Posted: Thursday, September 27, 2012 12:00 PM
Carol Ryan Dumas/Capital Press
Brian Gould, left, ag economics professor at the university of Wisconsin, talks with Rick Norell, University of Idaho dairy extension specialist, during a break in Gould's workshop on federal dairy insurance in Burley, Idaho, last week.
Expert warns 'marketing milk is not simple anymore'
Dairy producers seeking to manage the margin volatility of income over feed costs can use several risk-management strategies, such as forward contracting their milk and feed and buying puts and calls.
They can put a floor on their milk price and a ceiling on their feed costs, but they need to understand the opportunities and advantages available, as well as the costs to protect that margin, said Brian Gould, professor of agriculture and applied economics at the University of Wisconsin.
"Marketing milk is not simple anymore. You have to think of marketing milk as an input, and it has costs," Gould said.
The direct costs for risk management come in the form of broker fees, options premiums and insurance premiums. Those costs are part of doing business in today's volatile milk and feed markets, he told those attending a workshop on a federal dairy insurance program on Sept. 19 in Burley.
Producers might want to consider the Livestock Gross Margin for Dairy Cattle Insurance Program, LGM-Dairy, offered through USDA's Risk Management Agency. Gould said the subsidized program could give producers some of the same margin protections at a lower cost and it is easily customized to a dairy's size, the desired amount of milk marketings in any given month and the desired months of coverage. It is also gives the producer options as to his declared feed use, deductible and premiums.
Gould said contracts can cover up to 10 months of production, and producers can sign up for the program on the last business Friday of any month. Premiums are subsidized at varying levels and aren't due until the end of the contract, with premiums being netted out of any indemnity payment.
Producers can insure up to 240,000 hundredweight of milk per year and choose a deductible between zero and $2 per hundredweight of milk in 10 cent increments.
The plan uses the futures markets for Class III milk and feed to determine an expected (and guaranteed) gross margin and the actual gross margin, with a paid indemnity if the actual margin is less than the guaranteed margin.
While determining all the variables may seem complicated, a wealth of help, information, calculators, analyzers, and forms are provided on the University of Wisconsin's website, he said.
Advanced planning is key because there is only a 27-hour window to purchase contracts each month. Producers need to interact with their insurance agent and work out all the variables ahead of time, he said.
But Gould said producers should consider a few points.
Premiums go up as deductibles decrease and also increase with higher protected milk marketings.
With grain markets so volatile, a producer will decrease his margins if he declares his entire feed use and should only cover the market risk of feed he has to purchase.
The more risky the asset covered, the higher the premium. So a producer declaring less feed use would actually be insuring a higher margin at a lower price of coverage.
Producers' milk price is likely more than the CME Class III price, because it may go to higher paying markets such as fluid milk and even Class III has bonuses for components. LGM insurance only values the covered milk at Class II prices. To construct a contract that covers the margin they want for their milk on their farm, producers need to know the difference between what they are really paid and the CME Class III price.
Producers also need to know their actual income over feed costs so they can determine a level of margin they want to protect.
Software is available on the university's website to help producers compare the tradeoffs with various deductibles and covered marketings.
The LGM-Dairy analyzer is an integrated software system that will help producers find the least-cost contract and the cheapest way to protect their target margin, Gould said
"You can get a significant amount of protection for all your milk without insuring all of it," he said.
Producers will need up to 40 pieces of information, but they only have to input it once and save it to an Excel file for future use and review, he said.
While the program offers benefits, it also has limitations in the milk production cap and the current limited amount of funding and available contracts, he added.