The Dairy Margin Coverage Program The Dairy Margin Coverage Program — a new risk management option Mark Stephenson, Director of Dairy Policy Analysis

Risk Management Options Do nothing—self insure Futures & options Cash contract with coop or plant Swaps LGM-Dairy Dairy-Revenue Protection Dairy Margin Coverage—(Revised MPP-Dairy)

Does Contracting Work? USDA-AMS Study

Futures Markets A clearing house for information relevant to markets Big sponge for weather, politics, general economy, production reports, etc. They are trying to find agreement at a point in time about a future value of a product They transfer risk for hedgers They provide profit motive for speculators to accept risk Provide price discovery for the rest of us Futures markets will be wrong about the price We have no evidence that they are biased The closer we are to the expiration date, the more accurate a futures price is

Futures Markets Options provide the right to own the underlying futures contract at a specified price Cost of option premium reflects the likelihood of having to supply the underlying contract at the specified price If the commodity is harder to predict future prices, the option costs more If the expiration date is further away (we are less certain about the market conditions) the option costs more We can used options prices to calculate the future risk of a price forecast

The Margin Protection Program becomes Dairy Margin Coverage

The Agriculture Improvement Act of 2018 Title I contains the commodity titles which have temporary authority. They will expire at the end of a Farm Bill’s life. Subtitle D, Sec. 1401 is the Dairy Margin Coverage program

Dairy Margin Coverage New Name, same basic concept—based on margin between milk and feed prices Farms must choose coverage level and pay premium— higher coverage requires higher premiums Can only cover a percentage of historic production Most of the parameters of the program were tweaked in some way to make it more farmer-friendly

Production History You keep your same production history that you last had if you participated in the program You get all of the “bumps” that were accumulated If you didn’t participate previously, your production history will be established in the same way: Highest annual production in 2011, 2012 or 2013 If you have a new operation since 2013, you can estimate production If you got “caught” with a partial year’s production in 2013, there will be a means to establish a full year’s history There will be no more “bumps” in production history FSA will let you know what your production history is

Amount of Milk Covered Tier 1 coverage is increased from 4 million pounds to 5 million pounds of historic production You can elect to cover a percentage of production history from 5% to 95% (previously 25% to 90%)

New Premiums and Coverage Levels

Objective: Avoid Tier 2 Coverage For farms with more than 5 million pounds of historic production, choose the percentage coverage that gets you closest to 5 million pounds. Example: 10 million HP, choose 50% = 5 million Example: 23 million HP, choose 20% = 4.6 million If you have more than 100 million pounds of HP, choose 5%, but you will have to buy some Tier 2 coverage If a farmer elects $8.00 coverage or less, then he/she must select the same coverage level in Tier 2 If a farmer elects $8.50 coverage or more, then he/she may select any different coverage level in Tier 2

Strategy Tier 1 coverage is inexpensive at any level If you are a larger farm (more then 5 million lbs PH), always pick $8.50 or above Cover as much Tier 2 as you want. At $5.00— it’s cheap catastrophic coverage

Discount Option #1: You can elect coverage each year at signup Option #2: You can elect coverage once for the entire 5 years of the Farm Bill and receive a 25% discount on premiums

Coverage at $9.50* * At $9.50 coverage, Tier 1 payments would have averaged $1.00 and would have net $0.85

Historic Benefit at Different Coverage

Net Benefit with Annual Choice

What Would I Do? Sign up for 5 year coverage with discount It’s a small benefit, but use a “set it and forget it” mentality If I’m a smaller farm (less than 250 cows), buy as much production history as I can at $9.50. It’s inexpensive risk management, and it offers good coverage for all your milk production. If I’m a medium to large sized farm, buy as much $9.50 coverage as you can and put the Tier 2 at $5.00 coverage. You will maximize your Tier 1 payments and you get low cost catastrophic coverage. Consider your additional risk management needs with Dairy- RP, LGM-Dairy, futures or cash forward contracts. There are no restrictions with DMC and other coverages

A Couple of Other Items… If you paid more money into premiums under MPP than you received in indemnity payments, then you can: Apply 75% of the difference toward DMC purchase Receive rebate of 50% of the difference in cash September 20th is the last day to reclaim this repayment The 2019 DMC signup begins June 17th and ends September 20th With the first 3 months of the year, we already know that we will receive almost 30¢ on all Tier 1 milk at $9.50 or almost 14¢ net benefit.

Observations DMC offers coverage regardless of market sentiment Futures, options, cash forward contracts, LGM-Dairy and Dairy RP, are all tied to futures market sentiment May not be able to get coverage you need Requires active management of your marketing and risk management plans Have a marketing plan in place to take the emotion out of choices

The DMC Decision Tool https://DairyMarkets.org/MPP/Tool/

Questions?