A Delicate Balance

Opening your settlement check this month may feel better than it did a year ago. That is because milk prices are up significantly, with the April Class III milk price announced at $24.42 per hundredweight and the Class IV price announced at $25.31 per cwt. While milk futures for the next 12 months are a little lower than April prices, the market is predicting 2022 prices to average $22.86 for Class III and $23.91 for Class IV, based on May 13 settlement prices. If realized, 2022 is shaping up to be a record year for dairy prices, surpassing levels not seen since 2014.

Factors that are driving the increased prices are a shrinking global milk supply, more demand for dairy exports, and a stable domestic demand for dairy. In late April, the USDA released the March US milk production report, which had total milk production in the US down 0.5 percent to 19.690 billion pounds for the month. For the first quarter of 2022, total milk production in the US is down 1 percent, with 85,000 fewer cows in the nation’s dairy herd than a year ago. Milk production per cow in the US is also down slightly year over year, falling just 7 pounds, or 0.2 percent, from a year ago.

Supply Side Challenges

The US is not the only region plagued by a declining milk supply. All major dairy regions in the world are decreasing in milk production. New Zealand’s milk production for this season is down 4 percent from a year ago, with droughty weather conditions persisting throughout the season. In the European Union, increasing input costs coupled with Climate Change restrictions is limiting the region’s ability to grow, with output in the Netherlands alone down 4 percent from a year ago.

On the other side of the equation, US dairy export volumes reached an all-time high in 2021, with double-digit growth in both volume and value. More than 2.3 million metric tons of milk solid equivalent products were shipped overseas, up 10 percent from 2020. The value of dairy exports in 2021 was up 18 percent to reach a record $7.75 billion, with more than 17 percent of the US milk supply marketed overseas, also a record. This is the second consecutive year of record growth for US dairy exports.

Dairy exports in 2022 remain strong, with year-to-date export volumes up 0.2 percent to 1.432 billion pounds, a new January – March record. Exports of butter, cheese and whey were all up, with cheese exports in March reaching a new all-time high record. Domestic demand for dairy is also steady, with stocks of cheese and butter both down despite increased production. Total cheese stocks fell 1 percent from a year ago in March, while butter stocks were down 20 percent from a year earlier.

Rising Input Costs

It’s a delicate balance, though, because higher milk prices alone do not make strong margins. Feed costs are also approaching all time high levels, with a bushel of corn now above $8, up 50 percent from a year ago. Soybean meal prices are down from a year ago to $412 a ton, while alfalfa hay and other commodity prices are increasing. Concerns about a delayed planting could cause supply issues the next couple of months, while increasing input costs here in the US, with fertilizer alone priced three times higher than it was last year, could cause feed prices to continue to escalate.

The USDA recently released the first World Agricultural Supply and Demand Estimates report for the 2022-23 crop year earlier this month. US corn production is expected to fall 4.3 percent from a year ago due to the slow start to planting. Winter wheat projections are also at historical lows. The USDA also projects that 30 percent of Ukraine’s farmland will go unplanted this year, due to the Russian invasion of Ukraine. The lower production forecasted for the US coupled with the expected decreased production in Ukraine could weigh heavily on feed pricing forecasts into this fall.

Outside of feed costs, dairy farm families are seeing increases in almost every aspect of their business. Labor shortages are driving up wages, while increasing fuel prices are bolstering energy and fertilizer costs. Many service vendors have also increased hourly rates to carry increasing costs they are experiencing within their own businesses.

Preparing for an Uncertain Future

With so much volatility coming from all areas right now, you need to know how you are going to protect your operation against shrinking margins that could be brought on by higher input costs and/or declining milk prices. Whether it is through cash reserves or through one of the risk management programs available, every farm needs to have a plan to manage their risks. It is not enough just to assume what is forecasted now is what you’ll receive when your milk check hits your mailbox.

One program available to dairy producers to protect that margin is the Dairy Margin Coverage Program offered through the USDA. The DMC is a voluntary program administered through the USDA’s Farm Service Agency (FSA) that pays farms when the difference – or the margin – between the national milk price and the average feed costs falls below a certain level selected by the program participant. Margin levels range from $4.00 to $9.50 per hundredweight in this program, with premiums attached to the different levels. The DMC works much like an insurance program. The farmer pays a premium to lock in a margin and receives an indemnity payment when the margin falls below that level.

In addition to enrolling in the DMC Program, some farmers are leveraging contracting programs available through their cooperatives or hedging their feed costs and milk prices through a brokerage firm. Other farms are growing all their own feed or locking in any purchased feed at their local mill to protect themselves against rising commodity prices. Finally, a handful of producers in the state have leveraged the USDA’s Dairy Revenue Protection Program to manage their milk price risks.

The Dairy Revenue Protection Program offers market-based price coverage for the next five quarters, which currently includes the first quarter of 2022 through the first quarter of 2023. The program allows you to put a floor under your milk price. The benefit to the Dairy RP Program is that you are paying a premium to protect your business from the downside risk in milk pricing, but you’re not locking yourself out of any upside potential in the marketplace.

Whatever tool you use to manage your risks, the most important step is to make sure you have a plan. Consult with your family, business partners, lenders, and other trusted advisors to identify a plan that works best for your operation and then stick with that plan. Not even the very best economist can predict with certainty what milk prices or feed costs will do in the future. It’s up to each individual business to make sure they are protected from whatever happens. It’s a delicate balance but a necessary part of doing business in today’s dairy industry.

If you would like to learn more about how to protect your price risks on the dairy, Zach Myers is the risk education program manager at the Center and is willing to help you better understand your options and develop a plan. To contact him, call the Center at 717-346-0849 or email him at zmyers@centerfordairyexcellence.org.

Editor’s Note: This column is written by Jayne Sebright, executive director for the Center for Dairy Excellence.