Is There Opportunity During These Low Prices?
It certainly appears low milk prices will be with us for a period of time according to current futures prices and USDA’s estimates released on the recent World Agricultural Supply and Demand (WASDE) report. Class III futures as of the close on January 12th show an average price for 2018 of $14.54. This compares with an average Class III price for 2017 of $16.17 and an average Class III price for 2016 of $14.87. USDA estimates Class III price to average $14.65 according to the WASDE report. USDA also estimated the All-milk price to average $16.20 for 2018 compared to $17.65 for 2017.
Barrel cheese price declined to the lowest level since July 30, 2009 last week increasing the concern over how low milk prices may move in the near-term. There is much concern over the ability of dairy farmers to weather this season of low prices. I am already hearing of herds of cow that are for sale if anyone wants them. The problem is that no one or very few may want them. This creates another dilemma. Does the farmer send them all to slaughter at low cull cow prices or milk them until a buyer might be found? It will be a trying time for dairy producers.
Even with lower milk prices the past two years and potentially lower prices this year, some farms are in a better equity position than others and may continue to expand if the milk plant has capacity. However, expansions will be few and far between. Those who may be in a better equity position or encouraged by the lender to push milk production or add cows, may have some very good opportunities to do so.
Farms need to make application to their milk plant in order to expand and increase milk production in most cases. With low milk prices, there will be some farms going out of business which may reduce the milk receipts at the plant level depending on where those cow go. This creates the opportunity for another farm to possible obtain the go ahead to produce more milk. Those who may want to expand and increase milk production need to be aware of what is taking place with the other patrons of the milk plant. A possible win-win situation might be to purchase cows from a patron of the milk plant that is going out of business thereby assuming that farms milk production allowing the purchasing farm to expand without a problem with the plant. The farmer that is getting out of the business is able to sell his cows at a better price than the cull price and may have a willing buyer thereby gaining a better value for his animals. You could think of this similar to purchasing quota. Of course, this would need to be cleared with the milk plant before this could take place, but it could be a win-win situation despite the unfortunate loss of a business for one entity.
Dairy farmers will need to be creative to weather these low prices. Those who use the tools of risk management and have been able to hedge better prices are the ones who will fare better than those who do not. Those who are looking at employing some sort of damage control to protect against the possibility of yet lower milk prices should only use put options or put option strategies. Do not use forward contracts or futures contract unless your plan would be to purchase call options if and when milk prices begin to move higher. You do not want to lock in a price below your cost of production.
Put option spreads can be implemented for the second half of the year to protect the downside if supply exceeds demand for much of the year. I recommend buying at-the-money put options and selling put options $1.25 below to provide downside protection to the sold put option level. This strategy provides some protection while leaving the upside completely open if prices increase. There are no margin calls and risk is limited to the cost of the option spread. Initiating these strategies will provide some confidence of milk income as we move through the year. Milk prices will, at some point, increase again and will be very good. We have experienced these cycles many times and this one will follow similar patterns. Dairy farmers are not alone with grain producers holding or selling their product below cost of production as well. Low prices will cure low prices. The duration of these low prices is uncertain.
- January Federal Order Class I price on January 19
- December Milk Production report on January 23
- December Cold Storage report on January 23
- December Livestock Slaughter report on January 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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