Despite current futures prices pointing to improved dairy producer income margins, it’s advisable to build a price floor using available risk management tools, according to Alan Zepp, risk management program manager at Pennsylvania's Center for Dairy Excellence (CDE).
Zepp provided a dairy market update and discussed risk management options during his monthly “Protecting Your Profits” conference call, Aug. 31.
Risk management options
As usual, the call summarized three income-protection options. Cynthia Walters, with the Pennsylvania USDA Farm Service Agency, provided an update on the Margin Protection Program for Dairy (MPP-Dairy), while Zepp reviewed Livestock Gross Margin-Dairy (LGM-Dairy) and puts and options on the Chicago Mercantile Exchange (CME) futures market.
A reminder: By law, producers already enrolled in MPP-Dairy can’t participate in LGM-Dairy.
MPP-Dairy
The May-June MPP-Dairy margin was announced last month at $5.76 per hundredweight (cwt), providing an indemnity payment of about 74¢ per cwt for any producer insuring a margin at $6.50 per cwt.
Using an example herd of 100 cows with a production base averaging 22,222 pounds of milk per cow per year, a herd protecting a $6.50 per cwt margin on 90 percent of milk production would received a May-June indemnity payment of about $2,466.
Stronger milk futures prices have improved forecasted MPP-Dairy margins for coming months. Current pay-period projections are as follows: July-August – $8.09; September-October – $ 9.94; November-December – $10.36; between $9.90-$10.00 for the first half of 2017; and closer to $11.00 per cwt for the second half of 2017. Based on those preliminary estimates, there will be no MPP-Dairy indemnity payments through the end of 2017.
LGM-Dairy
Under LGM-Dairy, producers can insure milk income over feed cost margins for a 10-month period. The August 25-26 sales period offered coverage for October 2016 through July 2017, with policies available through certified crop insurance companies.
During the latest sales period, the insurable 10-month LGM-Dairy margin averaged $8.65 per cwt. The cost of a zero-deductible policy for the 10-month period was 58 cents per cwt, with a $1-deductible policy costing about 15 cents per cwt.
CME Class III puts/options
In comparison, as of Aug. 31, a December 2016 Class III $16.00 per cwt “put” was trading at 65 cents per cwt, with a $15.00 “put” (similar to a $1 deductible LGM-Dairy policy) costing 25 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.
“Both minimum price contracts and LGM-Dairy contracts can provide a safety net against a catastrophic price fall without taking away the upside,” Zepp said.
Market fundamentals
Based on USDA estimates, July U.S. cow numbers, at 9.332 million, remain near the previous peak set in December 2008 of 9.334 million.
U.S. butter stocks are 65 percent higher than the three-year average and 30 percent higher than a year ago. Domestic butter prices have fallen recently, but remain at about 10 percent above the Global Dairy Trade international price.
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. U.S. cheese prices remain about 20 percent above European Union and Oceania prices.
The gap between 2015-16 Class III milk prices is narrowing. And, while the Class III price is still about $1 per cwt below the five-year average, income margins are $2.40 per cwt above the five-year average, thanks to lower feed prices.
Additionally, cheese, butter and powder prices are improving all over the world.
“Nonetheless, there’s still a fair amount of risk in the market,” said Zepp, citing continued growth in U.S. cow numbers and milk output per cow.
While dairy product export volumes are improving, lower prices are putting a lid on export value.
Find Zepp’s archived Protecting Your Profits podcast on the Center for Dairy Excellence website. Next month’s call is scheduled for Sept. 21, with the next LGM-Dairy policy sales period set for Sept. 30-Oct. 1. 
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Dave Natzke
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