volatility
August 1, 2016

How to Use the Margin Protection Program to Manage Risk

 |  By: Robin Schmahl

Most of the time since MPP began, milk prices have been in decline with no protection of milk price in and of itself.  MPP, as well as the Livestock Gross Margin program needs to be used in conjunction with the futures and options market to protect farm income.


Although milk prices increased somewhat in June, it did not help profitability. Milk prices did not improve very much with the June All-milk price reaching $14.80, an increase of 30 cents from May. This certainly was welcomed, but still remained far below cost of production. However, despite this increase income over feed cost declined 2 cents per cwt. This does not sound like much, but with an income over feed cost of $5.75, it certainly does not make one feel warm and fuzzy. Averaging this price with the May price of $5.77, we end up with an income over feed cost of $5.76 rendering payments under the Margin Protection Program (MPP) for those who chose the $6.00 and above levels. This is the lowest income over feed cost since the MPP program began.

 

USDA has been calculating a milk/feed ratio for quite some time which is designed to reflect the price the All-milk price of 100 pounds of milk divided by the price of a 16% protein ration. This ration consists of the price of 51 lbs. corn, 41 lbs. of alfalfa hay, and 8 pounds of soybeans. Using the milk/feed ratio for calculating income over feed cost we come up with $7.05 and a slight improvement from May rather than a slight decline using the calculation of MPP. The reason for this difference is the calculation used for each application. There are different formulas for MPP than the milk/feed ratio and there is a different commodity used for each. MPP uses a soybean meal price from Central Illinois while the milk/feed ratio uses the price of soybeans. It is clearly more advantageous to use the MPP calculation rather than the milk/feed ratio calculation to determine payments. Yet, there still has been much dissatisfaction with the program and the level at which payments are rendered. There has been discussion as to how to improve the program for the next Farm Bill.

 

Lawmakers have recently made a recommendation to USDA to extend the program sign-up period until December 31 in order to encourage greater participation. Allowing the ability to sign-up through the end of the year gives the advantage of a better sense of market strength and direction. This could provide a more informed decision for choosing a price level for protection if your goal is for a greater opportunity of a greater return on investment and an attempt to beat the market. However, if the goal is to protect an income over feed cost that is profitable and needs to be protected, then trying to outguess the market becomes a non-issue. The level and cost of the chosen level of protection plays an important role in the decision factor.

 

There is one very important attitude difference I have seen between the previous Milk Income Loss Coverage (MILC) program and the Margin Protection Program (MPP) and this is in the area of risk management using futures and options. Under the former MILC program many dairy farmers did not view this as a risk management tool and used the futures and options market to manage milk price risk. However, under MPP more have viewed this as their risk management program and had grasped the idea that milk prices could fall and feed prices could decline resulting in no payments which we have experienced most of the time. Payments that have been received largely just covered the cost of the program leaving the dairy operation open to substantial price swings in milk. Most of the time since MPP began, milk prices have been in decline with no protection of milk price in and of itself.  MPP, as well as the Livestock Gross Margin program needs to be used in conjunction with the futures and options market to protect farm income. Strategies can be and should be implemented using the tools available.

 

Upcoming reports:

  • California Classes 4a & 4b prices on August 1
  • Global Dairy Trade Auction of August 2
  • July Federal Order class prices on August 3
  • June Dairy Products report on August 4
  • California September Class I price in August 10
  • World Agricultural Supply and Demand report on August 12

 

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