managing risk and seizing opportunity in 2012 and beyond dr. marin bozic nebraska state dairy...
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Managing Risk and Seizing Opportunity in 2012 and
Beyond
Dr. Marin BozicNebraska State Dairy Association│ March 13, 2012
1) Recent events in the dairy markets
2) Risk factors in 2012
3) Hedging margin risk
4) Long-run risk management
Topics for today
June 2012 Class III Futures
1/12
/201
2
1/16
/201
2
1/20
/201
2
1/24
/201
2
1/28
/201
2
2/1/
2012
2/5/
2012
2/9/
2012
2/13
/201
2
2/17
/201
2
2/21
/201
2
2/25
/201
2
2/29
/201
2
3/4/
2012
3/8/
2012
3/12
/201
2$14.00
$14.50
$15.00
$15.50
$16.00
$16.50
$17.00
$17.50
$18.00
June 2012 Class III FuturesComponents contribution to decline
1/12/2
012
1/20/2
012
1/28/2
012
2/5/2
012
2/13/2
012
2/21/2
012
2/29/2
012
3/8/2
012
-$1.80
-$1.60
-$1.40
-$1.20
-$1.00
-$0.80
-$0.60
-$0.40
-$0.20
$0.00
Butter
Dry Whey
Cheese
Term structure of futures prices
Based on options data, there is 20% chance Class III price will settle below the shaded area, and 20% it will settle higher.
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15$10.00
$11.00
$12.00
$13.00
$14.00
$15.00
$16.00
$17.00
$18.00
$19.00
$20.00
Dow
nsid
e Ri
sk
12.2
12.4
12.6
12.8 13
13.2
13.4
13.6
13.8 14
14.2
14.4
14.6
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
June 2012Futures: $15.80 (as of 3/12/2012)
Dow
nsid
e Ri
sk
10.9
11.1
11.3
11.5
11.7
11.9
12.1
12.3
12.5
12.7
12.9
13.1
13.3
13.5
13.7
13.9
14.1
14.3
14.5
14.7
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
Dec 2012Futures: $16.75
(as of 3/12/2012)
Risk factors
• U.S. recovery to stop?• Eurozone collapse?• War with Iran?• Runaway inflation? • Three year cycles? (2009 + 3 = 2012)
Implied Probabilities of Uncertain Events:1. U.S. Economic Recovery
Implied Probabilities of Uncertain Events:2. Dropping out of Euro zone
Implied Probabilities of Uncertain Events: 4. War with Iran
Implied Probabilities of Uncertain Events: 4. War with Iran
Can we make use of prediction markets in dairy?
Information discovery:• E-verify to become mandatory before
12/31/2012• Farm bill to pass before 9/30/2012
Risk transfer:• “The Secretary of Agriculture to announce
that the stabilization program is in effect for June 2012”
Expected Inflation: Evidence from Treasury Securities
Expected Inflation: Evidence from Treasury Securities
Jan-
08
Apr-0
8
Jul-0
8
Oct-08
Jan-
09
Apr-0
9
Jul-0
9
Oct-09
Jan-
10
Apr-1
0
Jul-1
0
Oct-10
Jan-
11
Apr-1
1
Jul-1
1
Oct-11
-2.00
-1.50
-1.00
-0.50
0.00
0.50
1.00
1.50
2.00
2.50
3.00
Historical Milk-Feed Margin 2010-2011
$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
$12.90
$5.72
$7.57
$15.46
$7.54
$16.56
$3.55
$6.28
$13.10
Margin - Historical Top 50% Percentile
Source: Katie Krupa, Rice Dairy, LLC.
1 cwt of milk
- 0.80575 bu of corn
- 0.0087 ton of SBM
2/8/2012
Rice Dairy Milk-Feed Margin Formula
Source: Katie Krupa, Rice Dairy, LLC.
1 cwt of milk
- 0.80575 bu of corn
- 0.0087 ton of SBM
3/12/2012
Rice Dairy Milk-Feed Margin Formula
Source: Katie Krupa, Rice Dairy, LLC.
Three year cycles? Evidence from forward margins
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
$18.00
Three year cycles? Evidence from forward margins
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
$18.00
Historical Perspective
$7$8$9
$10$11$12$13$14$15 $14.15
Dec '07 Margin Trade Data
Source: Katie Krupa, Rice Dairy, LLC.
Historical Perspective
$2$3$4$5$6$7$8$9
$10$11$12
$10.63
$3.62
Feb '09 Margin Trade Data
Source: Katie Krupa, Rice Dairy, LLC.
Forward Dairy Profit Margins 1998-2011
17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
$18.00
Margin = Class III Milk -0.80575*Corn -
0.0087*Soymeal
9-12 Months:Consistently Stable and
Sustainable Margins
Months to maturity
Inco
me
Ove
r F
eed
Mar
gin
Hedging by any other name…
There are (at least) three very different way dairymen can manage risk:• Contracting – i.e. futures and options, forward pricing
through the coop, cash contracts for feed
• Strong equity/fast growth – increasing efficiency to keep costs below national average, possibly by attracting investors to keep debt/equity ratio low in face of fast expansion
• Dairying as a hedge – low cash-flow costs, but high opportunity costs of feed. Dairying as a hedge against lower future value of land/crops
S
D
D′
Quantity
Price
Short run (wish there was a fifth udder)
S
D
D′
Quantity
Price
Long run (eight udders are better than four)
What does the long run U.S. milk supply look like?
130 140 150 160 170 180 190$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
$18.00
Annual U.S. Milk Production (3 year moving average) - Billion Pounds
U.S
. All
Milk
Pri
ce, 3
-yea
r M
ovin
g A
vera
ge
Data period: 1980-2010
Change in Dairy Farm Technology
1993
1995
1997
1999
2001
2003
2005
2007
2009
10
12
14
16
18
20
22 100-200: Peak in 1997 @
20%
200-500: Peak in 2000 @
18%
500-1000: Peak in 2005
@ 14.3%
1000-2000: Peak in 2007
@ 16.1%
100-200 200-500 500-1000 1000-2000
Percent of U.S. Milk Production by Large Dairy Farms
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
0
10
20
30
40
50
60
2000+ 1000-2000
Percent of US milk production by farms with 2000+ cows grows on average by 2.2% a year.
Flat supply curve – what are the implications?
In the long run…• Dairy Darwinism: dairyman to businessman, or out
of business.• Demand-enhancing activities boost quantity, not
price (think exports, check-off, product research & development)
• Increase in price of one milk fraction decreases the price of another (think whey vs. cheese) until returns to dairying revert to average
• Uncertainty = higher average returns• Vertical integration as the 21st century version of
“cooperative revolution”
Support from these companies is greatly appreciated
Managing Risk and Seizing Opportunity in 2012 and Beyond
presented at the I-29 Dairy ConferenceSioux Falls, February 8, 2011
Dr. Marin [email protected] of Applied EconomicsUniversity of Minnesota-Twin Cities317c Ruttan Hall1994 Buford AvenueSt Paul, MN 55108
You may download this presentation at http://marinbozic.info/