Dairy Markets and Policy Watch, August through October 2013

Dr. Cameron Thraen, State Extension Specialist, Dairy Markets and Policy, and John Newton, Ph.D. candidate, The Ohio State University

Well, here we are again.  The U.S. Senate passed its version of the farm bill, complete with all farm and nutrition provisions. The U.S. House of Representatives failed to pass its version of the complete farm bill, instead opting instead to strip out the food and nutrition aspects and pass a farm commodities only bill.  President Obama immediately stated that he would veto any such legislation sent to his desk.  Now the impass begins anew.  You will very likely hear much about the coming dairy cliff once again as this 113th Congress struggles to get a joint farm bill completed and passed.  On January 1, 2014, the provisions of the 1949 dairy price support program will become law unless held in abayence by either a new farm bill or another extension of the current farm bill.  We shall have to wait and see.

In spite of the current wrangling, 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 BDN 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/Risk Management Agency underwritten Livestock Gross Margin-Dairy Insurance.

The focus of income support for agriculture, including dairy, will be on providing the opportunity to 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.  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 12 months suggests a steadily improving IOFC margin picture.  Figure 1 shows the mean and upper 75% and lower 25% bands for this forecast, along with the actual values for January 2013 through June 2013.

The lower 25% boundary 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 $9/ cwt in the coming 12 months.  This reflects continuing higher feed cost not offset by a higher milk price. The optimistic 75% boundary depicts an IOFC time path reflecting stronger milk prices and moderate or lower feed input prices.  The low point is for July 2013, just at $6.00/cwt and steadily climbs to an average of $10.60/cwt for September 2013 through January 2014.  This time path reflects a return to abundance for crop growing conditions with a lower feed cost and higher late summer and fall milk prices.  These margins are above the long run average of $8.35/cwt for the U.S. milk producing sector.

Figure 1 Thraen

Figure 1. The 2013 to 2014 forecast income over feed cost.
You can find monthly updates for this IOFC forecast chart on my website: http://aede.osu.edu/programs-and-research/ohio-dairy-web.