For many years we have said that it was important to consider feed costs as part of dairy farm risk management planning. That is, locking in milk price without having a handle on feed price, could result in being squeezed if feed prices unexpectedly increase. The volatility of the past 4 or so years makes this even more important.
Consider Figure 1 which displays the margin between milk price and feed price using US all-milk price as well as Chicago Board of Trade (CBOT) corn and soybean meal monthly average price and NASS average alfalfa hay price. The feed quantities are those used by National Milk Producer’s Federation in their margin protection plan. Over the almost 11-year period, the margin averaged $7.66/cwt. There was a great deal of volatility in the value which peaked at $13.77/cwt and had a minimum of $1.26/cwt. There were only 9 months that were below $4/cwt, but all of them occurred in 2008 and 2009.
We are again in a feed price situation similar to 2007 and 2008 with corn currently near $7/bu for July 2011 on the CBOT. Carryover stocks of grains are tight, cash land rents have increased, and many important planting decisions will be made in the next couple of months.
A number of tools are available to dairy farmers that might make sense to consider in managing milk and feed prices. These include forward contracts through dairy cooperatives and futures and options for milk. Similarly feed prices often can be locked in using these same set of tools.
Another possibility is the dairy-livestock gross margin (dairy-LGM) insurance which is essentially a set of bundled options that can lock in a margin. Dairy-LGM is available on the last Friday of each month. It uses the Class III milk as well as corn and soybean meal futures and options price data to calculate the implied distribution of the margin between milk and feed prices. Farmers select quantities of corn and soybean meal within certain boundaries. Farmers also select the deductible with a government premium subsidy.
If you are locking in both milk and feed prices, consider that there are still risks involved—even if all of the milk production and feed use is covered (which would not normally be the preferred quantities). The risk for milk basis, the difference between the Class III futures price and your mailbox milk price, would not be covered.
Since the mailbox milk price includes the pool value (e.g., Class I price times Class I utilization), as well as over-order and quality premiums, we expect the basis to be positive. In Michigan, the average basis over the past 10 years has been about $1.05/cwt with a considerable range above or below the average for monthly basis values.
Thus, when using milk risk management tools related to Class III price, farmers still have basis risk. Similarly, basis risk exists for corn and soybean meal where we expect negative basis.
Finally, the margin between milk and feed price is what is left to pay for all other expenses including unpaid management, labor and capital. Table 1 displays the top 10 dairy-related farm cash expenses from 2005-2009.
Note that a couple of the expenses are almost certainly used for field crops on many farms (i.e., fuel and custom hire) but the primary enterprise on these farms was dairy so much of these crops were fed. The largest cash expense was for purchased feed. The value of home-grown feed (not displayed in the table) averaged $5.32/cwt of milk produced for 2005-2009. Many of the other cash expenses beyond feed are generally not too volatile. The exception is likely energy costs in the form of fuel (5th) and utilities (9th). Another increasingly important expense has been interest which might reflect the need for operating loans to alleviate cash flow considerations.
Source: Christopher Wolf, Dept. of Agricultural, Food & Resource Economics, Michigan State University