Matching Dairy Risk with Government Programs

1. Matching Dairy Risk with Government Programs Ben Brown June 17, 2019

2. Federal Dairy Programs- Addressing the Need • Outline of Risk Management Options for Dairy Producers • What conditions have occurred to create various government programs • Private and Public Risk Management Options • Self Insure • Futures and Options • Dairy Margin Coverage (DMC)- Old MPP • Partnership with other producers through cooperatives • Livestock Gross Margin Insurance- Dairy • Dairy Revenue Protection • Current market conditions and the impact of DMC • Understanding the DMC Program • Participation and election decisions of DMC Photo Credit- Ohio Farm Bureau

3. What does Strawberries have to do with Federal Dairy Programs Photo Credit- Ozark Beauty

4. One word: Perception • The old Margin Protection Program (MPP) was extremely unpopular with dairy producers • Implication- The name had to be changed to Dairy Margin Coverage • The farm bill started a refund of premiums paid into MPP for producers • Federal Commodity Programs, whether they are dairy or crops, are expenses to tax payers • The reality - there are more consumers than there are producers • Some will say and are saying that there is too much money being allocated to dairy programs, others say it is not enough • The increase in funding helps dairy producers financially now, but • Is it enough to keep operations in business long term • Will it encourage more production and thus drive down milk prices further without increases in demand

5. Federal Dairy Programs- Market Regulations History of Federal Dairy Programs: Great Depression to Today MPP Dairy- revenue program that made payments when difference between feed and milk got to a certain coverage level. First Policy was Dairy Pricing Schemes- differing versions of flat and pooled prices Dairy Production Stabilization Act- reduced U.S. milk production. Import Quotas- restricted milk imports from overseas. 2002 1937 1980s 1949 Today 1900 2014 1951 1996 Stayed in Place till the U.S. enter the World Trade Organization. MILC- revenue program that made payments when income fell to low. Federal Milk Marketing Orders- classified pricing and revenue pooling. Still used today. Import Quota Tariffs- restricted milk imports to a certain amount then tariffs on the additional amount. Still used today. DMC- enhanced version of MPP-Dairy. Milk Price Support Program- government bought milk off the market.

6. Federal Dairy Programs- Market Regulations History of Federal Dairy Programs: Great Depression to Today MPP Dairy- revenue program that made payments when difference between feed and milk got to a certain coverage level. First Policy was Dairy Pricing Schemes- differing versions of flat and pooled prices Dairy Production Stabilization Act- reduced U.S. milk production. Import Quotas- restricted milk imports from oversees. 2002 1937 1980s 1949 Today 1900 2014 1951 1996 Stayed in Place till the U.S. enter the World Trade Organization. MILC- revenue program that made payments when income fell to low. Federal Milk Marketing Orders- classified pricing and revenue pooling. Still used today. Import Quota Tariffs- restricted milk imports to a certain amount then tariffs on the additional amount. Still used today. DMC- enhanced version of MPP-Dairy. Milk Price Support Program- government bought milk off the market.

7. Economic Event- Policy Reaction 42% Drop in Milk Price Data Credit- USDA- NASS

8. Economic Event- Policy Reaction Parity Price System: Taxes and Interest were rising quicker than milk prices. A Parity Price Ratio was introduced in 1946 Data Credit- USDA- NASS We still have price supports, but they are really just a fear based mechanism to get a new farm bill.

9. Economic Event- Policy Reaction Data Credit- USDA- NASS

10. Collapse of Milk Prices in 80s Inflation Period Data Credit- USDA- NASS

11. Economic Event- Policy Reaction Large Purchases of Grain in the 80s and the WTO in 1996 changed Gov. purchases. Data Credit- Commodity Credit Corporation Annual Expenditure Reports

12. Milk Price “Volatility”- The New Threat Uruguay Round Agreement Data Credit- USDA- NASS

13. Milk Price “Volatility”- The New Threat Calculated using data from USDA- NASS

14. Removal of Price Supports Increases Volatility but also Reveals Cycles Prolonged Cycle Data Credit- USDA- NASS

15. Challenges to Price Volatility • Volatility- implies prices move around a bunch. Prices become hard to predict and usually have a larger downside. • Traders love volatility because when there is movement in prices- there is money to be made. • However, it is terrible to risk management plans for producers of the commodity. • Characteristics of Risk Management • Uncertainty/Certainty- good or bad, to what degree can I predict what the price will be? • Instability/Stability- good or bad, price do or don’t change much from one period to the next. • Inadequacy/Adequacy- stable or volatile, prices are enough to cover my costs and keep my liquidity ratios in tact? Credit to Andrew Novakovic, Cornell University

16. Global Markets- How they Impact Producers • The U.S. was a closed dairy economy until 1996. • Consumers benefit from cheap dairy products and there are more of them. • You can’t use an old price support system in a global market. • Supporting U.S. dairy prices support the world price. • When times are bad they are equally bad for everyone, but when times are good it’s a lot better for the large operations. • Economies of scale are still prevalent in dairy operations.

17. Public Offering - Volatility Mitigation The average of $8.24 was above highest margin coverage of $8 under MPP. Author Calculation using USDA- NASS, AMS and FSA Data

18. Dairy Revenue Protection • What is it? • Private insurance product “It’s the crop insurance for milk” • Where? • Everywhere (in the U.S.) • When? • Traded every trading day (which is almost every day, when the market is closed (from 4pm to 9am) Slide Information- Marin Bozic, University of Minnesota Photo Credit- USDA-FSA

19. Dairy Revenue Protection • What is Protected? • Revenue = Price x Quantity • Which Price? • Based on Federal Milk Marketing Order Prices • It can be just on Fluid Milk Prices (Class III or Class IV) • You can also protect against milkfat and protein contents. • Which Quantity? • Whatever coverage level you choose. It is assumed that the production risk is similar to state-level changes in milk per cow • Quarterly Program not Monthly Slide Information- Marin Bozic, University of Minnesota Photo Credit- Progressive Dairyman

20. Effective Risk Management- Dairy RP • Hedge Frequently • Hedge a Long Way Out- Now is not the time to Hedge Next Quarter • Can only go out 5 quarters Information Source – USDA RMA

21. Effective Risk Management- Dairy RP Slide Information- Marin Bozic, University of Minnesota

22. Effective Risk Management- Dairy RP Slide Information- Marin Bozic, University of Minnesota

23. Summary- Risks in Dairy Prices • Dairy Policy has gone through major reforms since the first policies in the 1930s. • Likely to go through many more until dairy policy finds a way to help producers manage liquidity instead of measures of profit • There is a disconnect between what is needed and what has been provided • Two Major Challenges • Dairy Producers feel that they are victims of large price volatility • Larger farms have historically handled the “cycles” better than others, resulting in farm declines and changes to the industry • The old MPP and the new DMC might have found a sweet spot by providing • MPP had the same thought as DMC, but with less money • Income significant subsidies tailored for small sized operations • Price and revenue risk well suited for large sized operations

24. This material is based upon work supported by the USDA-NIFA under Award Number 2018-70027-28586 and prepared by Ben Brown- The Ohio State University College of Food Agriculture and Environmental Sciences with reference of information to Andrew Novakovic at Cornell University and Mark Stephenson, Director of Dairy Policy Analysis at University of Wisconsin

25. The Dairy Margin Coverage Program County Educator Best County in the State

26. Federal Dairy Programs- Addressing the Need • Outline of Risk Management Options for Dairy Producers • What conditions have occurred to create various government programs • Private and Public Risk Management Options • Self Insure • Futures and Options • Dairy Margin Coverage (DMC)- Old MPP • Partnership with other producers through cooperatives • Livestock Gross Margin Insurance- Dairy • Dairy Revenue Protection • Current market conditions and the impact of DMC • Understanding the DMC Program • Participation and election decisions of DMC Photo Credit- Ohio Farm Bureau

27. The Mechanics of DMC • Under the hood • If you lift up the hood and look in, the program mechanics are very similar to the Margin Protection Program. • Same basic concept- based on margin between milk and feed prices • Farms must choose a coverage level and pay the associated premium- higher coverage levels have a higher premium, but trigger more frequent. • Can only cover a percent of historical production • Most program functions were changed to make it more farmer-friendly. • The one exception is that historical milk production was left the same as MPP. Photo Credit- American Dairy Association

28. DMC- Changes from MPP • Coverage levels for Milk in Tier I • Added $8.50, $9.00, and $9.50 • Changes to Tier I and Tier II Premiums (Lower for Tier I) • Higher level of milk production coverage • Did not change production history- still highest of 2011, 2012, or 2013 • Ability to dual participate in the Livestock Gross Margin Program • Review of Feed Costs • Review of corn silage vs corn and the price of high quality alfalfa • Cash Back or Premium Credit for Producers who enrolled under MPP

29. Production History- Stayed the Same • Producers will retain the SAME production history if they participated in MPP. • This was the highest of 2011, 2012, or 2013 • You will get to keep all the production “bumps” released by USDA • There will be no more “bumps” in production history • If you are a new operation since 2013, FSA will help you estimate your production history. • If you’ve expanded in the last couple of years- it is still the same production history you had before. • However……. Photo Credit- Dairy Processing Handbook

30. Amount of Milk Covered- Increased • Tier I Coverage increased from 4 million pounds to 5 million pounds. • This change was made in the Budget Bill at the start of 2018 • Producers can elect to cover a percentage of their historical production. • Between 5% and 95% (Previously was 25%-90%) Photo Credit- American Dairy Association Mid-East

31. New Premiums and Coverage Levels Taken from the Farm Service Agency release rules

32. Premiums- Graphically

33. Tier II- Graphically

34. Example: Buckeye Farms Example Buckeye Farms has a Base Milk Production of 4,500,000 lbs. They Elect to cover 90% at $9.50 Coverage Level Covered Milk = (4,500,000 x 0.90)= 4,050,000 lbs. or 40,500 cwt The program assumes the same production each month (40,500/ 12) = 3,375 cwt. The differences between the U.S. all milk prices and feed prices for Jan. Feb. and Mar. are already know. January- $7.99, February- $8.22, and March - $8.85 Subtracting 9.50 from each and multiplying by 337,500 and adding up gets us the total payment thus far. January = $5,096, February = $4,320, and March = $2,194 Total = $11,610 Premium was $0.15 per cwt. ($0.15/cwt x 40,500)= $6,075

35. Objective: Avoid Tier II Coverage • For farms above 5 million pounds of historic production- choose a coverage level that gets you closest to 5 million pounds. • 10 million pounds, choose 50% = 5 million pounds • 23 million pounds, chose 20% = 4.6 million pounds • Producers that select $8.00 coverage level or less in Tier I, then they MUST select the same coverage level in Tier II • Producers that select $8.50 coverage level or above in Tier I, may select a different coverage level in Tier II. Photo Credit- Farm and Dairy

36. DMC- Strategy • Tier I coverage is inexpensive at any level. Insure as much as you can. • Above 5 million lbs.? Then pick a coverage level above $8 so you can do a lower on in Tier II. • If above 5 million lbs, the $5 coverage level is the same as Tier I, but jumps 10 cents for $5.50 Big Jump

37. DMC-Discount for multi year enrollment • Option 1- Elect for annual sign-up. • Option 2- Elect coverage once for all 5 years of the Farm Bill and receive a 25% discount on premiums. • There are also discounts for rebates on old MPP premiums (difference between payment and premium for (2014-2017) • 75% of the difference if taken as a credit for DMC • 50% of the difference if taken as cash Photo Credit- Morning Ag Clips

38. Does the New Coverage Levels Matter?? Author Calculations based on Data from USDA- NASS, AMS, and FSA

39. Does the New Coverage Levels Matter?? Author Calculations based on Data from USDA- NASS, AMS, and FSA

40. Concurrent Participation with LGM- Dairy Could not do both under MPP. Low participation in Ohio last couple of years, but now more attractive. Photo Credit- USDA- RMA

41. DMC- Observations • Futures, Options, Forward Cash Contracts, LGM-Dairy and Dairy RP are all tied to futures market sentiment • Consider needs in liquidity • Requires active management • A marketing plan to take the emotion out is important • DMC- A federal program that does not depend on future market sentiment • Set it (maybe for five years) and forget about it • Based on feed and milk prices that happened in the last month Photo Credit- Ohio Dairy Veterinarians

42. Questions? Photo Credit- Krauss Dairy, Ohio State University

43. This material is based upon work supported by the USDA-NIFA under Award Number 2018-70027-28586 and prepared by Ben Brown- The Ohio State University College of Food Agriculture and Environmental Sciences with reference of information to Andrew Novakovic at Cornell University and Mark Stephenson, Director of Dairy Policy Analysis at University of Wisconsin