What keeps you awake at night? This question, while cliché, prompts consideration of the risks confronting your dairy operation. When contemplating risk, a multitude of potential hazards arises. Among them are weather fluctuations, fluctuating milk prices, changes in government regulations and labor shortages. Virtually every facet of dairy farming harbors risk, some within control and others beyond it.
Milk price volatility represents a controllable risk to some extent. Various programs exist to assist in milk marketing, thus curtailing the effects of price fluctuations. Commodity markets inherently exhibit high volatility, and adept management thereof can delineate profitability from losses.
The year 2023 exemplified this volatility, with milk prices plummeting during summer before rebounding in the fall. Operations with robust risk management strategies in place not only safeguarded their bottom line but also ensured profitability.
Relying solely on hopeful price stability is an ineffective strategy. Establishing the true cost of production forms the cornerstone of a solid risk management plan. Such data also facilitates rational decision-making by dispelling emotional influences. A thorough understanding of production costs allows the opportunity to secure margins and ensure profitability. Employing multiple risk management tools in conjunction can provide solid milk price protection, making milk price risk management more critical than ever.
Dairy Margin Coverage
Dairy Margin Coverage (DMC) through the local FSA office represents one of the fundamental options for milk price risk management, suitable for producers of all sizes. DMC enables producers to mitigate the margin between the all-milk price and the average feed price at a margin selected by the producer.
Under Tier 1 coverage, producers can insure up to 5 million pounds of milk at a margin level of $9.50 per hundredweight (cwt). The cost of this coverage is reasonable considering the protection it affords. Additional pounds may be covered under Tier 2, albeit at a higher cost.
Payments are calculated on a monthly basis. While Tier 1 coverage offers solid catastrophic protection, operations exceeding 5 million pounds of milk production may need supplementary risk management measures.
Dairy Revenue Protection
Dairy Revenue Production (DRP or Dairy-RP) is another option for milk price risk management. DRP permits producers to insure milk price declines in quarterly increments, with expected revenue predicated on futures prices for milk and dairy commodities, coupled with the producer’s chosen milk production coverage.
Producers can opt for coverage based on class milk price options or commodity price options. Under DRP, producers may cover up to 95% of their anticipated milk revenue, irrespective of the milk price received from processors. Quarterly loss calculation mitigates potential losses within a single month.
DRP establishes a price floor for covered pounds of milk while allowing for potential market upswings. Many producers combine DRP with DMC to effectively manage milk price risk.
Livestock Gross Margin Dairy
Livestock Gross Margin Dairy (LGM-Dairy) operates on a more intricate level than DRP and DMC. LGM-Dairy uses futures prices of corn, soybean meal and milk to project gross revenue, contrasting it with actual gross margin to determine indemnity payments. Prices are based on the simple average of the Chicago Mercantile Exchange daily settlement prices of each commodity.
Producers must insure at least two months within the 11-month insurance period to qualify for program subsidies and a per-hundredweight deductible and feed cost for margin calculations. If actual gross margin falls below the expected gross margin (minus deductible) for the insurance period, indemnity may ensue. Producers may enroll in LGM-Dairy on a weekly basis and can insure milk concurrently under both DMC and LGM-Dairy.
Moreover, producers can integrate LGM-Dairy and DRP in the same crop year, albeit with only one policy – either LGM-Dairy or DRP – endowed with endorsements for a given quarterly insurance period. DMC, DRP and LGM-Dairy can also complement direct contracts with milk processors, enabling dairy operations to secure prices per hundredweight. Additionally, futures and options trading can augment risk management strategies.
Risk management plans are not one-size-fits-all. Each dairy operation must assess its individual risks and prioritize accordingly. Given the persistent volatility in commodity markets, income risk needs to be taken seriously. Fortunately, we have an arsenal of tools to mitigate milk price volatility.
By using a combination of DMC, DRP, LGM-Dairy, direct contracting and futures and options trading, dairy farmers can effectively mitigate milk price risk and reduce some of the volatility. Ensuring bills are settled and fostering prospects for future success fosters peace of mind. Just as we insure barns, vehicles, tractors and crops, insuring income through these tools is equally prudent.
This article is provided for information purposes only. Readers should consult their own professional advisers for specific advice tailored to their needs. Information contained in this article may be subject to change without notice.
