Download NRCS Pastureland Ecology - Agricultural and Resource Economics

THE NEW DAIRY MARGIN
PROTECTION PROGRAM
GEOFF BENSON
PROFESSOR EMERITUS
DEPT. OF AGRICULTURAL & RESOURCE ECONOMICS
NORTH CAROLINA STATE UNIVERSITY
GEOFF BENSON, ARE, NCSU
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Historical Examples of Payment Thresholds
National Margin by Two-Month Averages, Jan/Feb 2000 to May/Jun 2014
$16.00
$14.00
$12.00
$10.00
$8.00
$6.00
$4.00
$2.00
$-
9 September 2014
The National Program on Dairy Markets and Policy
2
If We Picked the Optimal Strategy
Year
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Optimal Strategy
$4.00
$8.00
$4.00
$4.00
$8.00
$4.00
$4.00
$8.00
$8.00
$4.00
Optimal Outcome
-$100
$1,673
-$100
-$100
$106,715
-$100
-$100
$78,885
$35,687
-$100
Total
per cow
per cwt
$224,137
$128.08
$0.56
175 cow herd & 23,000 lb/cow = 4 million lb. prod. history
Topics
 Pros and cons of the Decision Tool
 Potential impact on production and
prices
 Overview of milk price and feed cost
risk
 Deciding how to use MPP-Dairy to
protect your business
GEOFF BENSON, ARE, NCSU
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Acknowledgements
 USDA
 The National Program on Dairy
Markets and Policy
 NC Farm Bureau Federation
GEOFF BENSON, ARE, NCSU
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Who is the National Program on Dairy
Markets and Policy
A voluntary association of Land Grant agricultural economists who
share an interest in the economics of dairy markets and policy and
who are committed to provide educational and research materials to
assist policy-makers and dairy industry decision-makers.
Marin Bozic
University of Minnesota
Brian Gould
University of Wisconsin
John Newton
University of Illinois
Charles Nicholson
The Pennsylvania State University
9 September 2014
Andrew Novakovic
Cornell University
Mark Stephenson
University of Wisconsin
Cameron Thraen
The Ohio State University
Christopher Wolf
Michigan State University
The National Program on Dairy Markets and Policy
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1. The Decision Tool
1.The tool is based on futures market prices for corn
and soybean meal, updated daily
2. Futures markets have proved to be the most reliable
guide to future prices
3. However, futures markets are not infallible and
cannot foresee unexpected events that affect dairy
markets like abnormal weather, financial crises and
political turmoil
4.The tool uses historic data on futures prices and
actual prices to give a range of predictions to provide
you with the best estimate of what the future holds
GEOFF BENSON, ARE, NCSU
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3 Characteristics of a Forecast
• It will be wrong (there will be some error)
– So a range of values with likelihood is useful
• It will be less accurate farther into the future
(longer time horizon)
• Multiple methods (forecasts) can be useful to
give a range
– Analyzing market fundamentals (supply and
demand)
– And are usually more accurate
Open Interest: All Dairy Futures And
Options
180,000
160,000
Contracts
140,000
120,000
100,000
80,000
60,000
40,000
20,000
0
1996
2000
2004
2008
2012
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An Example using the MPP Tool
2. Market Impacts
 Economic research tells us that
reducing risk also reduces profit
margins
 Key Question: If dairy producers can
use MPP to reduce financial risks
are those producers likely to
produce more milk?
 More milk = lower average prices
GEOFF BENSON, ARE, NCSU
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A Complication: MPP Is Likely to
Decrease Margins
• The MPP works in a way that will lower
margins if the program is active
– It will slow the adjustment of milk production
during low price/margin periods
– Risk reduction enhances supply
• This could complicate the development and
use of margin forecasts
A Complication: MPP Is Likely to
Decrease Margins
• Average Margins are likely to be lower with
MPP-Dairy in effect
• How much lower depends on producer
participation
– Limited participation = limited impacts
– Widespread participation = larger impacts
Impacts of MPP Participation Levels
on the MPP Margin
MPP participation decisions will affect the MPP Margin
Implications
 Futures markets should take account of
participation rates, estimated and known
 Forecasted MPP margins should account
for the participation decisions of farmers
 Expected participation decisions of
producers collectively could (should)
influence the decisions of an individual
producer
3. Milk and Feed Cost Risk
 Milk prices are volatile and the milk check
accounts for most of the farm income,
typically around 85%
 Purchased feed costs are volatile and are
the single largest expense, typically 3035% of income
 Extended periods of low milk prices and/or
high feed costs can put a dairy farm out of
business
GEOFF BENSON, ARE, NCSU
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Price Volatility, 1980-2013
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4. The Decision about Participating
 Things to consider:
Your farms financial health
How much extra cash do you need during
periods of low IOFC margins?
How does your IOFC margin compare to the
MPP margin?
Choice of MPP margin and production
history coverage
Margin risk management alternatives to MPP
GEOFF BENSON, ARE, NCSU
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The “Big Three”
CASH
FLOW
SOLVENCY
BUSINESS
HEALTH
PROFIT
GEOFF BENSON, ARE, NCSU
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Business Performance
 Income and expense, investing and debt,
and cash flow activities are inter-related
 If a farm is financially healthy
 Cash is available to meet financial obligations on
time
 Asset values are increasing, debt load is falling,
net worth is increasing
 The business is profitable as measured by return
on assets and returns to management
GEOFF BENSON, ARE, NCSU
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Financial Health
In times of financial stress, cash
flow and solvency are critical
aspects to focus on
Longer term, profitability is more
important
GEOFF BENSON, ARE, NCSU
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Family farm cash flows
FARM
RECEIPTS
FARM
EXPENSES
ASSET
SALES
ASSET
PURCHASES
NEW
LOANS
NONFARM
INCOME
FARM
CASH
POOL
PRINCIPAL
REPAID
FAMILY
LIVING
GEOFF BENSON, ARE, NCSU
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169 New York Dairies, 2012
Cash Item
$/Farm
Milk income
Total income
Purchased feed
Crop expense
Labor
Other
Total Oper. Exp.
Net Farm Income
3,059,578
3,545,769
1,127,735
189,932
420,353
1,087,987
2,826,007
719,762
Source: RB 2013-01, AEM, Cornell Univ.
Avg. Cows = 609
$/Cow
$/Cwt
5,023
5,822
1,852
312
690
1,787
4,639
1,183
19.77
22.92
7.29
1.23
2.72
7.03
18.26
4.66
GEOFF BENSON, ARE, NCSU
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169 New York Dairies, 2012, cont
Cash Item
$/Farm $/Cow $/Cwt
Total income
Total Oper. Exp.
Net Farm Income
Debt Payments
Family draw
For investing, other
3,545,769
2,826,007
719,762
321,156
202,943
195,663
Source: RB 2013-01, AEM, Cornell Univ.
Avg. Cows = 609
2,286
4,639
1,182
527
333
321
22.92
18.26
4.65
2.08
1.31
1.26
GEOFF BENSON, ARE, NCSU
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Key numbers: Liquidity
LIQUIDITY OR CASH FLOW measures tell you
how easily you can pay your bills:
 Working Capital =
Current Assets - Current Liabilities
e.g. $355,222 - $219,041 = $136,181
 Current Ratio =
Current Assets/Current Liabilities
e.g. $355,222/$219,041 = 1.6
 Focus on readily available financial assets
GEOFF BENSON, ARE, NCSU
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Cash Flow “Stretchers”
 We have been there before
 Draw on financial reserves, e.g., savings
 Postpone non-essential farm expenses
 Postpone investing in equipment, facilities, land
 Refinance or reschedule (extend) debt payments
 Sell non-essential farm assets, e.g., timber, lots,
spare equipment, livestock
 Family members seek added off-farm income
 Cut or delay family living expenditures
 Borrow more (if you will be able to pay it back)
GEOFF BENSON, ARE, NCSU
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Solvency:What Am I Worth?
 The Balance Sheet is a “Snapshot” of a farm’s
financial position at a point in time
 Shows value of assets (at market & cost),
liabilities and net worth/wealth of the owner(s)
 Measures Solvency 
 Ability to bear financial risk
 Collateral for new loans
 Prepare one on the same date each year for a
reliable trend analysis -- preferably the first day
of the fiscal year
GEOFF BENSON, ARE, NCSU
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169 New York Dairies, 2012
Investment
$/Farm
Current assets
Livestock
Equipment
Other intermed.
Land & Buildings
Total Assets
- Liabilities
= Net Worth/Equity
1,155,894
1,392,270
1,075,671
193,536
2,700,261
6,514,632
2,029,703
4,484,930
Source: RB 2013-01, AEM, Cornell Univ.
Avg. Cows = 609
$/Cow
1,898
2,286
1,766
318
4,434
10,697
3,332
7,364
%
18
21
17
3
41
100
31
69
GEOFF BENSON, ARE, NCSU
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Key numbers: Solvency
SOLVENCY compares your assets and
debts. It measures collateral available as
security for new loans or credit:
 Example:
Farm Assets at market value = $6,514,632
Farm Liabilities = $2,029,703
Equity (Assets – Liabilities) = $4,484,930
Debt/Asset ratio = 0.31:1
GEOFF BENSON, ARE, NCSU
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Aren’t There Other Financial Risk
Management Tools for Dairy Farmers?
• Absolutely!
• Public Tools: LGM-Dairy and now MPP-Dairy (pick one)
• Private Sector Tools (things a farmer can do on his own):
– Hedging milk (Class III & IV), corn, SBM
– Options: PUT milk to floor milk price, CALL to cap corn and SBM
prices
– Forward contracting feed
– Advance purchase of feed
• Collective Solutions (things farmers do with help):
– Forward pricing: cooperative or other buyer offers a fixed price
contract for a future period and uses futures markets to protect
their position.
9 September 2014
The National Program on Dairy Markets and Policy
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Choice of MPP Coverage
 No one-size fits all – different farms have
different IOFC margins, financial health
and riskiness
 Is your goal looking for profit or
managing risk
 No one MPP strategy fits all years
 The best strategy one year may not be the
best strategy another year
GEOFF BENSON, ARE, NCSU
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If We Picked One Risk Strategy
Year
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Advance Strategy
$6.50
$6.50
$6.50
$6.50
$6.50
$6.50
$6.50
$6.50
$6.50
$6.50
Advance Outcome
($3,340)
($3,340)
($3,340)
($3,340)
$75,574
($3,340)
($3,340)
$48,004
$14,930
($3,340)
Total
per cow
per cwt
$115,128
$65.79
$0.29
175 cow herd & 23,000 lb/cow = 4 million lb. prod. history
If We Picked the Optimal Strategy
Year
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Optimal Strategy
$4.00
$8.00
$4.00
$4.00
$8.00
$4.00
$4.00
$8.00
$8.00
$4.00
Optimal Outcome
-$100
$1,673
-$100
-$100
$106,715
-$100
-$100
$78,885
$35,687
-$100
Total
per cow
per cwt
$224,137
$128.08
$0.56
175 cow herd & 23,000 lb/cow = 4 million lb. prod. history
Risk Management Strategy
 Complications!
 In a margin squeeze you want to
ensure you have certain mount of
cash – a lump sum – to cover
necessary expenses
 The MPP program quotes margins
and premiums in per cwt terms
 Your IOFC margin will not be the
same as the national IOFC margin
GEOFF BENSON, ARE, NCSU
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Milk Income, Feed Cost and IOFC Margin,
Same 76 New York Dairy Farms, 2007-12
$25.00
$20.00
$15.50
$15.00
$15.39
$13.53
$12.84
$12.68
$10.00
$8.65
$5.00
$0.00
2007
2008
Milk Income/cwt
2009
2010
Purch. feed cost/cwt
Source: Cornell University DFBS, RB 2013-01
2011
2012
IOFC Margin/cwt
GEOFF BENSON, ARE, NCSU
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Risk Management Strategy
 Calculate the “normal” or required IOFC
margin you need as an annual lump sum
using, say, 5 years of data
 Look at variations in your yearly IOFC -2009 IOFC was approx. 60% lower than 2013
 From history and your financial risk
situation, estimate how much MPP
“insurance” you want to cover as an annual
lump sum
GEOFF BENSON, ARE, NCSU
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Risk Management Strategy
 Calculate the “normal” or required IOFC
margin as a per cwt figure from your
actual yearly milk sales figures
 Compare your IOFC margin history with
the national margin history – may be
over or under – calculate the difference
 Adjust your required lump sum
“insurance” amount to account for this
difference
GEOFF BENSON, ARE, NCSU
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Source: Joe Horner, U of MO
GEOFF BENSON, ARE, NCSU
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Comparing Margins
Year
MPP Margin
$/cwt
2008
8.55
2009
4.58
2010
8.25
2011
8.82
2012
5.32
2013
7.15
Your Margin1
$/cwt
Difference
$/cwt
1 Use actual cost of feed used, allowing for unpaid or prepaid feed
MPP data from Dr. Cam Thraen, Ohio St U
GEOFF BENSON, ARE, NCSU
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169 New York Dairies, 2012
Cash Item
Milk income
Total income
Purchased feed
Total$
Margin
$/Cwt Margin
3,059,578 3,059,578 19.77
3,545,769
-22.92
1,127,735 1,931,843 7.29
$19.77
-$12.48
Crop expense
189,932
1,741,911
1.23
$11.25
Labor
420,353
--
2.72
--
Other
1,037,987
7.03
Total Oper. Exp.
2,826,007
---
18.26
---
Net Farm Income
719,762
--
4.65
--
GEOFF BENSON, ARE, NCSU
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Picking your strategy
 Premiums change with coverage –
under 4 mil. lb. vs. over 4 mil. lb.
 Premiums change with the margin
selected
 2014-15 year premiums are
reduced
GEOFF BENSON, ARE, NCSU
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Premia for MPP-Dairy, exclusive of $100
Administrative Fee (dollars per cwt.)
Coverage Level
Threshold
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
$7.00
$7.50
$8.00
9 September 2014
Tier 1 – 2014 to Tier 1 – 2016 to
2015
2018
CPH 4 Mil. lb. or less
0
0
$0.008
$0.010
$0.019
$0.025
$0.030
$0.040
$0.041
$0.055
$0.068
$0.090
$0.163
$0.217
$0.225
$0.300
$0.475
$0.475
The National Program on Dairy Markets and Policy
Tier 2
CPH above 4 Mil lb.
0
$0.020
$0.040
$0.100
$0.155
$0.290
$0.830
$1.030
$1.360
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Coverage Options*
$ 8.00
$ 7.00
$ 6.50
$ 6.00
$ 5.50
*113 Possible
Coverage
Choice
Combinations
$ 5.00
$ 4.50
Coverage Percentage
90%
85%
80%
75%
70%
65%
60%
55%
50%
45%
40%
35%
30%
$ 4.00
25%
Coverage Level
$ 7.50
Coverage Options
Coverage Level
$8.00
$6.00
$4.00
25%
60%
Coverage Quantity
90%
Premia for MPP-Dairy
$1.50
Tier 1 - discounted
Tier 1
Tier 2
$1.25
$1.00
$0.75
$0.50
$0.25
$0.00
$4.00
9 September 2014
$4.50
$5.00
$5.50
$6.00
$6.50
The National Program on Dairy Markets and Policy
$7.00
$7.50
$8.00
45
Select the least cost combination of Margin
Level and Production Coverage %
6 mil. lb.
Prod History
MPP cost rises dramatically above $6.50 and nearing 90% Coverage
Production Coverage Example: Payoff
200 Cows, 20,000 lb/cow = 4 million lb History.
National Margin of $3.50/cwt for 12 months
Margin
-- Payoff at Coverage of --
Covered
$/cwt.
4.00
25%
$5,000
50%
$10,000
90%
$18,000
5.00
$15,000
$30,000
$54,000
6.00
$25,000
$50,000
$90,000
7.00
$35,000
$70,000
$126,000
8.00
$45,000
$90,000
$162,000
GEOFF BENSON, ARE, NCSU
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Production Coverage Example: Premium
200 Cows, 20,000 lb/cow = 4 million lb History
Margin
Covered
Premium
Coverage
cost at
Coverage
cost at
Coverage
cost at
$/cwt.
$/cwt.
25%
50%
90%
4.00
0
$100
$100
$100
5.00
0.025
$350
$600
$1,000
6.00
0.055
$650
$1,200
$2,080
7.00
0.217
$2,270
$4,440
$7,912
8.00
0.475
$4,850
$9,600
$17,200
GEOFF BENSON, ARE, NCSU
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Summary
 The 2014 Farm Bill is a game changer
 Old programs are gone and dairy
producers must make more of the
decisions for managing financial risk
 MPP-Dairy provides opportunities to
protect cash flow
 The MPP tool can help by providing a range
of price forecasts based on current data
GEOFF BENSON, ARE, NCSU
49
Summary
 Participation decisions are complicated
 Deciding how much “insurance” you need must be
based on your own farm financial history
 Calculate the lump sum protection needed
 Convert the lump sum to per cwt sold
 Your IOFC will not be the same as the national IOFC;
compare them
 Different combinations of margin coverage and
production history coverage may give similar
amounts of “insurance” at different premium costs
GEOFF BENSON, ARE, NCSU
50
Some Resources
 USDA-FSA web site
http://www.fsa.usda.gov/FSA/pages/content/
farmBill/fb_MPPDTool.jsp
 Dairy Markets and Policy program materials
and tools:
http://dairymarkets.org/MPP/Tool/
 U. of Illinois Dashboard Tool
http://farmdocdaily.illinois.edu/2014/05/2014farm-bill-mpp-dairy-dashboard.html
GEOFF BENSON, ARE, NCSU
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Geoff Benson
 E-mail: [email protected]
 Web page:
http://www.ag-econ.ncsu.edu/
faculty/benson/benson.html
GEOFF BENSON, ARE, NCSU
52
Questions
GEOFF BENSON, ARE, NCSU
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