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It’s time to re-think and re-calculate, Part I

This graph is one Zepp uses to show that even the different ways of calculating "milk margin" track together with similar patterns; however, some margin protection tools may work better than others under certain market conditions and dairy feeding scenarios.

Farm Bill shifts feed focus from milk herd to whole herd; uses historic prices, not CME futures

Special for Farmshine
BROWNSTOWN, Pa. -- The “milk margin” is a way of measuring dairy profitability by calculating the amount of milk income remaining after subtracting the largest cost on the dairy – feed.

Over the years, there have been several different ways of calculating this margin. Some figure it as “income over feed cost” on a per-cow basis, using 65 pounds/cow/day as the average for calculating milk income. Others take income over feed cost and figure it per hundredweight of milk. Up until this point, the concept of “milk margin” has been the amount of milk income per hundredweight of milk that is left over after subtracting the cost to feed the lactating herd. Rations for this calculation use the going price for corn, soymeal and alfalfa.

In 2008, USDA Risk Management Agency (RMA) started a pilot project called Livestock Gross Margin (LGM) for Dairy. It had already been in existence for beef cattle and swine, so they adapted the premise of this so-called “insurance” to be usable by dairy farmers. The purpose was to give farmers a tool for protecting themselves from risk in the milk market (output) and from risk in the feed market (inputs). This LGM “margin” is adjustable depending on whether farmers want to cover more milk risk or feed risk, but it uses just the feed fed to the milking cows, not the dry cows and replacements. It is more of a straight “milk margin,” which can be adapted to regional risk not just national market risk.

Then, along came the 2014 Farm Bill signed into law in early February. It defines “milk margin” in the new Margin Protection Program (MPP) differently. It uses “whole herd” feed costs to reflect what it costs to feed all dairy animals on a dairy farm -- not just the milk cows. Thus, when producers look at whether or not to participate in MPP or LGM or to build a plan using just commercial risk management options, they need to understand that the new margins will be lower because all feed on the farm is subtracted from the milk income to arrive at that margin, whereas other calculations look just at the cost to feed the milking herd, so those margins are higher.

These milk margins and/or income over feed cost figures are reported differently, they trend pretty much the same, but not exactly the same.

The MPP will be administered by the Farm Service Agency (FSA) so we’ll call the new Farm Bill Margin the FSA margin. The LGM Dairy program will continue to be administered by RMA through private insurers, and we’ll call that the LGM margin because people are familiar with LGM as a risk management tool in the crop-insurance-like toolbox.

The new Farm Bill states that a dairy producer can no longer participate in the old LGM-Dairy through RMA and private insurers if that producer intends to participate in the new MPP through FSA when final rules are announced later this summer by USDA.

While the relationship between the FSA margin and the LGM margin are similar, they are not the same. Put simply, the default LGM margin that has been quoted in the Markets and Management box every week in the markets and classified section of Farmshine, uses only the ration for the milking herd. Starting this week with the Markets and Management Update on page 36 of this edition, the “milk margin” lines near the top of the box beneath the Class III milk futures, will reflect the milk income after deducting the cost to feed the whole herd -- milk cows, dry cows, and replacements.

But, there is another difference between the LGM margin and the FSA margin.

The new FSA margin for the new MPP program compares historic USDA-announced prices for “All-Milk” and for feed ingredients corn, soybean and alfalfa hay and compares this margin derived from these historical prices to established margin thresholds for different levels of free and purchased “margin protection” that will be offered by the government. Specifically, the FSA margin uses the All Milk price reported by USDA as well as the corn price and hay price from USDA’s Agricultural Prices monthly report. It also uses the soybean price from the Central Illinois price report.

The LGM margin, on the other hand, looks at actual margins in comparison to expected margins that are based on the CME future contract prices for Class III milk as well as corn and soybean at the time such “insurance” is purchased. Specifically, LGM uses the closing future prices on the CME for Class III milk (not the announced “All Milk” price) and for corn and soymeal, with no calculation for alfalfa hay.

The new FSA margin for the new MPP program will be listed in the Markets and Management Update (page 36 this week) as the “Farm Bill (FSA) Margin” and the LGM margin will be listed as the “LGM margin now calculated with whole-herd feed costs like the FSA Margin” so that producers will be able to compare apples to apples instead of apples to oranges -- so to speak.

“We want to standardize these margins so producers can look at the numbers and see what it is today under both programs,” said Alan Zepp, RMA risk management coordinator at the Center for Dairy Excellence during a recent interview with Farmshine at the Center’s office in Harrisburg.

One of the most striking differences, apparent on a graph of how the FSA margin would have historically tracked compared with LGM, is that in 2009 and again in current times.

In 2009, the milk price downturn lasted so long that once the risk management opportunities provided by the market in 2008 vanished, producers found few opportunities in the market in 2009 to use CME hedging or LGM-Dairy to manage risk because profitable prices were unavailable.

Today, the situation is somewhat reversed. The market offers profitable margins to protect with commercial tools as well as LGM-Dairy; but a program like the Farm Bill MPP through FSA only insures at a margin level well below what is currently available through the market derivatives.

This sounds confusing, but the bottom line is that dairy producers may find LGM to be a good base for a marketing plan some of the time while the new Farm Bill MPP through FSA may be a good base for a marketing plan at other times. Since producers cannot use both programs, they will have to choose what fits their risk management approach best.

While today’s CME futures markets provide opportunities to protect margins well above the $4 to $8 per hundredweight range, the new Farm Bill MPP administered by FSA will only allow producers to protect margins of $4 to $8, with the $8 margin being prohibitively expensive to insure, except on the first 4 million pounds of annual production.

Next week, in Part II, we’ll dig into this “milk margin” discussion even further, and readers can keep track of changing margins every week in the Markets and Management Update -- a joint production by Farmshine, Center for Dairy Excellence and RMA found in Farmshine’s markets and classifieds section.