Dairy’s Margin Protection Plan Is Not a Cure-all for Marketing

Published on: 11:16AM May 12, 2014

Should you commit to the new farm bill program for dairies, or avoid it? Plus, a closer look at the cheese market.

Cheese prices have fallen further than many had expected for this time of year. The price decline was swift, with buyers purchasing on an as-needed basis but waiting for lower prices. There was a feeling that cheese prices would be able to hold above psychological support of $2.00 and, so far, that has been the case. Prices came near that level, increasing buyer interest with the desire to take advantage of lower prices.

Purchasing still seems to be on an as-needed basis. Increasing cheese production has allowed for cheese to move to inventory, lessening the concern of tight supply for the time being. Despite lower inventory than last year, buyers see sufficient supply for the next few months. Schools will be closing over the next few weeks, allowing for greater milk volumes to move to manufacturing. It is unclear as to the extent of milk output over the next few months. New forage supply could provide a boost to milk production.

Farm bill chatter has slowed, with a few items still unclear as to how they will be implemented or what the final provisions will be. In the case of the Margin Protection Plan (MPP), the key feature is to move from a safety net for the price of milk to the margin between milk and feed costs. This milk income over feed costs will be determined by the difference between the national average for milk or the All-Milk price and the cost of corn, soybean meal and alfalfa hay price. It is interesting to note that the milk/feed ratio calculation that we have been using for years will be changed for the purpose of the Margin Protection Plan.

The milk/feed ratio is based on the average price of corn, soybeans and alfalfa hay prices released by the USDA at the end of each month. The actual calculation consists of the All-Milk price minus the prices of 51 lb. corn, 41 lb. of alfalfa hay, and 8 lb. of soybeans. For the month of April, this equated to an income over feed costs of $15.05.

For the purpose of the MPP, the calculation will be the All-Milk price minus the price of corn times 1.0728, soybean meal price times 0.00735, and the price of alfalfa hay times 0.0137. This equates to an income over feed costs of $13.83. The good thing about this is that it reduces the income over feed costs by about $1.20, providing for an earlier level of protection compared to using the current milk/feed ratio calculation.

There is one aspect of the calculation of which I am not completely sure. Soybean meal price is not recorded on the monthly "Agricultural Prices" report. The price used for this calculation will be determined by the Central Illinois soybean meal price as reported by the Market News Service of the Agricultural Marketing Service. It is unclear whether the calculation uses the price by rail or by truck. These prices are not too much different, but using one or the other will make a slight impact on price calculation.

Your decision will be whether you want to commit to the program and choose a margin protection level between $4.00 and $8.00 or whether you will stay out and utilize some other form of market protection for your margin.

I encourage producers who choose this program or the Livestock Gross Margin for Dairy (LGM-Dairy) program to not solely rely on it for price protection. It will not protect against a decline in milk prices. The milk price could decline, reducing profitability while still leaving you out of getting a payment from either program. After all, the current income over feed costs of $13.83 for April would need to decline more than $5.83 before any payment would be received, if the highest deductible would be chosen minus the cost of implementation. This would reduce profitability substantially.

Use put option spreads consisting of the purchase of at-the-money puts and selling puts $1.25 below that level to reduce cost. This provides some downside protection while leaving the upside open. There is no potential for ongoing margin calls with this position.

Upcoming reports:

  • Livestock, Dairy, and Poultry report on May 15
  • April milk production report on May 19
  • GDT auction on May 20

Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wisconsin. He can be reached at 877-256-3253 or through their website at www.agdairy.com.

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