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Price volatility changes financing, business plans

Published on January 14, 2011 3:01AM

Last changed on February 11, 2011 10:39AM

Banking experts advise dairymen to prepare new business practices


Capital Press

Declining milk prices and rising feed costs have created a difficult, higher-risk environment for dairy producers.

"This combination is putting a lot of pressure on dairy farmers -- especially those who have chosen to leverage themselves extensively," said Ken McCorkle, head of Wells Fargo Agriculture Industries Department. "These conditions require operators to be better risk managers and to be better capitalized."

That means change, both in how producers do business and how lenders do business.

"Price and margin volatility will increase due to increased globalization and government policy. The business of financing agriculture needs to change to deal with this increased price and margin volatility," Wells Fargo ag economist Michael Swanson said in his 2010 year-end report.

"The volatility of milk prices and grain costs and their recent de-linkage, as a result of the federal ethanol mandate, have heightened the industry's risk profile and created great challenges for those farmers who have not responded by adjusting their business model," McCorkle said.

The government's decision to promote the use of corn for ethanol "effectively ties feed costs to energy markets, uncoupling them from their historical price driver: livestock," Swanson said.

The more widespread application of sexed semen technology is shortening the profitable phase and may be extending the less-profitable phase of the dairy cycle, McCorkle said.

"The dairy industry's fundamentals have changed dramatically over the past decade, and we've tried to help our customers understand this change and its implications," he said.

"This higher-risk profile should have prompted operators to evaluate whether they are adequately capitalized and to look at ways in which they operate their business during both favorable and unfavorable phases of the dairy cycle," he said.

The use of risk-management tools such as forward contracting or hedging grain and milk prices may be appropriate for some operators.

"Many operators should consider transitioning from the 'speculator' to 'margin manager' model," he said.

In 2007, dairy producers' profits ranged between $8 and $5 per hundredweight. In 2009, producers lost as much as $3 per hundredweight, Swanson said.

At the same time, asset values declined due to poor profitability. Dairy cow prices, which had averaged about $2,000 per head the last half of 2007 and all of 2008 fell to $1,240 by the fall of 2009. Facility values also declined from nearly $4,000 per cow in 2007 to $2,500 per cow.

Both factors lowered the borrowing base just as the operations needed additional liquidity, he said.

Challenges continued in 2010, and the first half of 2011 is not looking favorable, McCorkle said.

"Grain prices are up sharply, grain demand from ethanol plants is robust, oil prices are rising, and milk production continues to increase," he said.


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