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What to make of this irrational world?

Geoff Vanden Heuvel

Director of Regulatory and Economic Affairs

2020 has been crazy for everybody, but for dairy farmers who have the responsibility to feed, milk and care for their animals every day regardless of the economics of selling milk, it has been particularly stressful. At the early stage of the pandemic, prices for dairy commodities tanked. The population obtains its food, including dairy products, essentially through two distinct channels. The food service/institutional channel and the grocery channel. Overnight, the food service/institutional channel shut down and everyone lined up at the grocery channel.

The industry scrambled to make adjustments and chaos reigned. But amazingly and not uncharacteristically for Americans, adjustments were made. In addition, Congress voted unanimously to borrow $2.2 trillion to fund a rescue package for the American economy. This included direct payments to many, including dairy farmers, along with a myriad of other programs designed to address the impact of the pandemic. Major purchases of food, including dairy products, were initiated by USDA and these purchases have had a profound impact particularly on the price of cheese.

CME block cash cheese prices bottomed out at $1 per pound on April 15 and stayed at these levels for a couple of weeks. At that point we did not know what the future held, but things looked bleak. Then, starting about the middle of May, the cheese price began to soar upward, hitting $3 per pound on July 13 before starting back down again. It dropped all the way down to $1.58 on August 11 before starting to climb again in September. It passed $2 on September 3 and continues to climb hitting $2.72 today. All this incredible market strength for cheese is great for dairy farmers on the one hand because a rising tide lifts all boats, but unlike the tide, the strength of the cheese market does not evenly translate to higher milk prices across the board.

Butter prices, which also play a dominate role in determining milk prices, are languishing. For most of the past 6 years butter prices have been in excess of $2 per pound. But with the pandemic, butter prices bottomed out at $1.10 per pound on April 23. They briefly strengthened to $2 in June but have since fallen back down into the $1.40s, edging up to $1.51 today. Nonfat Dry Milk, which was in the high $1.20s in January, bottomed out in April at $0.80 per pound and has just recently gone back up over $1 per pound. These gyrations in the prices of the commodity dairy products that form the building blocks of the formulas that set U.S. milk prices have been difficult to understand and impossible to control. Finally, the government writing substantial checks directly to producers is unprecedented, and while welcomed and needed, is certainly not something that can be depended on in the future.

So, where are we? For dairy farmers selling their milk to predominately cheese manufacturers, 2020 may turn out to be one of the best years ever. For dairy farmers selling their milk to other uses, including Class I, the picture is not near so rosy. Another troubling trend is that corn and soybeans, which looked to be possibly in surplus and therefore relatively inexpensive, have been moving up in price significantly over the past few weeks and are now indicating that feed costs may be higher than expected as we move into 2021.

Looking ahead there are a couple of basic things producers need to seriously consider. The Dairy Margin Coverage (DMC) program is USDA’s safety net program for dairy. This program uses the monthly U.S. All Milk Price as an index and subtracts from that price a feed cost based on corn, soybeans and alfalfa hay to produce an Income over Feed Cost Margin. For $0.15 per cwt., you can buy coverage that will pay you the difference between that actual Income over Feed Cost and $9.50 per cwt. Below are the DMC prices and margins for 2020.

This program is worth doing, but since the opportunity to obtain margin coverage at the $9.50 level only pertains to the first 5 million pounds of annual production (about 200 cows), it is probably not the only thing you should consider when thinking about managing risk in 2021. Sign-ups for the DMC happen with your Farm Service Agency and started this week. You have until December 11 to sign-up. The other opportunity to manage milk price risk is the Dairy Revenue Protection (DRP) crop insurance program. This program allows producers to lock-in floor prices for Class III and Class IV milk based on futures prices for those classes of milk. It is an insurance plan, where in exchange for a premium, a certain amount of revenue, based on futures prices, can be secured. The government’s role in the DRP is to provide subsidies for the premiums and to finance the program so that the farmer portion of the premium is not due until after the insured time period has passed. This program has been around since late 2018 and did provide significant indemnities for many producers who had purchased coverage for Q2 of 2020.

Of course, the thing about insurance is that you never know when you will need it. And you cannot buy it after the fact. Another important consideration is that it matters where you sell your milk. If you are going to use the DRP as a risk management tool to protect your milk check, then you need to design your coverage levels to match what your milk is used for. This does get a little bit complicated and my experience is that everyone looks at it a bit differently. DRP is now widely available in California. In fact, according to industry sources, about one-third of the U.S. milk supply was covered by DRP in 2020 and already more than 15% of 2021 production has some coverage in place. DRP is sold through a licensed crop insurance agent. I happen to be licensed to sell it and have been able to help many producers navigate the program and put DRP coverage in place.

The bottom line is that while 2020 has been a crazy year, the picture for 2021 remains very murky as well. There is a lot of milk around. There is a very real threat of a national and worldwide recession if we are not already in one. There is an election in a few weeks and the pressure to throw billions of dollars at voters particularly in rural swing states will likely diminish. We have witnessed massive swings in dairy commodity prices occur virtually overnight. There are a couple of tools available to producers to help put a bit of a stop loss on the economics of your operation. Now is the time to seriously consider putting something in place.

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