Dairy Experts Underscore the Importance of Utilizing Risk Management Tools on Your Dairy
January 14, 2022
Milk production has always been a risky business, even before COVID-19 hit. Bad weather can negatively impact forage and crops, cows can get sick and breakdowns generally come at the least opportune time. Factor in a volatile milk market and it makes it difficult for farmers to get by, let alone plan for the future.
Dairy leaders highly recommend the importance of utilizing risk management tools for your dairy farm, like milk futures or Dairy Revenue Protection (DRP).
Ryan Yonkman, vice president with ever.ag, says that with current market conditions profitable margins for dairy is forecasted through all of 2022.
“In a year like this, where we are already testing extreme prices in milk and feed and other inputs, managing all ends is important in order to obtain a clean hedge or even secure a margin,” Yonkman states.
Where do farms go from here? According to Yonkman, in this market where the world is short of milk, it makes sense to keep as much upside as possible.
“The best avenue through which to achieve this is through the put option type strategies available both through insurance (DRP/LGM) and the CME,” he says. “Such strategies establish floor prices that may secure a lower margin than current future prices present but do so while maintaining upside openness and the ability to participate in even greater margins.”
Independent agriculture business financial consultant Gary Sipiorski says that approximately only 10% of dairy producers purchase milk futures but believes that risk management discussions should be happening on every single farm.
“The top 30% of dairy producers in the U.S. earn $1.25/cwt. more compared to the average producer. This is a good time to get your financials together and sit down and talk about risk management,” he states.
The first thing that producers should be doing, according to Sipiorski, is taking a hard look at their cost of production, especially with the rising expenses and inflation.
“Review cash flow productions based on the last three years of expenses and work to project what expenses in 2022 will be,” he says. “This requires time and producers need to be talking to outside team members and their suppliers.”
Sipiorski underscores the importance of drilling down expenses and encourages farmers to look at where they can save money. “Sometimes we get lax about costs when milk prices are strong,” he says.
Brian Vaassen, Midwest Regional business manager with Standard Dairy Consultants, concurs with Sipiorski and advises his dairy clients to know their cost of production when looking to control margins and notes that it’s not a ‘one program fits all’ type of approach.
“Some producers want to know their costs and try to book some feed here and there. While others are more aggressive and will book commodities longer term because they also know the historical price they paid,” Vaassen shares. “Some producers book feed and do short term puts on milk and others go in and work with a broker and manage the margins they want to target. It all depends on the risk tolerance dairy producers and their bankers feel comfortable with.”
Milk Check is King
Sipiorski notes that the milk check equates to 90-95% of the farm income. “What can you do with that,” he asks?
Increasing revenue from milk needs to be explored and Sipiorski encourages producers to work on increasing components, as a good way to add income even if the pounds of milk do not grow. “This approach takes time, however, it is worth it, while working it into the overall plan,” he says.
He also states that the conversation between an individual dairy farm and their broker is essential to determine what makes sense for them.
“Nobody can make that decision except the producer,” he shares. “Producers sign the bottom line and it's important they have gained enough information to make that decision.”
Yonkman says that in his opinion, hedging a margin is great and by all means the goal, however, he cautions the volatility of milk.
“At certain times in history, extreme prices can become more easily achieved,” he states. “Under those conditions, I personally am very cognizant to make sure we are growing upside opportunities so as to counter periods like the last five years which have been more of an equity burn. Most of us can’t afford to miss the boom year and perhaps this is that year,” he says.
Sipiorski underscores the fact that risk management programs are made to help create stability and lock in a return and encourages producers to take a hard look at both DRP and milk futures and begin those conversations with outside team members today.
Dairy Revenue Protection
Dairy Revenue Protection is designed to insure against unexpected declines in the quarterly revenue from milk sales relative to a guaranteed coverage level. The expected revenue is based on futures prices for milk and dairy commodities, and the amount of covered milk production elected by the dairy producer. The covered milk production is indexed to the state or region where the dairy producer is located. Government-subsidized DRP policies can be set up through private agents, much like regular crop insurance.
There are five key decisions that need to be made when purchasing a DRP endorsement with the maximum 95% coverage, with premiums subsidized at 44%.
Quarter – Endorsements are only available for entire quarters of the calendar year (e.g. January through March as Quarter 1). At any one time, sales are open for as many as five future quarters. Sales close 15 days before the beginning of the quarter. Distant quarters don’t open for sale until there is adequate market activity.
Price category – The choices are Class III milk, Class IV milk, or a selected butterfat and protein combination. The only obligation is that 85% of the covered milk volume or 90% of the components be delivered in order to receive full payments.
Quantity – Any volume can be selected for an endorsement, with no limit to the number of endorsements within a particular quarter.
Protection factor – This is a factor built into the program for the purpose of increasing coverage on a specific volume of milk up to 1.5 times the covered volume. A higher protection factor level will increase coverage (and the premium) at the same milk volume.
Date – The market changes daily. Endorsements must be purchased between the market closing and the next opening, meaning the time window on the East Coast is typically between 4 p.m. and 10 a.m. the following morning.
DRP must be purchased through an authorized crop insurance agent. You can fill out an application at any time. A list of crop insurance agents is available at: rma.usda.gov/
Guidelines to Consider When Contracting Milk Future
Knowing your budget is essential and it’s recommended to construct monthly or quarterly budgets for planning purposes.
Penn State Extension offers the following guidelines to be considered in developing a personal marketing strategy for using milk futures:
Don’t lock it all in. Set a minimum and maximum volume of milk to contract each month. If you are new to contracting or have low debt levels, consider less than 50% of monthly production. If you are more experienced and have a higher level of debt, consider a maximum volume of 60-80%.
Don’t concentrate on near-term or far-off contract months. Given lags in the pricing system, worrying much about contracting next month’s milk production does not make sense. Also, contracts nine months out and beyond are very uncertain. There aren’t many contracts traded for those outer months, so don’t concentrate on those either.
Lock in more contracts as prices rise. You may decide to contract 30% of your future milk production today. If contract prices rises for that month in the days ahead, then contract an additional 20-30%. This method will allow you to average into a strong price. While you are doing that, don't forget about contracts that are four to eight months out. Those contract months typically do the best in making positive returns when short-term cash markets are rising because strong cash markets today have a positive effect on all contract months.
Minimize your dairy’s risk and take advantage of the potential dairy boom in 2022 to help drive your dairy for success. Begin those much-needed risk management conversations today.