September 30, 2016

An Alphabet Soup of Dairy Risk Management Options

 |  By: Dairy Talk

MPP, CME, LGM, aka, the Margin Protection Program, the Chicago Mercantile Exchange and the Livestock Gross Margin-Dairy insurance program.

These are the major risk management options for dairy farmers. All will offer some level of protection. Each has its challenges. None is perfect.

Most dairy farmers, though certainly not all, have soured on the MPP. Most say it has not delivered the kind of risk protection that the National Milk Producer Federation’s original Foundation for the Future plan promised, primarily because that version did not fit within the federal budget baseline.

For the record, MPP did pay out more than $10 million in the May-June period, and smaller amounts earlier in the year. For a smaller producer with 2 million lb. of production history, the net payout in the first half of year was between $500 and $800, depending on the coverage level selected above $6.50/cwt. For a larger producer with a coverage level of 5 million lb., the only level that showed a net positive return was at the $6.50 level, according to analysis done by Betty Berning, a University of Minnesota Extension educator.

“In a bad year, MPP will not save a farm,” says Berning. “It can provide some protection and income to help offset losses…. That is where other risk management tools come into play.”

Those taking out LGM-Dairy insurance fared much better this year, depending on the level of insurance they purchased. “An LGM-Dairy producer, with a $1 coverage deductible, saw a net return after premium of $1.38/cwt,” says Ron Mortensen, with Dairy Gross Margin, LLC.

The advantage of LGM is that farmers can better match their own feed costs to the level of insurance purchased. Plus, insurance can be purchased every month. But the downside to LGM is that the sign-up period is limited to a narrow window of time one day each month, the cost is unknown until the day of purchase, and premium subsidies can (and sometimes do) run out—making the insurance unavailable. Plus, once farmers are enrolled in the MPP, they cannot purchase LGM insurance.

The CME offers farmers all kinds of risk management opportunities. But contract sizes can be prohibitive for smaller farmers, and in times of low prices, the chance of locking in a positive margin at a reasonable price are slim to none.

Some farms use a combination of MPP and CME. For example, Alex Coenen, Director of Business Development for Milk Source LLC, uses the $4 coverage of MPP as his catastrophic level of risk management. (Milk Source milks thousands of cows on farms in Wisconsin and Michigan, and Coenen devotes a good chunk of his time to risk management.)

Coenen will then wait until the last minute to sign-up for additional MPP coverage. Again this year, USDA has pushed back the MPP sign-up deadline to mid-December, which gives Coenen additional time to see how markets develop in the first half of the next year. That’s usually the time of year milk prices are at their lowest, and the period of greatest risk.  He will also use the CME, if opportunities arise, to lay off more risk.

Effective risk management is not easy. MPP is undoubtedly the simplest and the cheapest. LGM is more complex, and takes monthly minding. The CME is the most complex, especially if you’re going to protect milk, corn and soybean margins.

In other words, you get back what effort and treasure you put into risk management. It’s just that simple, and just that complex.   

 

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