A new report analyzing the proposed Dairy Market Stabilization Program is a thorough lesson in dairy economics. The purpose of the study, as sponsored by the International Dairy Foods Association, was to analyze the regional and farm-level impacts of the potential temporary supply management program if it had been in place from 2000 to 2009. It also highlights the unknown and unpredictable economic aspects of its implementation.
Known and predictable
The Dairy Market Stabilization Program (DMSP), which is included in National Milk Producer Federation’s Foundation for the Future, proposes to establish a temporary milk production base when the margin between milk price and feed cost narrows. The base would kick in when the price of milk minus feed costs is less than $6 for two consecutive months.
Dairymen would not be paid for production over their base while the program triggers were still active. The value for overbase milk production shipped to processors would be withheld and used to spur consumption of domestic dairy products and exports.
Further, a more strict production base would be triggered if the margin slips to $5, or even $4.
The study found that Midwest and Northeast states would have had the largest withholdings under the program, with Wisconsin, New York, Minnesota, Pennsylvania and Michigan accounting, by themselves, for more than half of the $626 million total in withholdings.
Nate Donnay, a senior dairy analyst with Informa Economics, which did the study, says his group’s research showed DMSP would have been active at four different times and for a total of 18 months between 2000 and 2009, or 15 percent of the study period.
Donnay explains how structural differences in feed purchases between the Midwest and Northeast played a role in the study’s findings.
“Farmers who are purchasing most or all of their feed are going to be more sensitive to the feed cost aspect of their margin than farmers who are growing their own feed,” Donnay says.
“The DMSP’s estimated national milk-feed margin more closely reflects what the farmers who are buying their feed are paying. Many of those guys are primarily in the West and Southwest.
So as feed costs began rising in 2008, those farmers had already slowed down their production or even pulled back. At the same time, guys in the Midwest were not feeling that run-up in feed cost as acutely.”
The report’s findings also state that “the program will hit higher-cost farms harder than lower-cost farms.”
The program would pay nothing for overbase milk, or in other words a reduction of between 2 percent and 8 percent in milk price for all milk shipped, when the program was active. This decrease in revenue when margins are already low will be easier for some farms to survive, Donnay says.
“Those who have a cost of production that is low – the most efficient farms –will be able to absorb a withholding much easier than those with a high cost of production,” he says.
The recent study also showed a “significant lag between the lowest milk price and the lowest level of milk production.”
A low milk price takes about 10 to 12 months to have an effect at decreasing milk production growth, reaffirming the economic principle that milk production is inelastic or that a large change in price leads to only a small change in production.
Unknown and unpredictable
How much producers will react to a reduction of milk price under DMSP is still unknown. Donnay says his group estimated producers faced with receiving zero dollars for overbase production would cut back production by 30 percent.
“No one really knows how much they will cut back,” Donnay says. “The rational thing to do in the short term is to not produce more than your base. But we are dealing with an industry that has a long-term outlook, so how they exactly react to it, we really don’t know.”
When Stephenson and Nicholson released their economic analysis estimates for production impact under DMSP, they estimated producers would cut back production by 50 percent.
Donnay says the only reference point to observe generally how producers will respond to temporary supply control is the Milk Diversion Program from the early 1980s. That program paid producers to withhold milk from the market for 15 months. It did hold down production during the program.
But shortly after it ended, milk production surged again. Donnay says he anticipates the same thing would happen under DMSP. However, DMSP would threaten sustained, unwarranted milk production more than a one-time government program would.
“There’s no good historical precedence for how farmers will react unless the program is actually implemented,” Donnay says.
Also unknown is how producers who didn’t have the advantage of foresight would choose how to allocate their base. Donnay gave producers in his group’s study the benefit of knowing exactly when the DMSP would kick in and deactivate when choosing how to calculate their base production for the year.
DMSP would allow producers to choose once per year to have their milk production base be their year-ago milk production for any given month or a rolling three-month average of milk production. Choosing a rolling three-month average had a steep risk-reward trade-off.
“The choice in terms of choosing how you want to calculate your base is a tradeoff between risk –not knowing what your base will be by using a rolling three-month average – and potential reward – that due to the seasonality in production you’ll actually be below your base when or if the program activates,” Donnay says.
“This is compared to using year-ago level production where you know exactly what your production base will be so you can make decisions but if the program gets activated, you’re almost guaranteed to be above your base level production, as most farms grow milk production incrementally year after year.”
If producers didn’t have perfect foresight and gambled with risk and reward, the DMSP activation dates in Donnay’s study wouldn’t have changed but the duration of the program’s implementation might have been different – both longer or shorter.
Still, Donnay says that wouldn’t have changed the study’s key finding about the regional differences in amounts withheld from producers’ milk checks under simulated DMSP implementation.
“When there is a run-up in feed costs, farmers in the West will cut back sooner,” Donnay says. “When the DMSP kicks in, farmers in the West are more likely to be able to stay within their base than guys in the Midwest, avoiding more withholdings.” PD
ABOVE: Informa Economics’ study showed that in three of the four periods when DMSP would have been active, except 2009, margins had already bottomed out and were starting to turn around by the time the program would have been activated.
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Walt Cooley
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