May 22, 2017

How Likely is $11 Milk?

 |  By: Mike Opperman

Milk price volatility is one of the constants of the dairy industry. Producers expect prices to fluctuate from month to month and year to year.

Prices over the summer of 2016 were low, triggering payments for those enrolled in the Margin Protection Program (MPP). But how likely are they to get really low, like in the $11 range? 

Nearly all producers signed up in MPP are protecting against prices like that. Almost all have signed up at the $4 catastrophic coverage level.

How likely is it that catastrophic events like what happened in 2009 and 2012 likely to take place? “In the last 10 years we have had two major events that each would cost more than $1 billion [if MPP were in place at the time],” says Dr. Marin Bozic, economist in the Department of Applied Economics at the University of Minnesota. “Are these events likely to occur again over the next 10, 20 or 30 years?” 

The answer to that question is important to producers. If there is expectation that margins will be low enough to trigger MPP payments, then participation in the program will go up. If price volatility is expected to decline, then producers will continue investing at the $4 catastrophic rate.

And that impacts the costs of the program. If bad years are rare, Bozic says the cost of participation in MPP or something like it should not cost much more than it does now. “But if we anticipate that the next 2012 will be just around the corner, then the expected cost of the programs should be much higher,” he says.

Thankfully it appears that production swings are becoming less volatile. “When we put together year over year growth in milk, connect the highs and the lows, the volatility in U.S. milk supply seems to be narrowing,” Bozic says. “We see information on margins and prices getting more volatile, but year over year production changes may be getting more stable.”

Disincentives are in place in an attempt to curb production growth to match capacity. “Because there are some systemic disincentives for investing, we may see the growth of the US milk supply being more manageable going forward,” Bozic says. “This may mean that $11 milk won’t be as likely, to the extent that it was provoked by oversupply of milk.”

We also have better export markets. “If the export engine stops working, we may have to go back to buying dairy products,” Bozic says. “That may mean consistent pressure on margins until we start pushing the dairy herd down again.”

If producers don’t anticipate a decline in milk prices in the near future, increasing participation in a program like MPP may be difficult, Bozic says. “Producers have an aversion to loss of premiums paid, more so than they appreciate the risk removed,” he says. “If you assume that someone is risk averse, then when presented with an incentive to avoid risk they would immediately latch onto it. In this scenario producers would use MPP even it if wasn’t subsidized just because it provides protection.”

Bozic says that rather than thinking of MPP as a risk protection program they see it as a stand alone opportunity so will only participate if it is highly subsidized. The consequences are that in a year like 2009 or 2012 where margins are predicted to be low, they will still only go part way and not all the way up to $8. To appease their loss-averse nature, Bozic says in order for producers to buy into MPP beyond catastrophic coverage a program would need to be designed with low premiums rather than high expected net indemnity.

If producers don’t actively participate in MPP, it may be difficult for the program to continue. “The issue is that people aren’t using it,” Representative Collin Peterson (D-Minn.) said on a recent edition of AgriTalk. “Leading up to the Farm Bill we will have had almost no participation in the program. That will be three years of people not using the program.” He’s afraid that opponents will point to the non-use as a reason to kill the program.