and areas of the U.S. faced with drought in the past five years. During these occurrences, the milk-feed margin fell below the $4 level and times were tough for most U.S. dairy farms.
For a mere $100 annual investment, you can protect you dairy from the harshest points of these unprofitable parts of the “margin cycle.” Participating also allows you to “buy-up” to a better level of protection, if you so choose.

Why bother with MPP for $4?

Schmahl: Dairy producers certainly are not going to make money at a $4 margin. Signing up requires the payment of a $100 fee and automatically establishes a margin protection at the $4 level. The reason that it is a good idea to sign up, even if the
intention is not to buy up to a higher level, is that it allows a producer to receive the first “bump” of 0.87% to the individual’s farm milk production history next year. If sign-up is first done next year, the advantage of the first bump will not available. Each subsequent year, the production bump will be raised by another percentage based on the increase in national milk production.

If I purchase MPP insurance in the $6 range, could I use it as a way to replace a risk manage-
ment program?

Devenport: No, I would not recommend it. Historically, it has not been very often that
income over feed cost—as defined by the MPP—has dropped below the $6 level. Given where current
Class III futures and feed futures prices are for 2015, margins are still projected over the highest levels of coverage offered by the MPP.

That means producers can utilize the many different hedging tools available to them to take control now, and preserve the higher margins the market is offering through hedging their milk price as well as their feed costs.

Consider $6 margin coverage, for example, as an added layer of coverage. If things get particularly bad, producers will be that much better off if they are also employing their current risk management strategy.

In its margin calculation, the MPP uses the U.S. All-Milk price and national feed prices. How does that affect my decision if I’m in California, for example, where milk prices are typically lower and feed prices are typically higher?

Gallagher: Federal dairy support programs have been based on a single, national index. Some of us can remember the 1980’s and earlier when the federal price support, for all intents and purposes, set the manufacturing milk price. Although a single national “base” price, those in the eastern U.S. had a gross milk price that was better than those dairies in the western U.S.—so it has always been this way.

The MPP program is a significant improvement, for everyone, over the old combination of the price support and MILC programs. Changing age-old federal policy is a major breakthrough. It likely would not have occurred if it were not a simple,
national program.

Will MPP be triggered during high or low milk prices?

Devenport: Possibly both—it all depends on where feed prices are. One common misconception of the MPP is that it protects against low milk prices. That’s not necessarily true because if feed prices are also depressed when milk prices are low, it may not automatically trigger an indemnity payment.

How do I know if or when I’ll get a payment from MPP?

Schmahl: Payment will be announced by the government through some channel similar to how the MILC payments were announced.

Will MPP cause changes to LGM-Dairy? How will the two programs play out against each other?

Schmahl: It is not anticipated that the MPP will cause any changes to LGM-Dairy. There are advantages and disadvantages to each program.

The MPP uses national average feed prices and the All-Milk price to calculate income over feed costs. LGM-Dairy uses a three-day average of futures prices for each month for feed and milk and allows a producer to choose a weighted feed or milk price, allowing for more flexibility.

The MPP makes a calculation for every two-month interval, whereas LGM-Dairy can choose a margin interval of two to 10 months. MPP buy-up levels for margin protection on the first 4 million pounds of milk are less expensive than LGM at a $0 deductible level but less costly than MPP at the $8 level.

If MPP guarantees at least $4 per cwt, how will the market respond to over-supply?

Gallagher: MPP was designed as a catastrophic “disaster insurance” program. If the insurance pays off, it will not generate profits, unless paired with private sector risk management transactions that were executed at profitable levels. The program’s impact should help to keep dairies in business in the short term, thereby supporting a more stable milk supply, which in the long run benefits everyone from dairies to consumers.

Are there potential consequences to MPP, such as affecting market liquidity?

Devenport: The risk of affecting market liquidity is there, but it is not something we are overly concerned with. The large dairy producers in the country make up a good chunk of open interest in the milk market because many of them already use risk management strategies, including futures and options. I would think these producers would continue with their current risk management strategies because they can often protect greater margins using futures and options.

Does MPP have a cap?

Devenport: Not on the monetary value of indemnity payments that MPP will pay.