Low Grain Prices Welcomed, But Not Always More Profitable
Income over feed cost is better during years of high grain prices. Milk prices generally respond by improving to a greater extent compensating for high feed prices. Projected low grain prices this year may not mean more money in the bank.
Obviously, the La Nina that was to dominate the U.S. in July and August and severely affect crops has not materialized. It may yet come, but the available window to affect this year’s crops in all but shut. USDA released the World Agricultural Supply and Demand report last Friday with estimates of a 15.153 billion bushel corn crop and a 4.060 soybean crop – both records. Of course, it is not yet in the bin and numbers could change from these estimates. Nevertheless, we are looking at large crops which will mean reasonable feed prices. Hay production has been very good in many areas resulting in plentiful supply and lower hay prices.
The general reaction to this report by dairy farmers is one of pleasure. It means purchased feed will be reasonable and supply plentiful. The result is usually increased milk production which is the desire of all dairy farmers. However, the result is usually higher milk production leading to lower milk prices. Thus, lower feed prices many times do not translate into greater profitability.
Looking back historically, there were many years that showed high feed prices resulted in high milk prices and a greater income over feed cost while low feed prices resulted in low milk prices and a lesser income over feed cost. In 2009, we suffered through a period of very low milk prices and we also had low grain prices. The result was one of the lowest income over feed costs on record. During the years of 2012 and 2013 when grain prices were very high, income over feed costs were substantially better than they were in 2009. Income over feed costs in 2014 were very high much of the year as grain prices slowly eroded while milk prices reached a record high. Thus, income over feed cost is more profitable during a period of higher grain prices according to history. These comparisons are for the purpose of putting the markets in perspective. We need to remember that just because feed prices are lower and are projected to remain that way, does not necessarily mean that the dairy operation will be more profitable.
This is where it is up to each dairy operation to implement different risk management strategies. Although there are problems with the Margin Protection Program which may be addressed on the next Farm Bill, it is one tool that is available for protecting a national income over feed cost. Then there are futures and options that can be utilized to protect both feed and milk prices at various times throughout the year. Those who are not in the government MPP program can also utilize LGM dairy as a tool to manage income over feed a bit differently than the choices for MPP. The important aspect of using these is that a plan needs to be made.
Looking ahead to next year’s milk prices based on current futures contracts is not very exciting. Class III contracts are all in the $16.00 range with a price swing from high to low of 60 cents. This makes it a challenge to implement a risk management strategy when we are currently looking at $17.00 Class III milk for August, September, and possibly October. It is also possible world dairy prices may increase as dairy output declines and inventories decrease. It will take some time for U.S. prices for butter and cheese to become competitive with world prices, but improving world prices will be a step in the right direction. Record cheese inventory is a real concern and one that will not go away until lower output or increased demand reduce supply. My recommendation is to purchase put spreads for milk for the first half of 2017. This would consist of purchasing at-the-money put options and selling put options $1.25 below the level of the purchased option. The cost is about 45-50 cents and will provide a floor while leaving the upside open. Then purchase call options for corn and soybean meal if prices move lower into harvest. These strategies will provide much flexibility by managing risk while allowing for income improvement.
- July Milk Production report on August 19
- July Cold Storage report on August 22
- July Livestock Slaughter report on August 25
Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wisconsin. He can be reached at 877-256-3253 or through their website at www.agdairy.com.
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