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 [email protected] Department of Applied Economics University of Minnesota-Twin Cities 317c Ruttan Hall 1994 Buford Avenue St Paul, MN 55108 http://marinbozic.info