The dairy market has experienced a historic level of volatility over the past two months. Cheese prices dropped to around $1 before rising all the way to a historic $2.89 price just a few weeks later.
As it would, the Class III price followed. Throughout the month of June, farmers welcomed a milk price rally that brought June Class III up to $22. However, it is important to not count your eggs before they hatch. Mary Ledman, global dairy strategist with Rabobank, warns farmers that extreme volatility has consequences.
“With this type of volatility, there are going to be repercussions,” she said on a Dairy Girl Network webinar. “I just want to give you guys the heads up that we’re looking at a horrific negative PPD.”
Ledman estimates Producer Price Differential (PPD) across the country will average -$5, an amount Ryan Yonkman, a farmer and vice president of producer services at Rice Dairy, says is very possible.
“I wouldn't think twice about that number,” he says.
The simplest way to explain the PPD calculation, which Yonkman reminds producers has been part of our system forever, is the Class III milk price minus the total blend price. Keep in mind the blend price includes Class I, II, III, and Class IV.
“So if you get an average price in your order, based upon a Class I market that's closer to $14.50, by the time we add the Class I differential to it the average price in the market ends up being something like $16 but the Class III price may be $21, you're looking at a $5 negative PPD,” Ledman explains.
PPDs are the most extreme to the negative side when the market makes extreme moves and the spread between Class III and Class IV widens.
“We’ve just experienced both of those,” Yonkman says. “Right now, you've got a historic III/IV spread June and July, Class III is trading anywhere from $6 to $8 higher than Class IV.”
He expects a largely negative PPD to be part of the conversation for the next several months.
How can you manage it?
The PPD is something that is 100% out of a producer’s control, but what you can do is plan ahead for it.
“We know June is going to be a terrible PPD and July is going to be a terrible PPD, because you're going to have July Class III somewhere around the $20 to $22 expiration, and you've got Class IV stuck at $14.50,” he explains. “I know that for the next two milk checks, for a fact, the PDDs are going to be ridiculous. The biggest thing you can do is to brace yourself for it and don't over anticipate your milk check.”
While most hedges for this timeframe have been in place for around 6 months, there are some things you can keep in mind from a hedging perspective.
“You’ve got to be really careful about, say for example, selling July futures at $22 Class III, because in your head you think that's a mailbox price of $24, because you're using normal basis,” he says. “Know that that calculation is not right. Very likely for a lot of states $20 to $22 Class III is going to transfer to a $16 to $18 milk check.”
He says it might be a reason to be less aggressive and to take a more conservative approach during this time.
“Where you get chopped is when you decide to sell milk at $22 and then it goes to $24 and your milk check doesn't move that same $2, that's where some guys can have some nasty cash flow crunches,” he explains. “They lose on their hedge and then their milk check didn’t follow.”