No Crystal Balls Here

If you ever heard an economist share their forecast about where markets are heading, they typically use the phrase, “I don’t have a crystal ball.” Basically, that means they don’t really know what next year’s markets will bring. They can only look at the market fundamentals to see what factors could influence prices.

Recently I heard Rob Goodling from Horizon Farm Credit share his 2023 dairy outlook, and his title caught my attention right away: “Short Term Opportunity or Fundamental Market Shift.” The reason why it caught my attention is because it seems like every time commodity prices increase, some people try to point to a fundamental shift in the market that will cause this to be the new normal. But if there is anything we should know by now, it’s that there is no “normal” in the commodity marketplace. It’s just a series of unforeseen highs followed by unpredictable lows, with the race to the top and bottom playing out in between based on what happens to supply and demand.

Currently dairy farm families must choose whether to sign up for the USDA’s Dairy Margin Coverage Program in 2023. If you look at current market prices, the program will yield an indemnity payment in every month next year because feed costs are higher and milk prices are starting to fall. That doesn’t mean the program is guaranteed to pay out. It’s like any other insurance program you use. You are purchasing protection against what you don’t know could happen next year.

In 2021, when producers looked ahead to 2022, they saw margins that did not yield payments for most of the year. So many chose not to sign up. However, fast forward to this fall, feed costs are higher and milk prices are lower than what was forecasted. So, those protected at the $9.50 per cwt. level margin received payments in August and September. The market is also projecting a payment in November and December, with October’s margin projected to be just 2 cents above the $9.50 ceiling for the program.

Why Enroll in DMC?

Earlier this month, USDA announced the September DMC margin at $8.62 per cwt., based on a $24.40 per cwt. all-milk price and feed costs that averaged $15.78 for every 100 pounds of milk produced. Although it is down from May’s peak of $27.30 per cwt., September’s all-milk price was well above the five-year average. However, feed prices are up significantly from earlier this year, peaking in August at $16.22 per cwt., up from $14.79 in May when the all-milk price peaked.

Factors that are shifting prices right now have more to do with demand than with supply. USDA reported the US total milk production was at 18.28 billion pounds in September, up 1.5 percent from a year ago but down close to 1 percent from August’s production, when calculated on a daily basis. Cow numbers are up only 6,000 head from a year ago and down 7,000 head from their peak in May. Most of the growth in September came from an increase in milk production per cow, up 27 pounds from last year.

Unfortunately, higher food prices and inflation are starting to restrict demand growth. Tighter supplies for butter and cream were pushing up Class IV prices earlier in the year. However, butter stocks are beginning to level out with higher retail prices slowing butter sales. That slowdown in sales is expected to increase after the holidays are over. In addition, nonfat dry milk demand has been sluggish for most of this year, with NDM exports through September down 9 percent compared to a year ago.

Class III milk prices are remaining relatively stable, with total cheese stocks only up 1 percent from a year ago to nearly 1.470 billion pounds. Cheese exports have been strong for most of this year, with September cheese exports up 4.8 percent from a year ago to 78.8 million pounds.

On the input side, though, feed prices through 2023 remain unpredictable. The USDA is still trying to get a handle on what this year’s harvest looks like, recently increasing yields of both corn and soybeans by an average of 0.4 bushels per acre. That resulted in an increase of 10 million bushels in ending corn stocks and 20 million bushels in ending soybean stocks. Still, global ending stocks of both commodities are projected to be down from a year ago, with supplies remaining tight.

Protecting the Margin

With the unpredictable nature of today’s commodity markets, every producer – whether you’re in the dairy business or in another aspect of farming – needs to know their risk management plan. That plan includes your crop insurance to protect against drought or other unforeseen weather events. It also includes fire and other hazard insurance to protect against those catastrophic events. Finally, it should include a plan to protect your business if the margins you receive fall below what is needed to cover your breakeven costs.

For some farms, that means having cash reserves. But with the huge capital demands of farming today, for many farms, that is not possible. Programs like the DMC Program provide that coverage for farmers who don’t have those cash reserves available to make up shortfalls in your margin. The unique advantage that DMC offers is that it protects your margin against changes in both the input and output side. If milk prices fall, DMC margin coverage kicks in. If feed costs skyrocket, DMC margin coverage kicks in. Price contracting and other types of risk management don’t cover both sides of the equation.

DMC is also cheap insurance. For just 15 cents per hundredweight, dairy farms producing less than 5 million pounds can guarantee that their profit margin will not fall below $9.50 per cwt. The coverage becomes more expensive for milk produced above 5 million pounds, but every farm can have that first 5 million pounds covered at 15 cents per hundredweight.

DMC coverage is also easy to get. All you have to do is go into your local USDA Farm Service Agency office before December 9, 2022, to sign up to receive the coverage in 2023. If you haven’t signed up before, you’ll need to have your production information from your milk market available, and you’ll have to pay a $100 administration fee in addition to the premium. However, only the administration fee is due upfront. You’ll have until September 2023 to pay the premium, and it can be collected off the indemnity payments you receive.

Enrolling in DMC basically protects your business from the unknown. Most farmers would not think of operating without fire or auto insurance. Although we don’t plan for a fire or an accident to happen, we never know when those incidents will occur so we protect our business from the catastrophic loss they could create. The same goes for losses in income created by changes in the marketplace.

Unfortunately, dairy farming doesn’t come with a crystal ball. Nobody knows when the next surge in supply or decline in demand is going to create havoc on milk prices. We also don’t know what weather disaster will suddenly create a shortage in feed supplies. Having a risk management plan in place and using tools like the DMC program can help you plan for those unforeseen events.

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