One word to describe the dairy economy of the last few years is volatile. Every producer was reminded that this year’s mailbox prices were a stark difference from the record-high prices that 2022 delivered. One big reason that producers have managed through the rollercoaster prices over the last few years is that they have learned to balance the profit equation by utilizing risk management practices.
Dairy Margin Coverage
Indeed, protecting both sides of the dairy margin can strengthen a dairy for uncertain economic times. Katie Burgess, director of risk management with Ever.Ag, encourages producers to continue to sign up for USDA’s Dairy Margin Coverage (DMC) program.
“It has a strong track record of generating producer payouts when margins get squeezed,” she says.
DMC allows producers to select a margin between the milk price and average feed cost to determine at which level they receive assistance.
Sarina Sharp, an analyst with the Daily Dairy Report, says that the dairy safety net has helped to sop up some—but not all—of the losses on dairy farm balance sheets.
With that being said, January through June DMC payments totaled nearly $610.6 million, averaging $35,925 per dairy operation enrolled in 2023 (minus the 5.7% sequestration deduction).
Dairy Revenue Protection
In addition to DMC, Burgess also encourages producers to look for opportunities to purchase Dairy Revenue Protection (DRP) insurance. She shares that DRP remains popular, as it covers nearly a quarter of the total U.S. milk supply.
DRP is sold by crop insurance agents, letting producers insure a chosen income amount needed to cover expenses. The quarters available for coverage correspond to the quarters of the calendar year, i.e., January to March, October to December. Under DRP, an indemnity is paid to a dairy farmer if an operation’s milk revenue falls below the final revenue guarantee. The final revenue guarantee is the product of the farmer’s chosen coverage level, from 80% to 95% in 5% increments, based on future values.
“DRP allows producers to set a milk price floor – and if the market falls below that level, a payout may be triggered,” Burgess says, reminding producers that DRP is insurance and that in an ideal world, if milk prices move higher, no insurance claims are made. “However, 2023 was an important reminder that milk prices can fall way further than ever expected, so having some insurance to prevent disaster is vital.”
Burgess also reveals that while she believes that milk prices will fare better in the year ahead, nothing is for certain and securing risk management coverage is advised.
Back to the Basics
Regardless of what milk prices are, Robin Schmahl, a dairy analyst at AgMarket.com, says producers must first know their cost of production before trying to obtain a margin. He says producers should talk to their nutritionists to help them put a true value on their home-grown forages.
“We need to start somewhere and getting an approximate value for your feed can help you figure your cost of production out, so you can figure out what margin you are trying to achieve,” he says, encouraging producers to look six months out.
Schmahl urges producers to go back to the basics, as so many articles and information on social media confuse producers to think clearly.
“It all can seem too complex,” he says. “Just start by doing simple math. Work with your outside team who can help you with this, if needed.”
The Other Side of the Equation
Burgess reminds producers not to forget about the cattle income side of the equation.
“Whether you are selling day-old bull calves or raising beef-on-dairy crosses to be sold as feeders or fat cattle, check out USDA’s Livestock Risk Protection (LRP) insurance,” she says. “Cattle futures posted new record highs in 2023 – but, what goes up usually comes back down. Elevated cattle prices have helped buoy dairy producer incomes this year, so locking in some high price floors while they are available may be a prudent move.”
Gary Sipiorski, an independent financial consultant says that the cost of producing 100 lbs. of milk has increased considerably over the last few years and in 2023 it was around $20 per cwt. and as high as $23 per cwt. in some cases.
“$19 may be the new target,” he says, sharing that producer’s depreciation should be the ‘functional depreciation’ not what is on the taxes that the IRS allows. For example, 10% on the value of machinery plus 5% of the buildings value. Using accelerated tax depreciation or any depreciation from the tax return will give a false COP.
“The very best way to calculate COP is using an accurate accrual adjusted income statement,” he says. “More important than a target would be to achieve a $2 margin over COP.”
Sipiorski shares that feed costs are the largest cost to a producer’s pocketbook, although he is optimistic that feed costs might be lower in the coming year.
“It may take a year or two to see if costs normalize once again,” he says. “Cost volatility makes for a difficult call on COP. It is now more important than ever for each producer to correctly calculate, monitor, and understand their COP.”
Sipiorski reiterates that the top 30% of dairy producers in the U.S. earn $1.25 per cwt. more versus the average producer.
“That $1.25 can add up to a significant amount over time,” he says, also emphasizing that more lenders are asking producers to share what their risk management plans are.
While 2024 mailbox prices are forecasted to be more promising than the lackluster prices that 2023 delivered, we do live in a volatile market. And, with a continued fickle dairy economy, all leading experts strongly urge producers to dive into risk management options to not only help them balance their dairy’s financial equation but also help them add longevity to their dairy operation.
