Dairy Policy and Risk Management

1. Dairy Policy and Risk Management A Comfortable Coexistence? Phil Plourd • Minnesota-Wisconsin Dairy Policy Conference •April 3, 2012

2. What Policy Reform? • Are we talking about “margin management” with a compulsory “supply management” component? • Meaningful reform of Federal Order System? • Something not yet contemplated? • It is difficult to discuss implications without knowing the proposed policy. • So: let’s take a step back and study the nature of the “problem” confronting the industry…

3. A Puzzling Path Problem Solution

4. The Choices • We can be Canada or we can be New Zealand…trying to find solutions “in the middle” will ultimately lead to frustration…and failure. • Risk can be managed in one of two ways: • Individually in the markets with best managers rewarded and industry makes most progress (most commodities!) • Blanket fashion through policy with better managers limited in their ability to outperform and poorer managers supported – and this assumes the policy “works” as anticipated

5. Risk is Being Managed

6. Lots of Markets Utilized

7. Elegance in Simplicity The Corn Model FUTURES MARKET

8. Not Simple, Not Elegant FUTURES MARKETS SPOT MARKETS NASS SURVEYS CHEESE CME CHEESE BUTTER CME BUTTER NDM AMS NDM AMS WHEY WHEY COMPONENT PRICES PROTEIN FAT OTHER SOLIDS CLASS PRICES BLEND PRICE CLASS I BASE CLASS II CLASS III/4b PPD/OVERBASE CLASS IV/4a

9. Two Big Improvements • Consolidate classes • Less complexity • More, deeper liquidity pools • In our opinion, the single best change • Find a better way for spot pricing • Current structures create volatility, complicate risk management, foster distrust • To the extent current risk management tools are “not working” it is because the dairy system is flawed, not because producers are uninterested or incapable.

10. Too Many Pools

11. CME Spot Market

12. CME Spot Market

13. Riding Only One Horse

14. Volatility

15. “Preventing” Another 2009 • The main motivation for a risk management safety net for producers is the 2009 disaster. • Reality: 2009 was much bigger than dairy. • No dairy policy would have protected producers from the demand meltdown of 2009 and allowed the flexibility to serve the resurgent demand of 2010 and 2011. • We may be trying to fix a problem that is not really “fixable” – and may no longer be a threat.

16. Globalization and Volatility • US entrance in to world market should have reduced volatility by exposing the US to many different supply and demand curves. • Reality: there are only a small number of supply and demand points that matter in the global market… • Consequence: volatility reduction has been minimal (and maybe elevated) as weather in New Zealand has become a primary driver of US export prospects.

17. What Drives Expansion? • Strong returns in high price periods drive producers to invest in their businesses (to avoid paying taxes) thereby preordaining the trailing period of low prices and over-production. • Proposals to guarantee margins will not address this issue and may in fact exacerbate the problem by raising overall profitability. • Proposals for tax-deferred saving accounts would seem more sensible.

18. Margin Management • “Margin Insurance” and LGM mimic being long calls on feed and long puts on milk…and can provide useful coverage. • However: positions are addressed on an actuarial basis, bypassing the traded markets. • Result: good for producers, but will potentially hamper end-user risk management activity because sell-side liquidity may be reduced – perhaps materially.

19. Margin Management • Some argue: if producers have guaranteed margin, prices will remain low so the buyers have little reason to worry. • Might be true if the support price program were maintained and years of strong production resulted in large inventories. Neither is likely. • Ignores the fundamental truth that weather issues are the main driver of production shortages. • Setting up for a market with little reduction in volatility/high prices and compromised tools?

20. Research, consulting and risk management strategy firm. Subscription service includes numerous, popular reports covering all aspects of the dairy markets – globally. Price forecasts and analysis across multiple markets. Staff with relevant, applicable experience. Strategic, long-term engagements with clients. Highly-detailed, highly-specialized projects. • Licensed commodity broker introducing business to ADM Investor Services. • Trading desk staffed with experienced professionals. • Expert order handling in thinly traded markets. • Premier order execution on Globex via industry-leading OAK Desktop trading platform or using dedicated resources on the CME Group trading floor. • Competitive rates. • Firm established to help clients find over-the-counter risk management solutions. • Facilitates transactions with Wells Fargo Bank. • Works with clients at each stage in the marketing chain, offering access to liquidity in several product lines and combinations. • Detailed understanding of client needs and dedication to finding structures satisfying those imperatives. MADISON, WISCONSIN 608-249-5030 Phil Plourdpplourd@blimling.com Mark Morningstar mmorningstar@blimling.com Dallas Sipes Chapmandsipes@blimling.com Lori Strong lstrong@blimling.com Theresa Rutztrutz@blimling.com Katelyn Morningstarkmorningstar@blimling.com John Sandstromjsandstrom@blimling.com MOUNTAIN TOP, PENNSYLVANIA 608-249-6727 Bill Curleybcurley@blimilng.com OMAHA, NEBRASKA 608-249-7873 Duane Banderobdbanderob@blimling.com JAMESTOWN, CALIFORNIA 608-249-7897 Tiffany LaMendolatlamendola@blimling.com ©2012 BLIMLING AND ASSOCIATES, INC. 5201 East Terrace Drive • Suite 280 • Madison, WI 53718 This information is carefully compiled but not guaranteed to be complete or free from error, nor does it constitute a solicitation to buy or sell futures/options contracts. Past performance is not indicative of future results This has been prepared for the exclusive use of clients. Redistribution and reproduction in part or in whole without written permission is strictly prohibited.