Each year, I see the level of sophistication within the dairy industry increase as producers learn to take advantage of new resources to help them manage their businesses.
For example, taking advantage of new financial tools helps them add stability and confidence to budget projections. And while they have used market tools to stabilize their feed cost — their largest expense item — most have not used those same tools to help minimize their milk-price risk.
The volatility of milk price continues to be a big concern for dairy producers and lenders alike. For example, during the past 10 years, the USDA-announced Class III milk price has ranged from a high of $21.70 per hundredweight to a low of $8.50. It’s difficult to achieve goals — both long- and short-term — when you sell your milk at whatever price the market will give you. Instead, producers need to learn to use risk-management tools to set their own milk price.
Managing exposure to volatile milk prices enables you to:
Stabilize cash flows and reduce earnings volatility.
Protect revenue streams.
Achieve budget targets.
Increase credit rating and reduce borrowing costs.
Reduce working-capital requirements.
How it works
Before implementing a risk-management strategy, ask yourself some key questions:
How much risk exposure can I stand?
What is the best strategy for me to manage risk?
Should I set a fixed price (also called a swap)?
Should I assure a price range? This technique is called a “collar,” and producers can use it to set a minimum and maximum price range without having to pay a premium to do so.
Should I guarantee a minimum price floor? Setting a price floor is like buying insurance with the premium paid up front for the life of the protection.
When milk prices look strong, producers are reluctant to hedge or lock in prices for fear of missing the peak. But if you know your cost of production for a hundredweight of milk — and every producer should — you can use these tools to guarantee a fair return on your investment.
Of course, some risk exists when you use risk-management tools. But using these tools will help you guarantee a set price for the milk you sell.
Producers can select from several different market tools — options, futures contracts and forward contracts — to develop a risk-management strategy that fits their needs. Many financial institutions, brokerage houses and milk processors provide risk-management products, and they also can provide you with insight and training on how to put these risk-management tools to work in the area you live.
Dairy producers have done a remarkable job on the production side —maximizing feed utilization to gain milk production, taking advantage of economies of size to lower their cost of production, and investing in continuous genetic improvement. And now, producers need to take the next logical step — setting their own milk price.
Take advantage of the many opportunities that abound today and learn how to use risk-management tools to reduce your price volatility. You will sleep better at night.
Anthony DeRose is an executive vice president of Wells Fargo Bank in Visalia, Calif.