Global milk production slowdowns have helped provide some price recovery. However, the USDA’s latest milk production report indicates a large jump in U.S. cow numbers. This, combined with large cheese and butter inventories, has heightened the degree of price risk faced by dairy producers, according to Alan Zepp, risk management program manager at Pennsylvania's Center for Dairy Excellence (CDE).

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Dave Natzke
Editor / Progressive Dairy

Zepp provided a dairy market update and discussed risk management options during his monthly “Protecting Your Profits” conference call.

Risk management options

The conference call, recorded and available on the Center for Dairy Excellence website, provided an update on the Margin Protection Program for Dairy (MPP-Dairy), Livestock Gross Margin-Dairy (LGM-Dairy) and puts and options on the Chicago Mercantile Exchange (CME) futures market.

MPP-Dairy

The July MPP-Dairy margin was announced at $7.59 per hundredweight (cwt), up more than $1.80 from May-June. The August margin, used to calculate the July-August MPP-Dairy pay period, won’t be know until Sept. 29.

Based on current futures prices, Zepp estimated the July-August pay period margin at $8.30 per cwt. Looking through the end of 2016 and beyond, pay-period projections are: September-October – $ 9.49 per cwt; November-December – $10.14 per cwt; and about $10 per cwt for the first six months of 2017. Based on those preliminary estimates, there would be no MPP-Dairy indemnity payments through the first half of next year.

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LGM-Dairy

Under LGM-Dairy, producers can insure milk income over feed cost margins for a 10-month period. The Sept. 30-Oct. 1 sales period offers coverage for November 2016 through August 2017, with policies available through certified crop insurance companies. Based on conditions as of Sept. 21, the insurable 10-month LGM-Dairy margin averaged $8.47 per cwt. The cost of a zero deductible policy for the 10-month period was 56 cents per cwt, with a $1 deductible policy costing about 15 cents per cwt.

A reminder: By law, producers already enrolled in MPP-Dairy can’t participate in LGM-Dairy.

CME Class III puts/options

In comparison, as Sept. 21, a January Class III $16 per cwt “put” was trading at 63 cents per cwt, with a $15 put (similar to a $1 deductible LGM-Dairy policy) costing 26 cents per cwt.

The cost for Class III puts/options and LGM-Dairy premium payments have both decreased in recent weeks due to a decline in CME milk futures price volatility, Zepp said.

Risk management interest is growing

“The latest production and cow numbers released by USDA are concerning, indicating the industry is not responding to negative market conditions, and adding increased downside risk for prices,” said Chris Laughton, director of Farm Credit East’s Knowledge Exchange. ”There has been some supply contraction globally, but we’re not seeing that domestically.”

That possibility of downside risk has increased interest in risk management tools.

Matt Mattke, director of Market360 Dairy with Stewart-Peterson, said he’s seen more interest among producers to get some form of downside coverage in place for next year’s milk, and expects the latest USDA milk production report to provide even more motivation.

“We have seen a consistent trade over the past month out in the 2017 months for both Cheese and Class III futures,” added Andy Faulman, floor manager with Rice Dairy. “Open interest has been building, which would suggest increased hedge activity from both long and short hedgers (producers).”

In some cases, however, dairy economic conditions have left producers unable to cover risk management costs.

“Risk management strategies out there are as diverse as farms themselves, but futures haven’t really been attractive enough to entice many farms to lock in prices,” Laughton said. “Cash is a concern for a lot of dairy farmers, which certainly affects their decision-making process. As many farms are trying to cut costs any way they can, paying LGM-Dairy premiums or hedging costs is something a lot of farms would rather avoid, particularly given the relatively weak price outlook.”

Despite opportunities to protect milk prices at near breakeven levels, many are reluctant to do so, explained Matthew Lange, business consultant with AgStar Financial Services.

 “Some producers are dismayed by the transaction costs of such marketing,” he said. “They might execute some type of put/call, but are looking for something in the 25-cent to 30-cent per cwt range. Another concern is that if the producer targets a position and milk markets rise, they may need to execute on margin calls. For clients who do not have hedge lines of credit or who have felt they have been burned in the past by such positions, may be reluctant to execute.”

“With many cash flows quite tight or running negative, spending money on something that is perceived as non-critical by some producers may be causing them to not act when their better judgment would typically protect margins,” Lange said.

In some case, the marketing strategy is based on hope that low milk prices are primed for an upswing. 

Market fundamentals

Zepp offered the following market fundamentals:

• The Class III price average for the next 12 months is about $16.13 per cwt, $2 below the five-year average. However, with lower feed prices, income margins are $1.40 per cwt above the five-year average.

• Based on USDA estimates, August U.S. cow numbers, at 9.36 million, are the highest since the 1990s.

• U.S. butter stocks are 65 percent higher than the three-year average and 30 percent higher than a year ago. Domestic cheese inventories are the highest on record, but only 16 percent above the three-year average, despite climbing 10 percent in the last year.

• Global cheese, butter and milk powder prices are still below average, but rising. With weakening U.S. domestic prices, the gap between U.S. and global prices continues to close, making U.S. products more competitive in export markets.

Find Zepp’s archived Protecting Your Profits podcast on the Center for Dairy Excellence website. Next month’s call is scheduled for Oct 26, with the next LGM-Dairy policy sales period set for Oct. 29-30. end mark

Dave Natzke