Pandemic-driven volatility in dairy highlights the need for sound risk management coverage, even as the markets return to a more stable pre-COVID-19 environment.
“When producers look at their milk checks, they should be expecting normalcy at least toward the end of this year, which is welcome,” said Catherine de Ronde, Agri-Mark’s vice president for economics and legislative affairs, during a recent webinar put on by Crop Growers LLP and Farm Credit East.
“We would all like to see prices higher, but that normalcy is going to be like a sigh of relief, really important, especially when trying to make the right decisions about risk management.”
“I’ve been thinking of the dairy market as one big game of tug-of-war,” she added. “The winner this past year has really been demand.”
She attributed this, in large part, to huge government-funded initiatives such as the Farmers to Families Food Box Program. But government purchases — one of three main “demand buckets” along with food service and retail — have greatly scaled back as the health crisis has subsided.
Steadily rising production, 4.9% higher than a year ago, is the new leader as things shift toward a supply-side market. The nation’s dairy herd is currently at a 25-year high.
“Demand is still good, but not enough to offset production,” de Ronde said.
At least three factors could determine the direction production and milk prices take during the near and long term.
The first is historically high feed prices, which are almost double last year’s level. The second factor is variable input costs, such as labor, which are growing during this inflationary period. Materials for expansion or maintenance projects are also extremely high.
“That should signify that margins are getting tighter and a decline in production,” de Ronde said.
“Usually the thought process for earnings is focused on the milk price,” said Chris Laughton, director of Farm Credit East’s Knowledge Exchange. “In 2021, it’s all about input cost calculations. That’s why these risk management programs based on margin are especially useful right now.”
The third factor is the historic drought out West. “Does production respond to drought conditions or keep plugging away?” de Ronde said.
Upside is in Class IV
Class III (cheese, whey) prices are expected to lose momentum this summer before recovering this fall and during the high-demand holiday period. Likewise, Class IV (butter, nonfat dry milk) prices will be close to Class III, especially next year.
“I see more potential for upside with Class IV than Class III,” de Ronde said.
She attributes this to increased demand for items such as cream cheese and ice cream that use a lot of butterfat. This, in turn, should work through current butter inventories by mid-2022, putting the butter price above $2.
Risk management options
“While volatility creates opportunity, having valuable risk management products that allow you to maximize profit by allowing you to capture upward market price movement while establishing a price floor to reduce risk, this is really the new dairy risk management strategy,” said Jeremy Forrett, manager of Crop Growers LLP, describing the three big dairy risk management programs available: Dairy Revenue Protection, Livestock Gross Margin-Dairy and Dairy Margin Coverage.
Dairy Margin Coverage, available through Farm Service Agency, is the most widely used program. In fact, Forrett said, 70% of all Northeast operations are currently enrolled in this plan, which protects the margin between the all-milk price and the average feed price.
The main drawback is that coverage choices are made annually, compared to DRP and LGM-Dairy, which are more flexible and let producers look at how the market is responding.
“But with options that you have and the affordable cost, this should be an important part of your dairy risk management plan,” Forrett said, adding that farms enrolled in DMC can also participate in DRP and LGM-Dairy.
Under DMC, the main benefits are that payments are made and determined on a monthly basis, and premiums for the first 5 million pounds of milk (Tier I) are relatively affordable. The coverage levels range from $4 to $9.50 per cwt in 50-cent increments.
DRP and LGM-Dairy are both available through crop insurance agents. DRP, first introduced in 2018, continues to grow in usage with more than 30% of U.S. milk production enrolled. “In the Northeast, we have just about 4 billion pounds of milk enrolled providing $700 million worth of market protection,” Forrett said.
The program protects against unexpected declines in quarterly revenue from price or production.
“You can lock in a price well into the future at 95% coverage level,” Forrett said. “Between 98% and 99% of milk enrolled is at the 95% coverage level.”
One of the program’s main benefits is that it provides protection for up to five nearby quarters. “If the market looks good, you can get coverage up to the third quarter of 2022,” he said. “That can bring you a lot of peace of mind.”
Premium support up to 55% also makes this program affordable.
Crop Growers LLP recently unveiled a new mobile app for DRP that lets producers perform “what-if” scenarios for making the best possible enrollment decisions.
LGM-Dairy, first introduced in 2008, is an all-encompassing plan that provides protection when feed prices rise or milk prices drop. This could be particularly attractive now when looking into the second half of this year and next year because of the high feed costs.
Until recently, enrollment could be taken at the end of each month. Under a new rule, producers may enroll weekly for the 2022 crop year, which began July 1.
Coverage ranges from zero to $2 per cwt in 10-cent increments.
The program provides protection for a rolling 11-month period and is affordable with premium support up to 50%.
Do your homework
Before deciding on coverage of any type, producers should determine their net cost of production with assistance from an agent, Forrett said.
“Having that deep understanding of dairy financials can help develop the most sound risk management plan personalized to your business,” he said. “We’ve got the means to put you in the best position for maximizing profit while reducing business risk.”
Post writes from eastern New York.