Dairy Situation and Outlook for 2009: Weathering the Storm

1. Dairy Situation and Outlook for 2009: Weathering the Storm Geoff Benson Dept. of Agricultural & Resource Economics NC State University March 10, 2009

2. Topics Situation & Outlook Production Sales Prices Weathering the Storm Financial Management Herd Management GEOFF BENSON, ARE, NCSU 2

3. Situation & Outlook for 2009

4. This graph shows the monthly Class III (cheese) milk price since 1975, in blue. We often use the cheese milk price as the reference point because it is the best indicator of the supply and demand balance in the market. Cheese uses most of the solids in milk, so co-products and by-products are not a major issue. More recently, cheese has become the product category that uses more milk than any other. The red line shows the federal dairy support price. Until 1989, the support price frequently set the price of milk because it was at or above the market clearing price most of the time. As a result, milk prices were more stable for months at a time, although not necessarily more predictable longer term because they depended on Washington politics. Since 1989, the support price essentially has been unchanged and costs of production have increased. As a result, the support price is below both the longer run cost of production and the long-run market clearing price. Milk prices are vary sensitive to small changes in production or sales. The result has been increasing price volatility, with higher highs and the lows often still supported by the price support program during times of oversupply. The circle covers the most recent Class III prices, which takes us back to prices we saw almost 20 years ago.This graph shows the monthly Class III (cheese) milk price since 1975, in blue. We often use the cheese milk price as the reference point because it is the best indicator of the supply and demand balance in the market. Cheese uses most of the solids in milk, so co-products and by-products are not a major issue. More recently, cheese has become the product category that uses more milk than any other. The red line shows the federal dairy support price. Until 1989, the support price frequently set the price of milk because it was at or above the market clearing price most of the time. As a result, milk prices were more stable for months at a time, although not necessarily more predictable longer term because they depended on Washington politics. Since 1989, the support price essentially has been unchanged and costs of production have increased. As a result, the support price is below both the longer run cost of production and the long-run market clearing price. Milk prices are vary sensitive to small changes in production or sales. The result has been increasing price volatility, with higher highs and the lows often still supported by the price support program during times of oversupply. The circle covers the most recent Class III prices, which takes us back to prices we saw almost 20 years ago.

5. Price Recovery How do you get the price up? Sell more milk Exports At home Reduce milk production Clearly, current (January and February, 2009) prices are way below cost of production and I know of no producers who won�t lose money at these prices. Two key questions are how long will prices stay low and what will it take to move them higher. There are only two basic ways to raise the price of milk, sell more milk and dairy products or reduce milk production. It is helpful to look at the sales picture in terms of exports and domestic sales. On the supply side, imports are largely controlled by tariff rate quotas, so domestic production is the key.Clearly, current (January and February, 2009) prices are way below cost of production and I know of no producers who won�t lose money at these prices. Two key questions are how long will prices stay low and what will it take to move them higher. There are only two basic ways to raise the price of milk, sell more milk and dairy products or reduce milk production. It is helpful to look at the sales picture in terms of exports and domestic sales. On the supply side, imports are largely controlled by tariff rate quotas, so domestic production is the key.

6. Dairy Exports For 2007 and the first part of 2008 exports of dried milk powders, butter and cheese showed strong growth Low US prices for part of the period Weak dollar Reduced production & exports from NZ & Australia Reduced exports from the EU Demand growth, especially in Asia Then came the global economic crisis & exports slumped both in volume and in value The last couple of years have been unusual. The US has never been a major exporter of dairy products because US prices normally make US dairy products uncompetitive in world markets. There are much lower cost producers like New Zealand and the European Union normally provides large export subsidies to move surpluses generated by their dairy programs. 2007 and 2008 were unusual years in than several factors came together to make the US a significant exporter, first of milk powders, then of butter and cheese. The result was extremely high world prices, which translated into high US farm prices. However, all of this came to halt in the latter part of the year as the world economy crashed and milk supplies increased. World demand and world prices slumped. The last couple of years have been unusual. The US has never been a major exporter of dairy products because US prices normally make US dairy products uncompetitive in world markets. There are much lower cost producers like New Zealand and the European Union normally provides large export subsidies to move surpluses generated by their dairy programs. 2007 and 2008 were unusual years in than several factors came together to make the US a significant exporter, first of milk powders, then of butter and cheese. The result was extremely high world prices, which translated into high US farm prices. However, all of this came to halt in the latter part of the year as the world economy crashed and milk supplies increased. World demand and world prices slumped.

7. Export Prospects ? Continued world economic crisis ?Weaker world demand ?Stronger US$ ?Supply-demand balance has weakened in the EU27 since quota was expanded, and export subsidies have increased ?More normal supplies from New Zealand and Australia ? More competition for export sales ? World market prices will soften ? US export opportunities will be greatly reduced The prospects for exports are gloomy. There is little likelihood that the world economy will recover quickly and continued recession will have a depressing effect on sales. The US dollar has gained strength against many currencies because the US is still seen as a relatively safe place to invest. A stronger dollar makes US exports more expensive for foreign buyers. New Zealand production rebounded from past production problems. The supply-demand balance has weakened in the EU as a whole and a greater volume of subsidized exports are available. All of this points to lower world prices and more competition for US exports.The prospects for exports are gloomy. There is little likelihood that the world economy will recover quickly and continued recession will have a depressing effect on sales. The US dollar has gained strength against many currencies because the US is still seen as a relatively safe place to invest. A stronger dollar makes US exports more expensive for foreign buyers. New Zealand production rebounded from past production problems. The supply-demand balance has weakened in the EU as a whole and a greater volume of subsidized exports are available. All of this points to lower world prices and more competition for US exports.

8. Sales Outlook US Demand ? Continued population growth ? Continued producer & processor funded advertising and promotion ? Lower consumer prices v. 2008 ? US economic recession Projected commercial sales: Butterfat slightly lower than 2008, with small government purchases Skim-solids lower than 2008, with significant government purchases 8 GEOFF BENSON, ARE, NCSU The US market absorbs most of US production. The few bright spots are continued population growth, continued advertizing for a share of �belly space� and the fact that lower farm prices do mean lower retail prices, albeit after somewhat of a lag, which will help support sales. However, the recession means higher unemployment and reduced incomes for many, and this tends to lead to some softening in sales. USDA�s most recent forecast is for reduced sales of both butterfat and skim solids and government purchases under the price support program. It is convenient to look at total sales in terms of the major components of milk, fat and skim-solids because of the great diversity of products produced from milk. The market balance for either component can be tight or oversupplied, which affects product prices and the value of the milk used to producer them. The US market absorbs most of US production. The few bright spots are continued population growth, continued advertizing for a share of �belly space� and the fact that lower farm prices do mean lower retail prices, albeit after somewhat of a lag, which will help support sales. However, the recession means higher unemployment and reduced incomes for many, and this tends to lead to some softening in sales. USDA�s most recent forecast is for reduced sales of both butterfat and skim solids and government purchases under the price support program. It is convenient to look at total sales in terms of the major components of milk, fat and skim-solids because of the great diversity of products produced from milk. The market balance for either component can be tight or oversupplied, which affects product prices and the value of the milk used to producer them.

9. �US Comm. Disappearance�, bil. lb. The table shows USDA�s current (2/09) projections for fat and skim-solids. It also shows sales of the major product categories in 2007 and 2008. Cheese showed no sales growth in 2008, which is a concern because cheese has recorded strong and consistent growth each year since the early 1980s. The growth in butter and powder sales reflects the growth in exports. Domestic use of these products has shown little year-over-year growth.The table shows USDA�s current (2/09) projections for fat and skim-solids. It also shows sales of the major product categories in 2007 and 2008. Cheese showed no sales growth in 2008, which is a concern because cheese has recorded strong and consistent growth each year since the early 1980s. The growth in butter and powder sales reflects the growth in exports. Domestic use of these products has shown little year-over-year growth.

10. Supply Outlook ? Butter & Cheese inventories are edging up ? January 1, 2009 cow numbers were up 76,000 over Jan. 2008 (up 0.8%) and up 92,000 over Jan �07 (up 1.0%) � have been increasing since 2004 ? January 1, 2009 heifer inventory was down 5,000 head but is still adequate Cow cull rate up sharply in January 2009 v. Jan 2008 Milk/cow will be affected by less rBST use Feed costs have increased and income over feed cost is unfavorable Higher fertilizer and energy related costs 10 GEOFF BENSON, ARE, NCSU If we look at the supply (milk production) side, we see some factors pointing to larger supplies and some pressures to reduce production. Inventories have been building and larger inventories have depressing effect on prices. Cow numbers have been increasing since 2004 and were up again in the January 1 inventory. This gives considerable momentum to production. Heifer numbers were down a little but there are still plenty available to maintain the national herd. On the other side of the equation, the culling rate increased smartly during the first few weeks of 2009, no doubt because producers anticipated lower milk prices and moved some low producers out. More and more processors are insisting they be supplied with milk from cows not treated with rBST. This happened in the southeast a year ago. As producers stop using this product they see milk production back off. This causes problems for the producer but overall it takes some pressure off the market as a whole. We always see milk per cow grow more slowly when the margin over feed costs shrinks because producers adjust their rations. These margins are particularly low now. Finally, the combination of high crop production costs, high feed costs, low milk prices and the resulting cash flow problems will undoubtedly cause some farmers to quit production. Some cows will move to other farms but some will be culled, leading to lower milk production. On balance, milk production must and will fall. The key question is how soon.If we look at the supply (milk production) side, we see some factors pointing to larger supplies and some pressures to reduce production. Inventories have been building and larger inventories have depressing effect on prices. Cow numbers have been increasing since 2004 and were up again in the January 1 inventory. This gives considerable momentum to production. Heifer numbers were down a little but there are still plenty available to maintain the national herd. On the other side of the equation, the culling rate increased smartly during the first few weeks of 2009, no doubt because producers anticipated lower milk prices and moved some low producers out. More and more processors are insisting they be supplied with milk from cows not treated with rBST. This happened in the southeast a year ago. As producers stop using this product they see milk production back off. This causes problems for the producer but overall it takes some pressure off the market as a whole. We always see milk per cow grow more slowly when the margin over feed costs shrinks because producers adjust their rations. These margins are particularly low now. Finally, the combination of high crop production costs, high feed costs, low milk prices and the resulting cash flow problems will undoubtedly cause some farmers to quit production. Some cows will move to other farms but some will be culled, leading to lower milk production. On balance, milk production must and will fall. The key question is how soon.

11. GEOFF BENSON, ARE, NCSU 11 . I mentioned higher feed costs earlier. This graph shows the average price of corn and soybean meal since 1981. These are market year prices, which begin in the fall of the year shown. The corn price is shown in red with prices per bushel on the left axis. It is the US average farm price, not the price paid by dairy farmers, but it tracks market conditions. There is considerable volatility but no real trend until the last couple of years. Most analysts think we have seen a major shift on the demand side that will cause corn prices to remain above the historic average. The forecast for the current crop year is $3.90 per bu., down 30 cents form last year. The soybean meal price is shown in blue and the prices per ton are shown on the right hand axis. This price is for Decatur, IL, a major terminal. The pattern is similar to corn. Because of competition for acreage, soybean production is expected to be reduced and prices will be higher than the historic average.I mentioned higher feed costs earlier. This graph shows the average price of corn and soybean meal since 1981. These are market year prices, which begin in the fall of the year shown. The corn price is shown in red with prices per bushel on the left axis. It is the US average farm price, not the price paid by dairy farmers, but it tracks market conditions. There is considerable volatility but no real trend until the last couple of years. Most analysts think we have seen a major shift on the demand side that will cause corn prices to remain above the historic average. The forecast for the current crop year is $3.90 per bu., down 30 cents form last year. The soybean meal price is shown in blue and the prices per ton are shown on the right hand axis. This price is for Decatur, IL, a major terminal. The pattern is similar to corn. Because of competition for acreage, soybean production is expected to be reduced and prices will be higher than the historic average.

12. GEOFF BENSON, ARE, NCSU 12 Prices Paid Index for Selected Inputs USDA produces monthly price indexes for some major farm inputs, including fertilizers , fuel and seeds. The bases for these indices are prices in 1990-92. The nitrogen index is a composite of different sources of nitrogen. Phosphate and Potash are combined into one index, which makes it harder to interpret. Similarly, field crop seeds covers a variety of crops. Nevertheless, these indices give some idea of the increases in input prices, and they are significant. The middle columns show the index values for January each year for 2006-09. The right hand column shows the change in each index from the average of 2006 and 2007 compared to 2009. Prices for most items spiked at very high levels in the late summer of 2008, but this is not captured in these data. In spite of falling back significantly later in 2008, prices in January 2009 were significantly higher than in previous years except for diesel fuel. For most dairy farmers, diesel fuel is a smaller part of total cost of production than fertilizers. USDA produces monthly price indexes for some major farm inputs, including fertilizers , fuel and seeds. The bases for these indices are prices in 1990-92. The nitrogen index is a composite of different sources of nitrogen. Phosphate and Potash are combined into one index, which makes it harder to interpret. Similarly, field crop seeds covers a variety of crops. Nevertheless, these indices give some idea of the increases in input prices, and they are significant. The middle columns show the index values for January each year for 2006-09. The right hand column shows the change in each index from the average of 2006 and 2007 compared to 2009. Prices for most items spiked at very high levels in the late summer of 2008, but this is not captured in these data. In spite of falling back significantly later in 2008, prices in January 2009 were significantly higher than in previous years except for diesel fuel. For most dairy farmers, diesel fuel is a smaller part of total cost of production than fertilizers.

13. Production The table shows US milk production data for 2007 and 2008 along with the most recent (2/09) USDA forecast. The forecast decline in cow numbers would put the national dairy herd back to where it was in 2007, approximately. Milk per cow is projected to increase but at a rate that is less than long term trend rates of growth. In combination, production is projected to shrink by only 0.3% for the year as whole. The table shows US milk production data for 2007 and 2008 along with the most recent (2/09) USDA forecast. The forecast decline in cow numbers would put the national dairy herd back to where it was in 2007, approximately. Milk per cow is projected to increase but at a rate that is less than long term trend rates of growth. In combination, production is projected to shrink by only 0.3% for the year as whole.

14. Milk Prices, $ per 100 lb. This table is the companion to the previous one and shows milk prices for 2007 and 2008 along with the current USDA price forecast for 2009. Prices are in dollars per 100 lb. and the Class III and Class IV prices are standardized at 3.5% butterfat content. I show the US average �All Milk� price as one of the national benchmark prices. I show Classes III and IV because the higher of these two prices sets the Class I price in the southeastern US federal order markets and reflect the component prices paid in other federal orders. The right hand column shows the forecasted drop in prices. They are downright scary and, to me, are not believable for the simple reason that few dairy producer can survive with milk prices at these levels, particularly given the high cost of production we are experiencing. It seems to me something has to give, and must give, so that we will see a much larger production decrease and see it more rapidly than USDA is forecasting.This table is the companion to the previous one and shows milk prices for 2007 and 2008 along with the current USDA price forecast for 2009. Prices are in dollars per 100 lb. and the Class III and Class IV prices are standardized at 3.5% butterfat content. I show the US average �All Milk� price as one of the national benchmark prices. I show Classes III and IV because the higher of these two prices sets the Class I price in the southeastern US federal order markets and reflect the component prices paid in other federal orders. The right hand column shows the forecasted drop in prices. They are downright scary and, to me, are not believable for the simple reason that few dairy producer can survive with milk prices at these levels, particularly given the high cost of production we are experiencing. It seems to me something has to give, and must give, so that we will see a much larger production decrease and see it more rapidly than USDA is forecasting.

15. Class III prices, $/100 lb. 15 GEOFF BENSON, ARE, NCSU An alternative view of the price outlook can be gleaned from the futures market for Class III milk. Class III milk futures are actively traded, which means a lot of people are �putting their money where their mouths are� in order to manage price risk. The graph shows historic Class III prices in blue, ending with the February 2009 price. The green line represents the price of the various monthly futures contracts through January, 2010. These prices show the Class III price recovering from a February low and reaching $14.00 per cwt by sometime in the fall. Not a very bright picture to be sure, but one that is better than the USDA forecast.An alternative view of the price outlook can be gleaned from the futures market for Class III milk. Class III milk futures are actively traded, which means a lot of people are �putting their money where their mouths are� in order to manage price risk. The graph shows historic Class III prices in blue, ending with the February 2009 price. The green line represents the price of the various monthly futures contracts through January, 2010. These prices show the Class III price recovering from a February low and reaching $14.00 per cwt by sometime in the fall. Not a very bright picture to be sure, but one that is better than the USDA forecast.

16. Futures & Market Prices The current futures prices suggest an average Class III price of around $12.10/100 lb. for 2009 v. USDA�s forecast of $10.05/100 lb. FO 5 Class I prices for 2009 will be down a little less because of a higher January price plus the increases in Class I differentials in May, 2008 VA Dairy Commission Class I prices remain above equivalent FO prices GEOFF BENSON, ARE, NCSU 16 The futures market prices in the previous graph suggest an average Class III price for the year a little over $12.00 per 100 lb., or about $2.00 per 100 lb. higher than the USDA forecast. Producers shipping into the federal order 5 (Appalachian) market should see prices in 2009 that are a little higher relative to the historical relationship of prices in this market to the Class III price. Changes in the pricing rules last May increased the Class I differential and changes in the pooling rules seem to have caused a slightly higher Class I utilization percentage. Virginia Dairy Commission Class I prices historically have been at a premium to federal order markets and this seems likely to continue.The futures market prices in the previous graph suggest an average Class III price for the year a little over $12.00 per 100 lb., or about $2.00 per 100 lb. higher than the USDA forecast. Producers shipping into the federal order 5 (Appalachian) market should see prices in 2009 that are a little higher relative to the historical relationship of prices in this market to the Class III price. Changes in the pricing rules last May increased the Class I differential and changes in the pooling rules seem to have caused a slightly higher Class I utilization percentage. Virginia Dairy Commission Class I prices historically have been at a premium to federal order markets and this seems likely to continue.

17. US & FO5 Milk Prices, $/cwt. 17 GEOFF BENSON, ARE, NCSU So, with some trepidation, I offer my forecasts for the coming year. I am counting on a rapid reduction in cow numbers and production if we are to see prices at this level. Even if I am correct in this forecast, the year will be a very tough one for dairy farmers. So, with some trepidation, I offer my forecasts for the coming year. I am counting on a rapid reduction in cow numbers and production if we are to see prices at this level. Even if I am correct in this forecast, the year will be a very tough one for dairy farmers.

18. Price Support Program Government has made purchases of nonfat dry milk starting in October, 2008 and butter starting in early January, 2009 No �milk� support price under the 2008 Farm Bill � Product prices are set directly: Block Cheese = $1.13/lb. Barrel Cheese = $1.10/lb. Butter = $1.05/lb. Nonfat Dry Milk Powder = $0.80/lb. All unchanged from previous prices 18 GEOFF BENSON, ARE, NCSU After many months of inactivity, the Commodity Credit corporation, which is the agency of USDA that operates the price support program, made purchases of milk powder starting last fall and more recently made purchases of butter. So far there have not been any cheese purchases. CCC is obligated to buy all the eligible products offered to it at the announced prices. This has been the case since the inception of the program. A technical change was made in the 2008 Farm Bill such that specific prices were set for eligible dairy products. Prior to this, the support price was established for milk and the Secretary of Agriculture has some discretion over the relative prices for butter and skim-solids. The prices in effect now are the same prices that were in effect prior to the passage of the 2008 Farm Bill.After many months of inactivity, the Commodity Credit corporation, which is the agency of USDA that operates the price support program, made purchases of milk powder starting last fall and more recently made purchases of butter. So far there have not been any cheese purchases. CCC is obligated to buy all the eligible products offered to it at the announced prices. This has been the case since the inception of the program. A technical change was made in the 2008 Farm Bill such that specific prices were set for eligible dairy products. Prior to this, the support price was established for milk and the Secretary of Agriculture has some discretion over the relative prices for butter and skim-solids. The prices in effect now are the same prices that were in effect prior to the passage of the 2008 Farm Bill.

19. MILC Continues the current version through 9/30/08 and in Sept. 2012 Maintains the current trigger price but Adds a feed cost adjuster Increases the payment % from 34% (back) to 45% from 10/1/08 through 8/31/12 Increases the payment cap from 2.4 mil. lb to 2.985 mil. lb from 10/1/08 through 8/31/12 � 150 cows approx. Has an income qualification test 19 GEOFF BENSON, ARE, NCSU A second change in the Farm Bill affected the Milk Income Loss Contract (MILC) program. Payments will be significant during the first part of the year, providing some additional income over and above the mailbox prices dairy farmers will receive. The new provisions took effect October 1, 2008 and continue through August, 2012. The basic trigger price remains the same at $16.94 per 100 lb. for Class I milk in the Boston federal order market and can never be lower. However this price is increased when estimated feed costs exceed a trigger. The feed cost trigger is $7.35 per 100 lb of milk. Feed cost is calculated from corn (51%), soybean (8%) and Alfalfa hay (41%) prices. If the feed cost is above $7.35 the percentage difference is calculated. 45% of this difference is computed and the milk trigger price is increased by this percentage. This is done monthly. If the announced Class I price in the Boston market is below the trigger price for that month, the payment rate is 45% of the difference. Producer payments are subject to a cap of 2.985 milk lb. in any fiscal year. This is raised form the previous cap of 2/4 mil. lb. and is now equivalent to about 150 cows. Producers who will exceed the cap choose the months they wish to apply for payment, in order to maximize the benefit. Producers are eligible if their non-farm Adjusted Gross Income is less than $500,000. A second change in the Farm Bill affected the Milk Income Loss Contract (MILC) program. Payments will be significant during the first part of the year, providing some additional income over and above the mailbox prices dairy farmers will receive. The new provisions took effect October 1, 2008 and continue through August, 2012. The basic trigger price remains the same at $16.94 per 100 lb. for Class I milk in the Boston federal order market and can never be lower. However this price is increased when estimated feed costs exceed a trigger. The feed cost trigger is $7.35 per 100 lb of milk. Feed cost is calculated from corn (51%), soybean (8%) and Alfalfa hay (41%) prices. If the feed cost is above $7.35 the percentage difference is calculated. 45% of this difference is computed and the milk trigger price is increased by this percentage. This is done monthly. If the announced Class I price in the Boston market is below the trigger price for that month, the payment rate is 45% of the difference. Producer payments are subject to a cap of 2.985 milk lb. in any fiscal year. This is raised form the previous cap of 2/4 mil. lb. and is now equivalent to about 150 cows. Producers who will exceed the cap choose the months they wish to apply for payment, in order to maximize the benefit. Producers are eligible if their non-farm Adjusted Gross Income is less than $500,000.

20. CWT CWT � Cooperatives Working Together � Program Voluntary, funded at 10�/100 lb. Herd retirements by bid � 6 so far Export subsidies Current initiative Two year commitment by contributors Borrow against future income Fund a new herd retirement program with a 12-month commitment GEOFF BENSON, ARE, NCSU 20 The CWT program began in 2002 as a voluntary supply management program operated by the participating cooperatives. It is funded by contributions from these cooperating cooperatives, currently 10 cents per 100 lb. of milk marketed, but not all coops participate. The major program activities are export subsidies and herd retirement programs or buyouts. Under the buyout programs, dairy farmer submitted bids which, if accepted, meant they had to sell their cows for slaughter. There have been six herd buyouts so far. These programs have been shown to increase milk prices significantly and to provide a return to members that exceeds the cost of the program. Of course, non-participants benefit as well. Because for the gravity of the current situation, CWT has developed a new proposal. An attempt is being made to recruit more participants and participants are being asked to make a two-year commitment to pay into the program at the current rate of 10 cents/cwt. If there are sufficient participants, CWT will seek a loan so that funds will be available for an expanded buyout program to be implemented right away so as to have an immediate effect on production and prices. The loan would be repaid from contributions received over the remainder of the two-year period. Producers who have their bids accepted must agree to stay out of production for 12 months and to keep their facilities idle for 12 months. There were no such restrictions on previous buyout participants.The CWT program began in 2002 as a voluntary supply management program operated by the participating cooperatives. It is funded by contributions from these cooperating cooperatives, currently 10 cents per 100 lb. of milk marketed, but not all coops participate. The major program activities are export subsidies and herd retirement programs or buyouts. Under the buyout programs, dairy farmer submitted bids which, if accepted, meant they had to sell their cows for slaughter. There have been six herd buyouts so far. These programs have been shown to increase milk prices significantly and to provide a return to members that exceeds the cost of the program. Of course, non-participants benefit as well. Because for the gravity of the current situation, CWT has developed a new proposal. An attempt is being made to recruit more participants and participants are being asked to make a two-year commitment to pay into the program at the current rate of 10 cents/cwt. If there are sufficient participants, CWT will seek a loan so that funds will be available for an expanded buyout program to be implemented right away so as to have an immediate effect on production and prices. The loan would be repaid from contributions received over the remainder of the two-year period. Producers who have their bids accepted must agree to stay out of production for 12 months and to keep their facilities idle for 12 months. There were no such restrictions on previous buyout participants.

21. Outlook Summary Higher net incomes in 2007 & 2008 because higher milk prices more than offset increases in production costs Outlook for 2009 The global financial crisis will affect demand for dairy products Higher world production & subsidies Stronger dollar Reduced exports & sluggish domestic sales ?Lower milk prices until production is reduced Higher production costs ?Net income will be low in 2009 and cash flow management will be very important 21 GEOFF BENSON, ARE, NCSU

22. 22 GEOFF BENSON, ARE, NCSU As a transition to the next part of my talk, I show this graph to show a history of milk prices since around 1989. The graph shows the monthly US All Milk price and reminds us just how volatile milk prices have been. It also reminds us we have been where we are today several times before before � at least 7 times in the last 20 years by my count, although none of the others have been as extreme. During this 20-year period with 7 major price peaks, the time from peak to peak has ranged from 10 months to 80 months, with an average of around 30 month -- for what its worth. The time from a bottom to the next has also varied about as much. What the graph does show is that the peaks are getting higher nut the lows are still as low, so the volatility in prices is getting greater. Typically, the price peaks are quite short but the price troughs tend to be somewhat longer. Price recovery can be quite rapid. As a transition to the next part of my talk, I show this graph to show a history of milk prices since around 1989. The graph shows the monthly US All Milk price and reminds us just how volatile milk prices have been. It also reminds us we have been where we are today several times before before � at least 7 times in the last 20 years by my count, although none of the others have been as extreme. During this 20-year period with 7 major price peaks, the time from peak to peak has ranged from 10 months to 80 months, with an average of around 30 month -- for what its worth. The time from a bottom to the next has also varied about as much. What the graph does show is that the peaks are getting higher nut the lows are still as low, so the volatility in prices is getting greater. Typically, the price peaks are quite short but the price troughs tend to be somewhat longer. Price recovery can be quite rapid.

23. Financial Trends A 20-year history of large and unpredictable price swings causing cash flow problems Historically, periods of really low and really high prices are short Length of time from peak to peak or trough to peak varies widely Price fluctuations are getting more extreme Milk prices must cover cost of production on average -- and will be higher 23 GEOFF BENSON, ARE, NCSU

24. Conclusions and Implications The future will look a lot like the past Profit margins per cow and per cwt of milk are slim, on average, and getting slimmer Nothing in the farm bill or the economic environment suggests past trends will change � continued �structural change� Regional competitiveness determines the market share of the national milk production �pie� Dairy diversity means at least some farms in a state and region are profitable (on average) and competitive 24 GEOFF BENSON, ARE, NCSU

25. GEOFF BENSON, ARE, NCSU 25 Financial Performance for Selected New York Dairies, 2006 & 2007 This table shows selected financial data drawn from the 2006 and 2007 Dairy Farm Business Summary from Cornell University. Over 200 New York dairy farms contribute their farm data. The table shows the average financial performance each year,. It also shows the performance of the top and bottom 10% of farms but note that each item (row) is ranked separately, so the farms may not be the same as you go down the top and bottom 105 columns. There are a lot of numbers here but I want to make two points. First, if you look at the two profit measures, Net Farm Income per Cow and Rate of Return on Assets, you see a large change between the two years. If you look at the average cost of production in 2006 and 2007 you can see the effects of the cost of production increases we have been experiencing. However, the large increase in profitability is due to a much higher milk price. This type of fluctuation is no surprise. More importantly, you can see a huge variation between the Top 10% and the Bottom 10% in all these financial performance measures � cost and profitability � and the variation around the averages is similar both years. I could have presented many more numbers but it is clear from these few figures that individual dairy farms are coming into this downturn from very different places as far as financial performance is concerned and some are better placed to survive than others.This table shows selected financial data drawn from the 2006 and 2007 Dairy Farm Business Summary from Cornell University. Over 200 New York dairy farms contribute their farm data. The table shows the average financial performance each year,. It also shows the performance of the top and bottom 10% of farms but note that each item (row) is ranked separately, so the farms may not be the same as you go down the top and bottom 105 columns. There are a lot of numbers here but I want to make two points. First, if you look at the two profit measures, Net Farm Income per Cow and Rate of Return on Assets, you see a large change between the two years. If you look at the average cost of production in 2006 and 2007 you can see the effects of the cost of production increases we have been experiencing. However, the large increase in profitability is due to a much higher milk price. This type of fluctuation is no surprise. More importantly, you can see a huge variation between the Top 10% and the Bottom 10% in all these financial performance measures � cost and profitability � and the variation around the averages is similar both years. I could have presented many more numbers but it is clear from these few figures that individual dairy farms are coming into this downturn from very different places as far as financial performance is concerned and some are better placed to survive than others.

26. Key Questions Long-term Can I make it through this downturn? If I can, do I want to? If I can and want to, what can I do in the near-term until prices recover? 26 GEOFF BENSON, ARE, NCSU Given this situation and the very durable trends in the dairy industry, every dairy farmer should be asking these two questions: �Can I make it?� and, if he or she can, �Do I want to?� The sad fact is that not everyone can make it. Some who can may choose not to, for example, dairymen close to retirement who do not want to see their hard earned equity erode.Given this situation and the very durable trends in the dairy industry, every dairy farmer should be asking these two questions: �Can I make it?� and, if he or she can, �Do I want to?� The sad fact is that not everyone can make it. Some who can may choose not to, for example, dairymen close to retirement who do not want to see their hard earned equity erode.

27. �What financial shape are you in?� Is the farm profitable most years based on returns on assets & to management? Do you normally have adequate cash flow to meet operating expenses, debt service, family living needs in a timely manner? Is the business solvent � is debt load low and equity high as collateral for loans and as a reserve? Financial performance cannot be predicted from farm performance There are relatively few production practices that can be recommended in all situations 27 GEOFF BENSON, ARE, NCSU The first task in weathering the downturn is to get a really good handle on the financial health of the farm business. There are three distinct aspects to this; profitability, cash flow and solvency. Some farms may have problems in one area, some in another, some in more than one area. Economists usually hedge their bets but I will state categorically, based on 30 years of experience working with dairy farm financial and performance records, that you absolutely cannot determine the financial health and performance of a dairy farm from information about herd and farm performance. You have to dig into the financial records to make the assessment. On a related note, there are relatively few production practices I have found that are profitable or feasible under all farm circumstances, so it is seldom possible to say �if you do this you will make money.� If the farm situation calls for changes in production practices and methods, the financial impacts for that particular farm should be evaluated. The first task in weathering the downturn is to get a really good handle on the financial health of the farm business. There are three distinct aspects to this; profitability, cash flow and solvency. Some farms may have problems in one area, some in another, some in more than one area. Economists usually hedge their bets but I will state categorically, based on 30 years of experience working with dairy farm financial and performance records, that you absolutely cannot determine the financial health and performance of a dairy farm from information about herd and farm performance. You have to dig into the financial records to make the assessment. On a related note, there are relatively few production practices I have found that are profitable or feasible under all farm circumstances, so it is seldom possible to say �if you do this you will make money.� If the farm situation calls for changes in production practices and methods, the financial impacts for that particular farm should be evaluated.

28. �Do you know your cost of production?� Long run competitiveness depends on relative profitability There is wide variation among farms, for a variety of reasons You cannot control your milk price You can only manage your cost of production Cows Heifer raising Crop production 28 GEOFF BENSON, ARE, NCSU Given the trends in the industry, each dairy farmer must look at his or her ability to compete financially when measured against other dairy farms. As we saw in the table of data from New York farms, there is wide variation among farms and there is no single reason that explains this range in performance. The first rule of management is to manage the things you can control and to manage around the things you cannot control. It is a waste of time and energy to worry too much about the price of milk. Focus on your cost of production because that is something you may be able to do something about. Depending on your particular farm operation this may include cows, heifers and crops and, if so, I recommend treating each of these as a separate cost center to make sure each is making a positive contribution to the total farm�s financial performance. Given the trends in the industry, each dairy farmer must look at his or her ability to compete financially when measured against other dairy farms. As we saw in the table of data from New York farms, there is wide variation among farms and there is no single reason that explains this range in performance. The first rule of management is to manage the things you can control and to manage around the things you cannot control. It is a waste of time and energy to worry too much about the price of milk. Focus on your cost of production because that is something you may be able to do something about. Depending on your particular farm operation this may include cows, heifers and crops and, if so, I recommend treating each of these as a separate cost center to make sure each is making a positive contribution to the total farm�s financial performance.

29. �Do you know your cost of production?� Operating cost - out of pocket expenses, e.g. bought feed, forage production, vet, hired labor, fuel, repairs Fixed/Ownership/Investment costs Depreciation Interest Taxes & insurance Cost or charge for the value of your time (if unpaid) and your investment (equity) How do you compare to other farms? Specific benchmarks are needed 29 GEOFF BENSON, ARE, NCSU If you don�t routinely measure your cost of production, now would be a really good time to get started. I recommend including three different types of cost. Operating or out-of-pocket costs. The costs associated with investments in facilities and equipment, which may be called fixed, ownership or investment costs. These include depreciation, interest on investment, property taxes, and insurance. The value of the unpaid contributions the family makes, including their labor and money invested (opportunty cost). In addition, you need a second piece of information � benchmarks for comparison. The recent sharp increases in input prices means cost of production is a moving target and a figure that was good last year may not be appropriate this year. Several universities and organizations collect farm financial information so they can produce these types of benchmarks. It is important to understand the definitions and calculations used in preparing these benchmarks to ensure your farm information is comparable. As we saw in the table of Cornell data, financial benchmarks change every year, so the farm data should be compared to benchmarks for the same time period.If you don�t routinely measure your cost of production, now would be a really good time to get started. I recommend including three different types of cost. Operating or out-of-pocket costs. The costs associated with investments in facilities and equipment, which may be called fixed, ownership or investment costs. These include depreciation, interest on investment, property taxes, and insurance. The value of the unpaid contributions the family makes, including their labor and money invested (opportunty cost). In addition, you need a second piece of information � benchmarks for comparison. The recent sharp increases in input prices means cost of production is a moving target and a figure that was good last year may not be appropriate this year. Several universities and organizations collect farm financial information so they can produce these types of benchmarks. It is important to understand the definitions and calculations used in preparing these benchmarks to ensure your farm information is comparable. As we saw in the table of Cornell data, financial benchmarks change every year, so the farm data should be compared to benchmarks for the same time period.

30. �Do you know where the money went?� Four sources and uses of cash: Farm Operations New investments & asset sales Financing � new debt & debt repayments Non-farm income and family living Severe problems can have several causes Low profits High cost of production Low milk price Recent large new investments Large debt repayments Large family living needs 30 GEOFF BENSON, ARE, NCSU My next question is �do you know where the money came from and where it went?� This is a particularly important question when cash gets tight in a period of low milk prices and rising costs. There are four ways cash comes into and leaves your farm and these are listed in the slide. For each of these, I recommend tracking the cash coming in (inflows), the cash going out and the net amount. The net amount may be positive (net inflow) or negative (net outflow). The milk check and the feed bill are examples of operating inflows and outflows, respectively. In most months the inflows should be greater than the outgo, obviously. For all the other categories the outflows normally exceed the inflows so the net amounts usually are negative (net outflows). This is because we must replace worn out equipment and outdated facilities, because we want to pay down our farm debts (eventually), and because the farm should be contributing to meeting family living needs. The farm must generate enough of a cash surplus in the �Farm Operations� category to allow for the replacement of equipment and facilities, to pay down the farm debt and to provide for family uses. Severe cash flow problems can, and usually do, have multiple causes. A drop in the price of milk may be one cause but it may not be the only one. If there are multiple causes, then action may be required in several areas.My next question is �do you know where the money came from and where it went?� This is a particularly important question when cash gets tight in a period of low milk prices and rising costs. There are four ways cash comes into and leaves your farm and these are listed in the slide. For each of these, I recommend tracking the cash coming in (inflows), the cash going out and the net amount. The net amount may be positive (net inflow) or negative (net outflow). The milk check and the feed bill are examples of operating inflows and outflows, respectively. In most months the inflows should be greater than the outgo, obviously. For all the other categories the outflows normally exceed the inflows so the net amounts usually are negative (net outflows). This is because we must replace worn out equipment and outdated facilities, because we want to pay down our farm debts (eventually), and because the farm should be contributing to meeting family living needs. The farm must generate enough of a cash surplus in the �Farm Operations� category to allow for the replacement of equipment and facilities, to pay down the farm debt and to provide for family uses. Severe cash flow problems can, and usually do, have multiple causes. A drop in the price of milk may be one cause but it may not be the only one. If there are multiple causes, then action may be required in several areas.

31. Cash Flow �Stretchers� Draw on financial reserves Sell non-farm assets, e.g., timber, lots Postpone non-essential maintenance and new investments Reschedule (extend) or refinance debt payments Borrow more (if you will be able to pay it back) Family members seek new off-farm income Cut family living expenditures 31 GEOFF BENSON, ARE, NCSU As I mentioned when I showed the graph, we have already been though 7 major price cycles, so there are not many new ideas for managing cash flow. All of these listed here are painful and few farms will have all of the options listed. But, hopefully, some of these can be employed on your farm to cope with the current cash flow squeeze. Keeping the farm going in times like these usually means taking on more debt and minimizing the amount of new debt or credit makes repayment easier and quicker. If the cash flow deficit is too large, the alternatives are dire.As I mentioned when I showed the graph, we have already been though 7 major price cycles, so there are not many new ideas for managing cash flow. All of these listed here are painful and few farms will have all of the options listed. But, hopefully, some of these can be employed on your farm to cope with the current cash flow squeeze. Keeping the farm going in times like these usually means taking on more debt and minimizing the amount of new debt or credit makes repayment easier and quicker. If the cash flow deficit is too large, the alternatives are dire.

32. Herd Management Re-evaluate the profitability of production practices. Focus first on areas that have the biggest potential impact on profitability and cash flow Milk still pays the bills and feed is the biggest cost Milking herd rations must still be nutritionally sound � cows don�t care what the price of milk is Feed prices have been volatile � shop around Some ration ingredients may not be profitable at low milk prices Continue with recommended practices for transition cows, cow comfort, cow health GEOFF BENSON, ARE, NCSU 32 To this point I have talked about farm finances because that is the place to start any assessment. A carefully done financial analysis will provide information about the overall health and performance of the farm business. It can also identify problem areas and point to some areas of the farming operation that need to be re-examined. Clearly, in the current economic environment, it makes sense to take a hard look at the practices you are using on your farm and the place to begin is with those parts of the farm that contribute most to income and/or most to cost of production. Milk pays the bills and feed cost is the biggest single cost on a dairy farm, so this is a logical place to start. However, cows need to be properly fed if they are to remain productive, so the herd rations must be as nutritionally sound when milk prices are low as when milk prices are high. That does not mean ration formulations will not be adjusted in response to changes in herd status or to take advantage of changes in feed ingredient prices of course. And some ingredients may become unprofitable at low milk prices. A key performance measure is income over feed cost to make sure each ingredient is contributing positively to profitability. Similarly, recommended transition cow management practices, cow comfort and cow health practices must be maintained in order to support milk production both in the short run and in the longer term.To this point I have talked about farm finances because that is the place to start any assessment. A carefully done financial analysis will provide information about the overall health and performance of the farm business. It can also identify problem areas and point to some areas of the farming operation that need to be re-examined. Clearly, in the current economic environment, it makes sense to take a hard look at the practices you are using on your farm and the place to begin is with those parts of the farm that contribute most to income and/or most to cost of production. Milk pays the bills and feed cost is the biggest single cost on a dairy farm, so this is a logical place to start. However, cows need to be properly fed if they are to remain productive, so the herd rations must be as nutritionally sound when milk prices are low as when milk prices are high. That does not mean ration formulations will not be adjusted in response to changes in herd status or to take advantage of changes in feed ingredient prices of course. And some ingredients may become unprofitable at low milk prices. A key performance measure is income over feed cost to make sure each ingredient is contributing positively to profitability. Similarly, recommended transition cow management practices, cow comfort and cow health practices must be maintained in order to support milk production both in the short run and in the longer term.

33. Herd Management Revisit other practices most affected by lower milk prices and higher input prices, particularly feed & fertilizers Voluntary culling decisions Herd health, including mastitis, involuntary culling, death loss Reproduction management programs Genetic progress � focus on milk income & productive life Heifer raising is expensive! Crop production is expensive! GEOFF BENSON, ARE, NCSU 33 It is worth re-evaluating all practices on the farm because lower milk prices and/or higher input prices may make some current practices unprofitable. For example, low end cows may no longer pay their way , tail end cows may need to be dried off a little earlier, crop choices and crop production practices may need to be modified in light of higher fertilizer and fuel costs. Everything should be on the table. However, in a well run farm, most changes are likely to be �fine tuning� and the financial impact won�t be enough to offset the effects of the current cost-price squeeze.It is worth re-evaluating all practices on the farm because lower milk prices and/or higher input prices may make some current practices unprofitable. For example, low end cows may no longer pay their way , tail end cows may need to be dried off a little earlier, crop choices and crop production practices may need to be modified in light of higher fertilizer and fuel costs. Everything should be on the table. However, in a well run farm, most changes are likely to be �fine tuning� and the financial impact won�t be enough to offset the effects of the current cost-price squeeze.

34. Financial Tools There are few practices and products that work for everyone or that work in all farm and financial situations Use budgeting to assess profitability Partial Budgeting � changes in specific costs and income associated with small changes within an enterprise, e.g., ration changes for the heifers Enterprise Budgeting � Evaluate the cost, revenue and net income of an entire enterprise when other parts of the farm are unaffected, e.g., heifer raising, crop production Whole farm budgeting � For major changes would affect the entire farm operation, e.g., expansion GEOFF BENSON, ARE, NCSU 34

35. Financial Tools Budgeting (profitability) should include Operating (out-of-pocket) costs Fixed or ownership costs � depreciation, interest on investment, taxes & insurance Opportunity costs of unpaid family time and money invested Cash flow -- looks only at changes in cash outflows and cash inflows Ideally, in a cash flow squeeze, you want to make changes that are both profitable and contribute to cash flow right away GEOFF BENSON, ARE, NCSU 35

36. Summary The future will look a lot like the past Trends to fewer and larger farms, regional shifts will continue Some farms in all regions will be profitable Price volatility and low average returns will continue � but milk prices will average higher Carefully evaluate your production practices, particularly those that might be sensitive to changes on milk price or input prices However, you pretty much manage a well run farming operation in low price periods the same way you should be managing when prices are more favorable

37. Summary Measure, monitor and evaluate financial, herd and farm performance to identify problems promptly Financial information on cost of production, profitability, cash flow and solvency is essential Set farm and financial performance benchmarks, e.g. Milk income over feed costs, feed costs per cwt. Measure and evaluate performance regularly Bring in outside advisors to help evaluate financial and farm performance 37 GEOFF BENSON, ARE, NCSU I can think of few things a well run farm can do differently in the face of a price downturn and higher costs. Managing farm finances to cope with reduced income and higher expenses is essential. This means taking time to understand and monitor what is going on with the farm finances. It may be helpful to bring in outside advisors to get a fresh perspective on the farm and it�s performance. This may include extension educators, veterinarians, nutritionists, financial advisors and other dairy farmers. I like the Profit Team approach used in Pennsylvania, where you bring all your advisers in at once and share full information with all of them together so they can bounce ideas of each other and to make sure all aspects of a problem and it�s solution are considered. I can think of few things a well run farm can do differently in the face of a price downturn and higher costs. Managing farm finances to cope with reduced income and higher expenses is essential. This means taking time to understand and monitor what is going on with the farm finances. It may be helpful to bring in outside advisors to get a fresh perspective on the farm and it�s performance. This may include extension educators, veterinarians, nutritionists, financial advisors and other dairy farmers. I like the Profit Team approach used in Pennsylvania, where you bring all your advisers in at once and share full information with all of them together so they can bounce ideas of each other and to make sure all aspects of a problem and it�s solution are considered.

38. Summary Higher prices will come mostly from a reduction in milk production � fewer cows and fewer dairy farms Some cannot survive this downturn and some who could will choose to retire from dairy farming. For those who will cease production, develop and execute a timely exit plan that considers tax consequences as well as the preservation of equity.

39. Geoff Benson Phone: 919.515.5184 Fax: 919.515.6268 E-mail: Geoff_Benson@ncsu.edu Web page: http://www.ag-econ.ncsu.edu/ faculty/benson/benson.html 39 GEOFF BENSON, ARE, NCSU