When it comes to risk management it seems like things are never simple. The new approach in the Farm Bill appears complicated. However, farms that have developed cash flow plans on their own or with the Extension Dairy Team, already have the tools available to implement the program effectively.
Deriving the Margin
The Margin Protection Program (MPP) in the Dairy Title of the Farm Bill uses a ration (Table 1) described with market prices for corn, soybean meal and alfalfa hay that was developed by the National Milk Producers Federation (NMPF) in conjunction with prominent dairy nutritionists. The ration incorporates all animal groups including the lactating and dry cows as well as heifers. The ration is based on a 1,000-cow herd milking 68.85 pounds per day with an 80% replacement ratio.
Table 1. NMPF Ration: herd size, feed ingredients and amounts fed Source: NMPF, National Milk Producers Federation, 2010.
|# Head||Total DM Lbs/Day||Corn Silage % of total DM||Shelled Corn % of total DM||Soybean Meal % of total DM||Alfalfa Hay % of total DM|
|Total Milking Cows||1000|
|Heifers expected to calve within 1 year||394||23||50%||5%||15%||30%|
|Heifers 500 lbs or over||203||15||50%||10%||15%||25%|
|Heifers <500 lbs||203||7||45%||25%||15%||15%|
Using this ration, the coefficients making up the final national margin formula are calculated based on the ration quantities of each ingredient for each animal group. The national all-milk price and shelled corn and alfalfa hay prices will be determined by the Agricultural Price Report from USDA National Agricultural Statistic Service (NASS). The soybean prices will be based off of the Central Illinois Soybean Processor Report from USDA Agricultural Marketing Service (AMS).
The final margin formula is:
All Milk Price - (1.0728 x Shelled Corn Price/bu + 0.00735 x SBM Price/ton + 0.0137 x Alfalfa Hay Price/ton)
This margin is used to determine the level of support producers enrolled in the MPP will receive based their elected coverage. The following section considers theoretical implementation of the MPP comparing to the Penn State dairy herd's margins during 2009 and 2012.
Margin Protection Program Payment Scenarios
Of the past five years, 2009 and 2012 have been the most challenging for dairy producers. The Margin Protection Program offers margin protection between $4.00 and $8.00 (at $0.50 increments). In these scenarios, three levels of the dairy producer margin protection were examined: $4.00, $6.00, and $8.00/cwt. This article will focus on the $4.00/cwt margin protection, because there are no premiums to obtain coverage at this level. Premiums for margin protection begin at $4.50/cwt through the maximum $8.00/cwt. A $100 annual fee is applied at program signup and guarantees the $4.00/cwt margin protection with no premium payment.
In Figures 1 and 2, the USDA margin calculated from the Farm Bill-derived ration and national all milk and feed prices shown as the light green line is compared with the Penn State dairy herd's own margin (dark green line). Using Penn State's feed and milk prices, the margins will not be identical, as would be the case with any farm calculating its own margin. Additionally, Penn State calculates its margin using only the feed costs from the lactating cows, whereas the USDA margin uses the total feed costs. Therefore the two margins cannot be compared directly. However, the most important message is the trend lines of both margins.
Figure 1. Comparing Penn State's dairy herd margin with the Farm Bill MPP using 2009 market prices
Figure 2. Comparing Penn State's dairy herd margin with the Farm Bill MPP using 2012 market prices
The USDA and Penn State Margins track in similar patterns showing the trend in lower milk prices during the 2009 year and the volatility of both milk and feed in 2012. In 2009 and 2012 there were four and two instances respectively that the margin fell below $4.00/cwt and would have generated payments to the producer. The USDA margin and its payments will be calculated on a bi-monthly basis. This is why payments in the examples show payments only every other month. The blue bars indicate the payment levels per hundredweight when the MPP is triggered at a $4.00 margin. The pink bars represent the payments at a $6.00 coverage level and the beige bars at the $8.00 coverage level.
Case Farm Example
The first question that comes to mind regarding the MPP is, "What level of coverage should I sign up for?" However, this question is impossible to answer accurately without first knowing the actual margin on the individual dairy farm. Producers must calculate their actual breakeven margin in order to compare that with the USDA margin protection program. Even after determining this value, a producer must compare the benefits of varying levels of coverage to that of the premium structure.
Dairy producers should be asking, "What would I receive in cash payments at the $4.00/cwt base protection level and how would this off-set the losses the farm would experience due to either extremely low milk prices (2009) or extremely high feed costs (2012)?"
For example, how would a dairy operation milking 80 cows and shipping 1.9 million pounds of milk annually with a yearly net margin of $285,000 have fared during 2009 and 2012 if the margin protection program was in place? This case farm needed $285,000 to pay all other expenses after feed costs. In 2009, with an average milk price of $13.33/cwt, this farm reported a cash deficit of $170,000. In 2012, with an average milk price of $19.16/cwt, this farm showed a smaller cash deficit of $54,800. Table 2 shows how this farm could have recovered some of their losses if they had insured 25%, 50% or 90% of their milk shipped at the $4.00/cwt base margin.
|Year||No protection||25% Coverage (4,750 cwt)||50% Coverage (9,500 cwt)||90% Coverage (17,000 cwt)|
Based on the information in the farm bill, when viewed from a risk management standpoint, an investment of $100 a year to participate in the program and to get the lowest level of coverage would provide compensation in the event of another disastrous year. Even during relative "good" years the $100 fee is a cost effective insurance policy to know that in months when markets may turn and negatively impact margins, the dairy operation would receive a payment.
Before the USDA opens enrollment in this program, dairy producers should know what their current margins are (based on actual costs) and how they relate to the USDA margin (based on market values). When a repeat of 2009 or 2012 occurs, this program has the potential to offset losses due to low national milk prices or high feed prices. However, it is important to note that if a farm experiences losses due to other internal circumstances (milk production decrease, extensive machinery repairs, sick cows, etc.) this protection program will not alleviate those on-farm challenges.
NMPF. National Milk Producers Federation. 2010. "Foundation for the future: A new direction for U.S. dairy policy."
USDA AMS. Central Illinois Soybean Processor Report. Accessed 04/12/2014.
USDA NASS. Agricultural Prices Report. Accessed 04/12/2014.