2015 Margins are Distressing but Not Disastrous

September 30,2015
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The federal government has had a sometimes helpful, sometime hurtful role in agriculture throughout the nearly 100 years that the National Milk Producers Federation has been in existence. Various government programs to help level the economic playing field for food producers have come and gone. But the clear trend is toward providing farmers with skin-in-the-game risk management tools to cushion some of the downside damage from the often incredible volatility that they face – without creating a cradle so all-encompassing that it snuffs out competition or innovation.

For dairy farmers, this type of a government-sponsored system to hedge some of their economic risks is a relatively new paradigm.  Up until last year, and dating back well into the 20th century, the government used a mix of interventions, including the price support program, as well as periodic direct payments, to assist the dairy sector.  But as a result of the farm bill that Congress passed last year, those days are behind us.  Today, the same type of risk management that crop producers use – economic insurance to prevent catastrophic production losses – is what dairy farmers now have. 

The USDA’s Margin Protection Program, which took effect back in January, remains a work in progress, but overall, the MPP is functioning the way it was intended.  While older programs were linked to a specific price for milk and dairy products, the MPP recognizes that price alone doesn’t determine the economic health of the industry.  Feed costs play a crucial role – and in fact, have grown in importance given the increased reliance of today’s dairy sector on purchased feed.  That’s why the MPP is focused on the all-important margin between the price of corn, soybean meal and alfalfa, and the farm-level price of milk.

When the initial sign-up period for MPP coverage in 2015 got underway 12 months ago, farmers were enjoying a year of record-high milk prices. Despite our industry’s long history of up-and-down price cycles, the notion that the commodity supply-demand pendulum could swing dramatically back toward lower prices was far from many people’s minds. 

But the cycle did reverse itself, with a vengeance, as this year began.  Growing output in the world’s major milk production regions, the Russian embargo, China’s cooling economy and a strong dollar combined to dampen world dairy prices and U.S. exports. Dairy farmers in Europe and New Zealand are suffering through prices worse than we faced in 2009. Milk prices here have actually been surprisingly consistent – better than the rest of the world, but still disappointingly poor – during the first nine months of 2015.  Unlike several years in the recent past, feed prices have been in a consistently moderate range.

The result of this dynamic has been an average margin of around $8 per hundredweight, using the national formula established under the MPP program.  That figure is close to the average margin we’ve experienced over the past 15 years.  It is certainly well above the horrifically bad margins of 2009 and 2012, when the gap between feed and milk prices was less than $4/cwt.

This year’s distressing, but not disastrous, conditions have created a challenging freshman year for the MPP program.  For those who elected to purchase the maximum level of coverage, at $8, the program has made small payments in every one of the four, two-month payment cycles through August.  While few farmers elected to cover up to that maximum margin level, those that did have been paid.  Those who insured less, including the majority of farmers who paid only $100 for basic $4 coverage, have not received any compensation because margins haven’t been at catastrophic levels. 

From this perspective, then, the MPP has been like any other insurance program.  From a national standpoint, this year’s margins have been closer to a fender-bender, where one’s auto insurance coverage probably isn’t the best way to cover the damages.  This year isn’t the equivalent of a total bumper-to-bumper wreck, necessitating a large payout to fund an entirely new vehicle.  So from that standpoint, the MPP hasn’t been tested by a worst-case scenario. 

Some may have a sense of buyer’s remorse, wondering whether the old MILC payment program would have been more beneficial.  In fact, using the feed-adjusted MILC target price, this year’s milk prices would not have triggered any MILC payments in 2015. Class I prices have been well above the MILC trigger level every month this year. 

We are now in the MPP sign-up period for next year’s coverage. Thankfully, USDA Secretary Vilsack honored NMPF’s request last month for an extension of the sign-up period beyond the fall harvest. Dairy farmers now have until November 20 to elect their coverage level for next year, and will have until September 1, 2016, to pay any premium due for that coverage.

The choice farmers have to make for next year is whether market forecasts indicate that additional margin protection will be worth the added premiums. Such a question is a perennial consideration when purchasing any type of insurance, including protecting your home and property. 

The choice is not, however, whether some other type of government program for dairy farmers is a better approach.  That question was effectively answered in 2009 and again in 2012 – and also this year, which is a historically average one. In each case, the MPP program – a safety net, not an income enhancer – has been the consistent winner.

Jim Mulhern