News & Resources

DMC an Essential Risk-Management Option for 2021

November 30, 2020

Forecasts for prices and politics both make signup for the Dairy Margin Coverage Program a compelling risk-management choice for 2021, National Milk Producers Federation Senior Vice President for Member Services & Strategic Initiatives Chris Galen says in an NMPF podcast released today.

“Congress is still trying to pass another stimulus bill to help all walks of life in our society and our economy and hopefully agriculture will be part of that, but right now there aren’t any serious negotiations. Who knows if that can will be kicked into 2021?” Galen said. “What we do know is that the DMC program is forecast to make payments in the first part of 2021. So you’ve got to go with what you know.”

NMPF is offering dairy farmers, cooperative members and state dairy associations a free webinar on Wednesday, Dec. 2, to help them develop effective risk management plans that can protect them in what’s predicted to be a volatile year in 2021. NMPF Chief Economist Peter Vitaliano will be discussing the dairy price outlook for next year, and the value of risk management tools including Dairy Margin Coverage, in the webinar, moderated by Galen, at 1:30 p.m. EST on Wednesday, Dec. 2.

Participants will be able to ask questions about the year ahead and learn more about how farmers can manage their risk through expected turbulence.  The webinar will examine the milk and feed price forecast, forecast margins, and analyze how the Dairy Margin Coverage program will offer farmers protection against price volatility. Dairy producers seeking more information can visit NMPF’s page on risk management to learn more about DMC, CFAP and other tools to promote financial security for dairy operations.

To listen to the full discussion, click here. You can also find this and other NMPF podcasts on Apple Podcasts, Spotify and Google Play. Broadcast outlets may use the MP3 file. Please attribute information to NMPF.

Transcript

Theresa Sweeney-Murphy, NMPF: Hello, and welcome to the Dairy Defined Podcast. Many dairy farmers learned a hard lesson this year about the value of risk management. When the sign-up period for the 2020 Dairy Margin Coverage program opened last winter, the outlook for dairy prices looked strong and DMC payments weren’t expected. So, many dairy farmers decided to take a chance on the market. But the coronavirus crisis turned rosy projections into a thorny 2020. Meanwhile, the DMC program worked as intended with payments triggered for producers in March, April, May, and September.

Today, we’re talking about DMC with Chris Galen, Senior Vice President of Membership Services and Strategic Initiatives at the National Milk Producers Federation. Chris, thanks for joining us.

Chris Galen, NMPF: Always a pleasure, Theresa.

Theresa Sweeney-Murphy, NMPF: How have you seen risk management tools for farmers evolve and how have farmers attitudes changed with them?

Chris Galen, NMPF: The last, I would say the last two decades that I’ve been directly affiliated with this we have taken steps towards having dairy farmers play a bigger role in risk management. And we no longer have the same tools that we had back in the late nineties, like the Price Support Program. But we certainly think that there is an appropriate role for the U.S. government, whether it’s through congressional appropriations or USDA programs to help dairy farmers deal with a certain level of risk, a lot of which is beyond their control, which then takes us to the tools that we have available to us in 2020 and looking at next year as well.

Theresa Sweeney-Murphy, NMPF: Can you explain how the Dairy Margin Coverage program works?

Chris Galen, NMPF: Yes. At its most basic level, it’s a way to ensure a margin between the primary cost of feed, your biggest feed ingredients on the typical dairy farm, and then the price of milk. Now, there are certainly many other things that influence your profit and loss as a dairy operator and there are many other expenses you have from the cost of capital and borrowing to the cost of your herds and taking care of them and even the cost of labor, and yet the things that are probably most important and the ones that we can benchmark most against are the cost of corn, the cost of soybean meal, and the cost of alfalfa hay.

And so those three feed grains are what we use as the feed cost formula. And then you compare that to what the all milk price is, which is a national average milk price that the USDA releases every month. It’s not any one farmer’s price, but it’s the national average. And then in good months, when feed costs are low and the milk price is high, well then the margin’s really good. But in some months, like what we saw earlier this year, when milk prices are low and feed costs are stable or perhaps rising higher, then margins can be compressed. And so the purpose of the Dairy Margin Coverage program is to give farmers the opportunity to prepare themselves and to hedge against those times when margins are really compressed.

Theresa Sweeney-Murphy, NMPF: There was a bit of apprehension to signing up for the Dairy Margin Coverage program when it first opened up, given farmers frustrations with the former Margin Protection Program or MPP. What changed from MPP to DMC and what was NMPF’s role in getting those changes made?

Chris Galen, NMPF: Yeah, this is a good question because it kind of combines the gist of your first two questions, which is that in the first part here of the 21st century we no longer had the Price Support Program, but we needed to have some form of risk management tool. And so we talked to Congress about having some form of risk management that looks not just at milk prices, which is what the old Price Support Program was designed to protect against, but also margins because there’s certainly been some years where milk prices aren’t necessarily bad but you could still be losing money as a dairy operator because the cost of feed was so high. So that’s where the concept of the margin was born, so that you could insure against not just low milk prices but the combination of low milk prices or high feed costs.

And so the first attempt at this was called the Margin Protection Program. And basically it was just a cup of tea that was too weak. It just didn’t have enough in the way of financial resources to ensure margins in a way that would be beneficial to most dairy producers. And I think after the first year we had it farmers signed up, they paid premiums, it didn’t return anything to them, and they got a really bad taste in their mouth from that weak cup of tea and they decided I don’t want anything to do with it.

So we got a second bite of the apple back in 2018 when the Dairy Margin Coverage program was created. And so the specific changes that benefited farmers is that the margin now is much higher. Under the old program, under the MPP, the maximum margin was $8. That was the most you can insure against. Now it’s 9.50. One of the other big changes is that the cost of premiums to farmers is lower, and so that makes signing up much more attractive because the cost of the insurance is less. And then to make adjustments on the feed cost margin or the feed cost formula, high-quality alfalfa hay is now covered by that. That was a change that National Milk specifically asked Congress to make. And so that allows farmers a truer reflection in that margin formula of what it costs to feed dairy cattle because they don’t just use any old alfalfa, they use much more high-quality to help with milk production.

Theresa Sweeney-Murphy, NMPF: And what was NMPF’s role in getting those changes made?

Chris Galen, NMPF: Farmers just got disgusted, frankly, with the old Margin Protection Program. That’s something that we shared in that we felt the concept was good but the execution was off. It was just too weak and there just wasn’t enough money. And so a lot of this, Theresa, boils down to if you have a more robust risk management tool it’s going to cost more. Like any other form of insurance, the more you cover the higher your coverage threshold, the more it’s generally going to cost you.

So we went to Congress and said, “You’ve got to allocate additional funds to make this new DMC program worthwhile.” And it took some efforts to show that farmers didn’t like the old MPP. A lot of them voted with their feet in the sense that they decided not to use the MPP in its final couple years because it wasn’t really very worthwhile. And so members of Congress saw that, we made sure that they saw that, and for that reason then we were able to allocate some additional money to this. And when USDA came up with the new improved Dairy Margin Coverage program, it featured more affordable premiums and more opportunity to insure higher levels of coverage.

Theresa Sweeney-Murphy, NMPF: How have farmers benefited from Dairy Margin Coverage in 2019 and so far in 2020? And what can we expect from 2021?

Chris Galen, NMPF: First of all, in 2019 what was interesting is that at the beginning, really the first six months of last year, margins were below the 9.50 coverage threshold. Now, they were above $8. So I mentioned a minute ago what’s interesting about that because in 2018 and previous years the maximum you could insure was up to an $8 margin. Right? Well, we had margins that were above $8 but below 9.50 at the beginning of last year. So that right there was a demonstration that changing that margin threshold from 8 to 9.50 would allow for more frequent payments and more significant payments if you insure up to that maximum level.

So 2020 is interesting because we actually had fewer months where there were any payments. It looks like there will just be four months this year where there will be payments up to the 9.50 coverage level. We have two small payments in the spring and then in September and then two very large payments in April and May, and of course those reflect the fact that we had a milk price crash due to the coronavirus and the lockdowns associated with that back in the spring.

So interestingly enough, last year in 2019 the overall payments under the DMC were about $300 million. This year, it looks like the payments will be right at 200 million. So even though the margins were worse for a couple months this year, overall on average margins were a little better this year compared to last year, and so the program isn’t expected to pay out quite as much. Still, $200 million is a significant amount of money, particularly when you couple that with the Coronavirus Food Assistance Program payments that also many, many farmers took advantage of this year.

2021 is certainly a big question mark for so many reasons and beyond just what’s happening in the dairy sector. Who knows how quickly the economy will continue to climb out of this trough created by the coronavirus and our reaction to it? We have a new administration. We’re going to have many, many new people in Congress. And so there’s a lot of things that will affect the economic outlook in the dairy sector, in agriculture, and even beyond that that we don’t really know about. I mean, certainly it’s a year where there’s probably less certainty than in any time since 9/11 back in 2001.

So having said that, the outlook for margins is kind of murky and not great. If you look at what’s happened to the cheese markets here in the middle part of November, there’s been a significant downturn in the price of cheese, which is the biggest driver of farmers milk checks of course, and that is reflected in the margins here as we wind up 2020 and as we look toward 2021.

There’s a calculator that USDA makes available on its DMC webpage, and if you look at that right now it is showing below 9.50 margins really in the first half of next year. So that’s something that farmers need to keep in mind as we push towards this December 11th sign-up deadline, which is that right now if you’re looking at the margin price forecast it’s not great. It’s not awful like it was in April or May, but it’s certainly not great. And so that is something that farmers need to be apprised of. And I wouldn’t necessarily cross my fingers hoping that things will suddenly turn around as we start 2021.

Theresa Sweeney-Murphy, NMPF: Chris, sometimes you hear that DMC is only for small farmers. What’s the truth?

Chris Galen, NMPF: Well, the truth is everyone regardless of your production history or the number of cows you have can sign up for this program and it treats everyone equally up to the first five million pounds. So I would say that there’s the specific truth that everyone can get the same premium rates up your five million pounds of production history. Now, obviously, if you have a larger farm and you’re producing more than five million pounds of milk per year, there is what we call a Tier II production where you can still get insurance, but the premiums are higher and you can’t insure up to that 9.50 maximum coverage level. And I think what we’ve seen here this year as well as last year is that larger farms probably have only got the free or what we call catastrophic level of coverage, which is around that 4 to $5 level, and haven’t paid up above that to get insurance at margin levels higher than that because it just doesn’t pencil out.

So for folks in that size category, what I would say is that the DMC is meant to be helpful. It’s not going to make anyone of any size a hundred percent whole, and that’s where you have to look at other risk management opportunities. Certainly the government also offers the Livestock Gross Margin Program for Dairy and that can be very useful. A lot of private companies are also offering the Dairy Revenue Protection program that was designed by the Farm Bureau, and that has also proven to be valuable this year. And then of course you can always do forward contracting and use options and puts to hedge your price risk that way.

So we are in an era, getting back to your very first question, Theresa, that’s very different from the late 1990s where in dairy in particular there weren’t a lot of very effective risk management tools when you looked at the marketplace and the government was primarily focused on helping people out with the Price Support Program by buying up surplus products. We’re no longer in that era any longer, and so there are many more risk management tools out there. The DMC is certainly the primary one offered by the government, but it’s not the only one available to farms of all sizes. And so I think that’s the bottom line here is that if you’re concerned about the economic health of your operation there are a number of different tools in the toolbox available for you to use.

Theresa Sweeney-Murphy, NMPF: How can farmers sign up for the DMC? And when is the sign-up deadline?

Chris Galen, NMPF: The sign-up deadline for coverage for next year is Friday, December 11th. And that’s an interesting coincidence because that’s also the sign-up deadline for the second round of the Coronavirus Food Assistance Program. And part of the reason I’m bringing that up, Teresa, is that the CFAP, both the first round that farmers could sign up for this spring and early summer and now the second bite of the apple, the version 2.0 they call it where you can sign up here by December 11th, that actually is going to pay out more money overall to dairy farmers as well as to producers of other commodities than the Dairy Margin Coverage program has paid out this year. So that has been very, very valuable. And frankly, we should pat ourselves on the back there were National Milk worked with members of Congress and later with USDA to make certain that the payment rates for CFP, rounds one and two, was much, much better than what we got in the former Market Facilitation Program last year. So the combination of CFAP and DMC is going to amount to several billion dollars in direct payments to dairy farmers.

Now, the difference between the two, while they may have the same sign up deadline, the difference is that we can’t count on any more money, whether it’s called the Coronavirus Assistance Program round three or something else that Congress may want to pass here this winter or in the spring. So getting back to this theory that there are more tools in the toolbox, the CFAP is one tool that we have to basically assume is going away at the end of this year and is not likely to come back. And so when you look at what is then available for farmers in 2021, you’ve really got to look at the DMC as the primary one that’s going to be offered by USDA.

I mean, it would be great if there’s going to be additional monies out there. Congress is still trying to pass another stimulus bill to help all walks of life in our society and our economy and hopefully agriculture will be part of that, but right now there aren’t any serious negotiations. Who knows if that can will be kicked into 2021 when we have a Biden administration? So all the way of saying we don’t know what the forecast is here for direct payments other than DMC. What we do know is that the DMC program is forecast to make payments in the first part of 2021. So you’ve got to go with what you know, and right now that’s the only game in town.

Theresa Sweeney-Murphy, NMPF: Why should farmers consider participation in a risk management program in both good years and in bad years?

Chris Galen, NMPF: Well, that’s the definition of insurance, isn’t it? Which is that you buy it for your health, you buy it for life insurance, you have property insurance, not because you hope that you’re going to crash your car or that you’ll have a heart attack and die, but in case those things do happen you will then have some level of financial compensation, or I guess in the case of life insurance your loved ones will. And so that’s the whole idea behind the risk management approach that is embodied by the DMC program. It’s not a payment for just doing nothing. I think the days of just direct payments to producers without any form or expectation that they have some risk management program in place, I think those days are gone. The idea that the government’s going to offer very favorable economic insurance to farmers, there has to be some component where, like I say, there’s their skin in the game in the form of the premiums that farmers pay.

Theresa Sweeney-Murphy, NMPF: Chris, where should folks go for more information about the Dairy Margin Coverage program?

Chris Galen, NMPF: Well, first of all, the USDA’s Farm Service Agency has a Dairy Margin Coverage page that has the premium rates as well as what the payments have been so far in 2020. And it also has what it’s calling a Dairy Margin Coverage decision tool, which is basically a forecasting device. I’ve mentioned it earlier in our discussion, Theresa, and it plugs in the futures markets for milk as well as feed costs, and then it turns out what the expected margins are going to be in the first six to eight months of next year. And I think that’s a very valuable resource as we get towards December 11th because if farmers are making decision about whether to sign up and for how much they should insure themselves, you want to make certain that you have access to that Dairy Margin Coverage decision tool.

In addition to the USDA website, National Milk has its own webpage for the DMC. We have a brochure that we worked on that is meant to answer some basic questions that farmers may have about this. And so we would offer, I think, the best private sector alternative or compliment to what USDA also offers online.

We are also offering a free webinar to anyone who’s interested in the dairy community on Wednesday, December 2nd. So that will be at 1:30 p.m. Eastern time. That’s 10:30 Pacific time. And again, if you go to our website, you can find out more information about how to register for that. We’re going to use Zoom, but it will be a live presentation. I’ll be moderating it. We’ll have as our featured speaker our chief economist Peter Vitaliano, and he’ll be walking through the forecast and then explain a little bit more about how the DMC has operated this year and what the expected payments may be next year. And that again is Wednesday, December 2nd, 1:30 Eastern time, 10:30 Pacific time. And that’s just nine days before the sign-up deadline for DMC of December 11th.

Theresa Sweeney-Murphy, NMPF: Thanks for being with us today, Chris.

Chris Galen, NMPF: You’re welcome.

Theresa Sweeney-Murphy, NMPF: That’s it for today’s podcast. Be sure to look at NMPF’s risk management page for more information about the Dairy Margin Coverage program. You can get there from our homepage at nmpf.org. And if you aren’t already a subscriber, be sure to become one so you can stay up to date on what’s happening on Capitol Hill that affects dairy farmers. We’re on Apple Podcasts, Spotify, SoundCloud, and Google Play under the podcast name Dairy Defined. Thank you for joining us and have a great week.