How are U.S. Milk Producers Prepared for Price Fluctuations –

The Future of U.S. Farm Bill System

Dr. Marin Bozic PI Dairy Forum 2013 Helsinki, November 21, 2013

Agenda  For  Today

§  Structural  Changes  in  the  USA §  Sources  of  Risk  to  U.S.  Dairy §  Risk  Management  Solu?ons:

§  Private  Markets §  Public  Policy

§ What  are  the  Lessons  for  EU  &  Finland?    

Copyrighted  Material  

U.S.  Dairy  Situa?on  at  a  Glance

SOURC

E:  Quickstats.na

ss.usda.go

v  

Year   Number  of  Farms  

Cows  (Million)  

Yield  (Kg/Year)  

Cows  Per  Farm  

Produc<on  (000  MT)  

1980 334,180 10.8 5,394 32 58,026  

1985 269,050 10.8 5,908 40 63,665  

1990 192,660 10.0 6,705 52 67,149  

1995 139,670 9.5 7,441 68 70,556  

2000 105,055 9.2 8,254 87 75,795  

2005 78,300 9.0 8,868 115 79,841  

2010 62,500 9.1 9,593 145 87,153  

2012 58,000 9.2 9,842 159 90,738  

Genera?ons  of  Farm  Technologies

SOURCE:  USDA  NASS  and  own  es<mates.  

10

12

14

16

18

20

22

%  of  U

.S.  M

ilk  Produ

c?on

100-­‐200 200-­‐500

500-­‐1000 1000-­‐2000

When  Was  Each  Farm  Type  at  its’  Peak  in  terms  %  of  Total  U.S.  Milk  Produc?on?

100-­‐200  Cows   1997  

%  at  peak   20.0%  

200-­‐500  Cows   2000  

%  at  peak   18.0%  

500-­‐1000  Cows   2005  

%  at  peak   14.3%  

1000-­‐2000  Cows   2007  

%  at  peak   16.1%  

Large  Farms  More  Important  than  Ten  Years  Ago

SOURCE:  USDA  NASS  and  own  es<mates.  

U.S.  Regions

Farm  Structure,  Costs,  Revenues  in  2012

SOURC

E:  USD

A  ER

S,  M

ilk  Cost-­‐of-­‐Produ

cMon

 EsMmates,  own  calculaM

ons  

In  Which  Areas  of  the  U.S.  is  Milk  Produc?on  Growing?

Source:  Dr.  Mark  Stephenson,  University  of  Wisconsin-­‐Madison

Share  of  U.S.  Milk  Produc?on:  1973  vs.  2013

SOURCE:  USDA  NASS  and  own  es<mates.  

U.S.  Government  Purchases  of  Dairy  Products

SOURCE:  Jesse  &  Cropp  (2008)  Basic  Milk  Pricing  Concepts  for  Dairy  Farmers  

U.S.  Corn  Use:  1998-­‐2013

SOURCE:  USDA,  World  Agricultural  Supply  and  Demand  Es<mates,  various  issues,  and  own  es<mates.  

U.S.  Dairy  Exports:  1996-­‐2013

SOURCE:  USDEC  and  own  es<mates.  

New  Zealand  vs.  U.S.  Yield  Per  Cow  Growth

SOURCE:  USDA  and  own  es<mates.  

U.S.  Dairy  Income  over  Feed  Costs  Dynamics

SOURCE:  USDA  and  own  es<mates.  

0  

5  

10  

15  

20  

25  

U.S  Dairy  IO

FC  M

argin,    /  cwt  

IOFC  Margins   Feed  Prices   All-­‐Milk  Prices  

Private  Risk  Management  in  the  U.S.

SOURCE:  CME,  own  calcula<ons  

0

50,000

100,000

150,000

200,000

250,000

300,000

Contracts

All  Dairy  Futures  &  Op?ons  Open  Interest

Futures  and  Op?ons  Contracts  /  Year  Introduced

Cheddar  Cheese  (D)   1993  

Nonfat  Milk  Pwdr  (D)   1993  

BFP  Milk   1997  

BuVer  (D)   1997  

Class  III  Milk   2000  

Class  IV  Milk   2000  

BuVer   2005  

Dry  Whey   2007  

Nonfat  Milk  Powder   2008  

Nonfat  Milk  Pwdr  (D)   2009  Intl.  Skim  Milk  Powder   2010  

Cheddar  Cheese   2010  

Tradi?onal  Dairy  Policy  No  Longer  Effec?ve

OLD  POLICY   NEW  PROBLEM   NEW  SOLUTION  

Focuses  on  Milk  Price   •  Many  dairies  buy  most  of  their  feed.  

•  Feed  prices  very  risky.  

 

Focuses  on  Income  over  Feed  Costs  (IOFC)  Margin  

Countercyclical  Payments   •  PoliMcal  Climate  Favors  Risk  Management  

Introduces  IOFC  Margin  Insurance  

Balances  Markets  Through  Government  Purchases  

•  U.S.  Dairy  Exports  Are  Strong,  Cannot  Isolate  US  Market  

Introduces  Dairy  Market  StabilizaMon  Program  (“Growth  Management”)  

Income  over  Feed  Cost  Margin  Insurance

$0.00  

$2.00  

$4.00  

$6.00  

$8.00  

$10.00  

$12.00  

$14.00  

$16.00  

Free  Catastrophic  Level  Protec?on:  $4.00/cwt  

$0.00  

$2.00  

$4.00  

$6.00  

$8.00  

$10.00  

$12.00  

$14.00  

$16.00  

Which  Level  To  Choose?  $6.50  is  cheap,  yet  effec?ve.

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

$16.00

Dairy  Margin  Insurance  Premiums  Never  Change

Dairy  Producer  Margin  Protec?on  Program (Bill  Proposed  in  the  U.S.  Senate)

Coverage First  4 Mil  lbs

Above

$4.00 $0.00 $0.00

$4.50 $0.01 $0.02

$5.00 $0.02 $0.04   $5.50 $0.035 $0.10   $6.00 $0.045 $0.15  

$6.50 $0.09 $0.29   $7.00 $0.40 $0.62   $7.50 $0.60 $0.83   $8.00 $0.95 $1.06  

Hybrid  Between  Income  Support  and  Insurance  Product

Expected  Margins  Near  Historical  Average

Program  Behaves  as  Modestly  

Subsidized  Risk  Insurance

Expected  Margins  Much  Above  Historical  Average

Margin  Insurance  Premiums  are  too  Expensive.  Private  Markets  Must  be  

Used.

Expected  Margins  Much  Below  Historical  Average

Margin  Insurance  Premiums  are  very  Highly  

Subsidized.  Program  Behaves  not  as  Insurance  but  as  Income  Boos?ng  

Counter-­‐cyclical  Payments  Scheme

Fixed  Costs  Slow  Down  Market  Balancing  

Varia

ble  Co

sts  

Fixed  Co

sts  

Milk  Price  

Loss  if  you  ConMnue  to  Produce  

Loss  Is  Bigger  if  you  Reduce  ProducMon  

…but  demand  for  dairy  is  “inelasMc”.  What  that  means  is  that  if  many  producers  cut  back  a  liOle  at  the  same  <me,  milk  prices  will  go  up  sufficiently  to  offset  lost  revenue.  

Five  Principles  of  the  Dairy  Market  Stabiliza?on  Program

1)  Temporary:  StabilizaMon  incenMves  only  in  place  while  margins  are  low.  When  markets  recover,  you  may  resume  growth  without  penalty.  

2)  Voluntary:  Only  those  that  wish  to  benefit  from  subsidized  margin  insurance  will  be  asked  to  cut  back  milk  producMon  when  margins  are  low.  

3)  Propor<onal:  If  margins  are  modestly  low,  you  are  asked  to  modestly  cut  back  milk  producMon  (i.e.  when  margins  are  between  $5.00  and  $6.00,  cutbacks  needed  to  avoid  penalty  are    2%  of  the  stabilizaMon  base).  When  margins  are  drasMcally  low,  needed  cutbacks  are  bigger.    

4)  Pro-­‐growth:  StabilizaMon  base  calculated  as  average  of  last  three  months  of  producMon.  Base  grows  fast  when  your  operaMon  grows  fast.    

5)  Exports-­‐Minded:  If  domesMc  prices  are  sufficiently  above  world  prices,  stabilizaMon  program  is  suspended,  even  if  margins  are  sMll  low.  Program  is  designed  to  balance  domesMc  market,  not  world-­‐wide  shocks.    

1.  Temporary:  Stabiliza?on  Program  Ac?ve  When  Margins  are  Low

-­‐9%

-­‐7%

-­‐5%

-­‐3%

-­‐1%

1%

3%

5%

7% USA  Year-­‐on-­‐Year  Milk  Produc?on  Growth  2008-­‐2013

2.  Voluntary:  Margin  Insurance  Subsidies  Mo?vate  Par?cipa?on

Coverage   2007-­‐2013  Average  Expected  Subsides  

2009  Expected  Subsidies  

($)   As  Percent  of  Average  Margin    

150  Cows  

3,000  Cows  

150    Cows  

3,000    Cows  

$4.50   55% 64% 28% 93% 86%

$5.00   61% 74% 48% 94% 88%

$5.50   67% 76% 30% 94% 83%

$6.00   73% 81% 36% 95% 83%

$6.50   79% 75% 18% 93% 76%

$7.00   85% 22% -­‐21% 74% 60%

$7.50   91% 15% -­‐18% 69% 57%

$8.00   97% -­‐1% -­‐13% 59% 54% Source:  Based  on  Newton  (2013)  

3.  Propor?onal:  Penal?es  are  Commensurate  with  Margin  Declines

–  If  margins  were  $5.00-­‐$6.00:  •  98  percent  of  stabilizaMon  base  •  94  percent  of  the  markeMngs  of  milk  

–  If  margins  were  $4.00-­‐$5.00  •  97  percent  of  stabilizaMon  base  •  93  percent  of  the  markeMngs  of  milk  

–  If  margins  were  less  than  $4.00  •  96  percent  of  stabilizaMon  base  •  92  percent  of  the  markeMngs  of  milk  

4.  Pro-­‐Growth:  Stabiliza?on  Base  for  a  Fast  Growing  Dairy

Source:  Newton  et  al.  (2013)  

5.  Exports-­‐Minded:  Stabiliza?on  Program  Will  Suspend  If…

If  Margins  are  $5.00-­‐$6.00,  DMSP  will  suspend  if  U.S.  cheese  price  is  higher  than  the  world  cheese  price,  or  if  the  price  in  the  United  States  for  nonfat  dry  milk  is  equal  to  or  greater  than  the  world  price  of  skim  milk  powder. If  margins  are  $4.00-­‐$5.00,  DMSP  will  suspend  if  U.S.  cheese  price  is  more  than  5%  higher  than  the  world  cheese  price… If  margins  are  below  $4.00,  DMSP  will  suspend  if  U.S.  cheese  price  is  more  than  7%  higher  than  the  world  cheese  price…

Current  U.S.  Dairy  Policy  Situa?on

Standalone  Dairy  Margin  Insurance   Dairy  Margin  Insurance  +  Dairy  Market  Stabiliza<on  Program  

Open  Ques?ons  regarding  New  U.S.  Dairy  Policy

1)  Will  it  work  as  intended?  Will  producers  find  some  loophole  and  not  reduce  milk  produc?on  when  DMSP  is  ac?ve?

2)  Will  the  new  margin  insurance  crowd  out  private  risk  markets?

3)  What  will  be  the  long-­‐run  effects?  Will  milk  produc?on  increase,  and  reduce  average  milk  prices?  

4)  Will  producers  that  are  bemer  financially  situated  exploit  the  hybrid  nature  of  the  margin  insurance  and  over-­‐insure  when  expected  margins  are  very  low?  

5)  Will  the  stabiliza?on  program  hurt  consumers  by  increasing  price  of  milk  in  recessionary  environment  when  incomes  are  fragile?  

What  are  the  lessons  for  the  E.U.  /  Finland?

1)  When  government  lets  private  markets  operate,  dairy  prices  become  more  vola?le.  An?cipate  vola?le  markets  post  2015.

2)  Would  a  Dairy  Market  Stabiliza?on  Program  work  in  Europe?  The  problem  is  that  some  countries  will  grow  faster  than  others  once  quota  is  abolished.  So  DMSP  may  impinge  on  farmers  in  faster-­‐growing  countries  more  than  on  farmers  in  countries  where  milk  produc?on  is  stagnant.  This  will  make  any  consensus  harder  to  achieve.

Sources  and  References

 The  quan?ta?ve  results  presented  here  are  based  on  a  research  project  led  by  Dr.  Cameron  S.  Thraen  and  John  C.  Newton,  the  Ohio  State  University.    Primary  reference:   Newton,  John  C.    Policy  OpGons  for  a  Modern  Dairy  Economy,  Ph.D.  DissertaGon,  Copyright  The  Ohio  State  University  2013.    

How are U.S. Milk Producers Prepared for Price Fluctuations – The Future of U.S. Farm Bill System PI Dairy Forum 2013 Helsinki, Finland November 21, 2013 Dr. Marin Bozic mbozic@umn.edu Department of Applied Economics University of Minnesota-Twin Cities 317c Ruttan Hall 1994 Buford Avenue St Paul, MN 55108 http://marinbozic.info