business tools
December 7, 2018

Manage Risks To Take Advantage of Price Opportunities

 |  By: Matt Tranel

When considering what 2019 might bring for milk prices, many factors come into play.  What happens to cow numbers and milk production?  Do political conflicts and tariffs continue to prevent export opportunities to key buying nations?  Will mounting inventories become even larger?  How will financial institutions handle another year of meager profitability for dairymen?  These are just a few ingredients that are certain to make the 2019 milk outlook an interesting one. 

Current CME product values suggest a soft Class III milk price early in 2019.  Cheddar blocks and barrels are trading near $1.30/lb and dry whey has had a setback.  Class IV markets are faring a little better as butter has held support at $2.20/lb and powder markets are steadily enjoying an uptick.

Looking into 2019, history would tell us that cheddar values have risk to fall and test $1.20/lb.  Lows in cheddar cheese over the past 3 years have included $1.22/lb in 2016, $1.335/lb in 2017, and $1.205/lb in 2018.  With total natural cheese inventories at record highs closing out 2018, a retest of $1.20/lb cheese in the first half wouldn’t be surprising.

Cheese inventories present a real risk to milk prices for the Feb-June months.  A look back at 2018 settlements in Class III milk during this period finds settlements ranging from $13.40-$15.21/cwt.  Among these, February has represented the low in 2 of the last 4 years.  Similarly, Class IV prices in 2018 ended with a range of $12.87-$14.91/cwt.  These same prices are possible for 2019.  If realized, this added pressure to already tight balance sheets will have financial lenders and producers sitting down for some difficult discussions.  Though belt tightening has been done for several years in our industry, one big question will need to be asked: "should/can the dairy keep operating?". While never an easy subject, fewer cows and lower production would add optimism to the future of the dairy market.

History shows us that we need to see 100,000-150,000 less cows on the milk production report before a large rally could occur – currently we’re at 39,000.  Working in combination with that will be exports and politics.  Exports in 2018 were strong, especially in the first half.  Regions such as Southeast Asia, South Korea, and Middle East/North Africa were terrific buyers of US dairy products.  Tariffs placed on Canada, Mexico, and China during 2018 hindered further growth.  Until tariffs are removed by Mexico on US cheese and Chinese relations begin a move back toward normality, political hurdles will continue to restrain export growth and cause further build up of US product inventories.

So, what can a producer do to manage price risk and opportunities in 2019?  Many different tools are at a producer's disposal.  Among the best right now are those that provide flexibility in any type of market.  Options are a great way to accomplish this objective.  Amid the noise of 2018, $16-$17 Class III opportunities were available.  The same can be said of 2019 today.  Those opportunities have defined some of the better opportunities in recent years and should be heavily considered.  To that end, put option strategies allow producers to defend against lower prices while allowing upside opportunity should market dynamics change.  A cousin to put options is the newly released Dairy Revenue Protection (DRP).  DRP used in conjunction with other marketing tools can be an effective way to manage the overall risk your business faces.  Your trusted advisor can identify strategies suitable for you.

Matt Tranel is a risk management advisor with Commodity Risk Management Group