Market and Policy Watch June - August 2013

Dr. Cameron Thraen, State Extension Specialist, Dairy Markets and Policy, The Ohio State University

In mid-May, the U.S. Senate Committee on Agriculture, Nutrition and Forestry passed a Farm Bill with a 15-5 vote.  The full bill moved to the Senate floor last week and received hundreds of amendments.  The Senated considered and rejected cuts to supplemental nutrition assistance programs, but approved means testing for crop insurance and improvements to the Risk Management Agency’s (RMA) fraud detection effort.  Action is expected to resume in the Senate on June 3.

The U.S. House of Representatives succeeded in getting a Farm Bill through committee this month with a three-quarter majority.  The toughest battle lies ahead with a floor debate expected in begin mid June.  Challenges on the U.S. House side include the lack of provisions tying conservation compliance to crop insurance benefits and a controversial supply-management style dairy market stabilization program.

The safety net provisions of the dairy subtile of the Farm Bill, when signed into law, will very likely be based on a margin insurance type program.  This puts the focus on an income over feed cost (IOFC) margin.  The point has been made in past issues of Buckeye Dairy News that an IOFC margin calculation based on U.S. average milk and feed values is pointless, as such a calculation may bear little connection to an individual dairy operator’s actual milk price or feed cost.  While it cannot be argued that calculating IOFC with using the USDA reported All Milk price, corn price, soybean meal price, and alfalfa hay price is representative of specific IOFC on any given dairy farm, this observation misses the point.
As a dairy farmer you will be provided the opportunity to participate in an insurance type program with participation costs based on your dairy’s production size and premiums paid based on IOFC coverage levels selected.  In return, you will be participating in potential financial payouts triggered by a macro measure of the IOFC for the entire United States dairy industry.  This is purely a financial consideration.  As a dairy farmer, you will have to decide whether or not to participate in this program, incurring cost and potential financial payouts, or to go another direction, relying on the private market instruments, such as futures market hedging, futures puts or calls, or possibly purchasing the USDA/RMA underwriten Livestock Gross Margin-Dairy Insurance.

The focus of income support for agriculture, including dairy, will be on providing the opportunity for farmers to particiapte in an insurance type program, whether that be crop insurance or IOFC insurance.  Therefore for dairy, it is important to be able to forecast this national IOFC margin for the coming production year.  Working with John Newton, Ph.D. candidate in the Department of Agricultural, Environmental and Development Economics, we have developed just such a forecast model for this IOFC.  Our current IOFC forecast is based on a complex model which uses the Chicago Mercantile Exchange (CME) Group futures market price paths for feed inputs and milk price and the CME Group put and call option prices to capture anticipated price volatility.  The IOFC time path over the coming 5 months suggests a steadily improving IOFC margin picture.  Figure 1 shows the mean and upper 75% and lower 25% bands for this forecast.

The lower 25% boundary (LB) is the most pessimistic outlook, showing that a combination of low milk price and high feed input prices will result in an IOFC path staying under $8/cwt in the coming 5 months.  This reflects continuing higher feed cost not offset by a higher milk price. The optimistic 75% boundary (UB) depicts an IOFC time path reflecting stronger milk prices and moderate or lower feed input prices.  The low point is just above $7/cwt and steadily climbs to exceed $10/cwt by October 2013.  This time path reflects a return to more normal crop growing conditions with a lower feed cost and higher late summer milk prices.
You can find monthly updates for this IOFC forecast chart on my website:

Figure 1 Thraen
Figure 1. 2013 Forecast income over feed cost.