$16.13 milk in September: How could that be?
Dairymen around the world are struggling with low milk prices. Whether you are in central Minnesota, the Central Valley of California, or central Waikato, New Zealand, all dairy producers are experiencing the same pricing crisis. That is, unless you were among the forward lookers who developed and followed a market plan. At one major dairy event this summer when many were complaining about low milk prices, one dairyman was especially quiet. When privately asked later how he was doing with the low milk price, he hesitantly responded he was filling a $19.00 contract at the time. Another dairy is working on a modest expansion and improvement project because he has a high percentage of 2009 production priced at over $18.00 per hundredweight.
So how is that possible? Those dairymen, and more, have committed themselves to developing a plan for protecting their milk price, and they have followed that plan. The methods available to an individual farmer vary. Some milk cooperatives offer contracting services to their patrons. Typically, these are contracts for delivery so they are set prices for the milk delivered. If the cash price at the time of delivery is lower, the contract guarantees the higher price. If the cash price at time of delivery is above the contracted price, the farmer still gets paid the contract price. That is when many farmers have said, "I lost money contracting milk. I'm never doing that again." If they had done their homework and contracted at a price above their cost of production, they didn't really lose any money. They just didn't make as much as they would have on the current cash market.
Not all cooperatives offer such marketing programs, so if their patrons are going to achieve price protection, they need to do it on their own with a broker. This entails establishing a relationship with an appropriate broker, and dealing in larger amounts of milk. Standard milk contracts are 200,000 pounds of milk per month. If your cows average 75 pounds of milk and you contract no more than 70% of your production, you will need about 125 cows to deal in the standard contracts.
A market tool recommended to dairymen wishing to employ price protection is the "put option". In its simplest terms, a put option is a price insurance policy. When you purchase a put option through a trader, you determine the minimum price you want to protect; the market then tells you how much premium it will cost you per hundredweight. The higher price you want to protect, the higher the premium. The trouble is, sometimes that premium is higher than can be justified. This price changes continuously, so attention must be paid to the market.
The other choice for dairymen is, what level protection can they afford? A strategy used by many is to see how high a price and what base amount of milk at that price they can protect for a given cost. Each farmer needs to determine their own comfort level.
For example, on September 9, for 54 cents premium, you could have protected a July 2010 price of $13.50. After paying the premium, your net base milk price would be $12.96. Remember, this is an insurance policy on which you hope you never collect. If the Class III price is higher than $13.50, you get the cash price and the policy expires. If the Class III price is less than $13.50 in July, you collect on your policy the difference between the actual price and your protected price.
Granted, this example is fairly simple, but it illustrates the points dairymen need to consider today in the volatile milk market where desired prices keep sliding farther away.
Now, to that $16.13 milk in September. How could it be achieved? Here is the example used to reach the price.
It is based on a 150-cow herd producing 75 pounds per day and can contract through its cooperative. To be conservative in the amount they market at any one time, they contracted 25,000 per month from the first month the September contracts were quoted (February 2008). They are willing to contract no more than 70% of any month's production so they had nine September contracts totaling 225,000 pounds. The balance of the milk (112,500 lbs) was sold at the September cash price.
The final result was an average price of $16.13 – a $4.00 advantage over selling all their production without protection at $12.13.
You should also notice that you need to be looking well ahead. The trend is for the contract price to decline the closer one gets to the actual month of delivery. Marketing early for future milk produced on the farm can be worthwhile.
|Market Day**||Sept 09 Class III contract||Pounds of milk contracted||Value of the contract at settlement|
|Cash market base price||$12.13||112,500||$13,646.25|
Gross income at base milk price
Average Milk Price for September Milk
|** These prices are from the first report of each month from KDM Trading, Inc. Prices change daily and these are a snapshot in time. Reference to a company does not imply endorsement of their services or products.|
Published in Dairy Star September 18, 2009