Academic journal article Journal of Agricultural and Applied Economics

Adoption of Milk and Feed Forward Pricing Methods by Dairy Farmers

Academic journal article Journal of Agricultural and Applied Economics

Adoption of Milk and Feed Forward Pricing Methods by Dairy Farmers

Article excerpt

Increasing volatility in milk and feed prices has led to higher levels of market and financial risk for dairy farmers. We examine dairy farmer use of forward pricing methods for milk sales and feed purchases. Operators with larger herds, higher levels of education, and those farm businesses that were not organized as sole proprietorships were more likely to have used forward pricing. We also examine reasons dairy farm operators had not used these tools to date and find that the most common reason was lack of knowledge. These findings may be used to target educational seminars and outreach to dairy farm managers.

Key Words: dairy farmers, feed price, forward pricing, hedging, milk price, risk management

JEL Classifications: G13, Q12, Q13

(ProQuest: ... denotes formulae omitted.)

Dairy farmers have received increasingly vola- tile cash milk prices and paid higher and more volatile cash feed prices in recent years. Much attention has been given to the increasing mar- keting and financial risks associated with this volatility. One measure of the variation of milk and feed prices at the farm level is income over feed cost, a commonly used proxy for dairy farm profitability (Wolf, 2010). The margin between milk price and feed cost is the amount available to pay for all other expenses, including labor and returns to management, capital, and un- paid labor. Figure 1 displays income over feed cost calculated as the U.S. all milk price less a weighted cost for corn and soybeans that the U.S. Department of Agriculture has used for many years to calculate the milk-to-feed price ratio.1 For the United States, from 1990 through 2012, this monthly income over feed cost mea- sure averaged $11 per hundred weight (data from USDA-NASS, 2013a). The relative varia- tion in the series has increased over time. From 1990 through 1999, the monthly coefficient of variation-the standard deviation divided by the mean as a measure of percent variation-of this margin was 13.6%. From 2000 through 2012, the coefficient of variation increased to 20.4%. This Variation in margin occurred because vari- ation increased in both the milk and feed prices. With respect to milk prices, one factor was that the Dairy Price Support Program had a farm milk price support that did not interfere with market prices in recent years (Chouinard et ah, 2010). Feed crop price level and variation has increased for various reasons including weather events and energy costs. In 2009, a prolonged period of low-or negative-margins resulted in substantial financial losses on most dairy farms.2

There are many reasons that dairy farmers might use forward contracting tools, including attempting to increase profit and for tax man- agement purposes, in the case of feed pur- chases.3 However, given the recent increase in feed price levels and volatility in both milk and feed prices, it is likely that risk management has been an increasingly important motivation. Forward pricing tools U.S. dairy farmers might find useful include milk and feed cash forward contracts as well as futures and options con- tracts. With respect to output price risk, Class III milk price futures contracts and options for each calendar month are available 24 months into the future. Class III price is the Federal Milk Marketing Order-defined minimum farm price of milk used for cheese (and whey ) and is the primary driver of farm milk prices in the United States. Class III is the primary driver of farm prices because cheese is the single largest class use of milk and because Class I (fluid) and Class II (soft manufactured product) minimum prices are established by formulas that use the Class III price.4 Class III futures and options traded on the Chicago Mercantile Exchange (CME) are 200,000 pound monthly contracts that cash settle when the Class III price is an- nounced for each month. The open interest and volume in Class III contracts has increased dramatically in the past decade reflecting the desire of both sellers (e. …

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