Managing Risk and Seizing Opportunity in 2012 and Beyond

1. Managing Risk and Seizing Opportunity in 2012 and Beyond Dr. Marin Bozic Nebraska State Dairy Association│ March 13, 2012

2. Topics for today • Recent events in the dairy markets • Risk factors in 2012 • Hedging margin risk • Long-run risk management

3. June 2012 Class III Futures

4. June 2012 Class III FuturesComponents contribution to decline

5. Term structure of futures prices Based on options data, there is 20% chance Class III price will settle below the shaded area, and 20% it will settle higher.

6. Downside Risk

7. Downside Risk

8. Risk factors • U.S. recovery to stop? • Eurozone collapse? • War with Iran? • Runaway inflation? • Three year cycles? (2009 + 3 = 2012)

10. Implied Probabilities of Uncertain Events:1. U.S. Economic Recovery

11. Implied Probabilities of Uncertain Events:2. Dropping out of Euro zone

12. Implied Probabilities of Uncertain Events: 4. War with Iran

13. Implied Probabilities of Uncertain Events: 4. War with Iran

14. Can we make use of prediction markets in dairy? Information discovery: • E-verify to become mandatory before 12/31/2012 • Farm bill to pass before 9/30/2012 Risk transfer: • “The Secretary of Agriculture to announce that the stabilization program is in effect for June 2012”

15. Expected Inflation: Evidence from Treasury Securities

16. Expected Inflation: Evidence from Treasury Securities

17. Historical Milk-Feed Margin 2010-2011 Source: Katie Krupa, Rice Dairy, LLC.

18. Forward Margins Source: http://dairymgt.info/netgiofc/

19. Rice Dairy Milk-Feed Margin Formula 1 cwt of milk - 0.80575 bu of corn - 0.0087 ton of SBM 2/8/2012 Source: Katie Krupa, Rice Dairy, LLC.

20. Rice Dairy Milk-Feed Margin Formula 1 cwt of milk - 0.80575 bu of corn - 0.0087 ton of SBM 3/12/2012 Source: Katie Krupa, Rice Dairy, LLC.

21. Three year cycles? Evidence from forward margins

22. Three year cycles? Evidence from forward margins

23. Historical Perspective Source: Katie Krupa, Rice Dairy, LLC.

24. Historical Perspective Source: Katie Krupa, Rice Dairy, LLC.

25. Forward Dairy Profit Margins 1998-2011

26. Hedging by any other name… There are (at least) three very different way dairymen can manage risk: • Contracting – i.e. futures and options, forward pricing through the coop, cash contracts for feed • Strong equity/fast growth – increasing efficiency to keep costs below national average, possibly by attracting investors to keep debt/equity ratio low in face of fast expansion • Dairying as a hedge – low cash-flow costs, but high opportunity costs of feed. Dairying as a hedge against lower future value of land/crops

27. Short run (wish there was a fifth udder) Price S D′ D Quantity

28. Long run (eight udders are better than four) Price S D′ D Quantity

29. What does the long run U.S. milk supply look like? Data period: 1980-2010

30. Change in Dairy Farm Technology

31. Percent of U.S. Milk Production by Large Dairy Farms Percent of US milk production by farms with 2000+ cows grows on average by 2.2% a year.

32. Flat supply curve – what are the implications? In the long run… • Dairy Darwinism: dairyman to businessman, or out of business. • Demand-enhancing activities boost quantity, not price (think exports, check-off, product research & development) • Increase in price of one milk fraction decreases the price of another (think whey vs. cheese) until returns to dairying revert to average • Uncertainty = higher average returns • Vertical integration as the 21st century version of “cooperative revolution”

33. Support from these companies is greatly appreciated

34. Managing Risk and Seizing Opportunity in 2012 and Beyond presented at the I-29 Dairy Conference Sioux Falls, February 8, 2011 Dr. Marin Bozic mbozic@umn.edu Department of Applied Economics University of Minnesota-Twin Cities 317c Ruttan Hall 1994 Buford Avenue St Paul, MN 55108 You may download this presentation at http://marinbozic.info/