Not Taking a Market Position Is Taking a Market Position
Oct 05, 2013
I’ll probably get in trouble for writing this. But one of the things that really struck me last week at World Dairy Expo was the stark contrast in attendance at the virtual farm tours and education seminars.
In nearly every case, there was standing room only at the virtual farm tours, where producers showed how they were using management, technology and genomics to achieve 100 lb./cow tank averages. Conversely, education seminars on topics such as risk management had a couple of dozen attendees—and some left midway through.
I get it. Risk management is tough stuff. It’s complicated. It requires knowing your cost of production, your basis (the difference between local prices for milk and feed and Chicago Board/ Chicago Mercantile Exchange prices), and an understanding of risk management tools.
But achieving a 100 lb. tank average means little if your income over feed costs won’t cover variable and fixed costs.
Brian Gould, a University of Wisconsin ag economist, gave a mid-level seminar on risk management last Friday, outlining eight possible risk management strategies. These ranged from fixing both milk and feed costs to more sophisticated fence and collar strategies to the use of LGM-Dairy and farm bill margin insurance.
The point of risk management is not to achieve the highest milk price, because the probability of doing that is low. The converse is not. Gould tabulated milk prices in both the Upper Midwest and California from January 1995 through May 2013. Over that time, prices were less than $15/cwt in the Midwest 55% of the time. In California, it was 70%.
Risk management strategies won’t always allow you to avoid these low prices. But if you do nothing, your milk price will fall below $15 more than half the time. "If you can get rid of the negative dips in milk prices, your average annual milk price will go up," he says. "By doing risk management, you increase the probability of achieving [desired] margin outcomes."
The important point to remember is that price volatility—both in milk and feed markets—is increasing. "With Federal Order reform in 2000 and resulting adoption of commodity-based milk pricing, milk price volatility has increased substantially," says Gould. "And following the Renewable Fuels Standards [ethanol] program implementation, corn and other feed prices have increased dramatically."
At the same time, U.S. milk prices have become increasingly reliant on export markets. This year, the U.S. is likely to export 15% of its milk solids—one out of very seven days’ production. While this has allowed U.S. milk production to expand, it adds increasing risk to price reductions if there are hiccups in world markets.
Gould likens risk management to worker’s compensation insurance. If you purchase worker’s compensation insurance for your employees, do you hope you use it? Of course not. The insurance is there to protect your farm assets should an accident occur.
Eisk management for feed and milk is much the same. The question is: How much unprotected risk can your balance sheet withstand?
You can view Gould’s presentation here.
The University of Wisconsin’s Understanding Dairy Markets website can be found here.