MU economist: Risk management skills determine dairy survival
To survive, dairy farmers must think risk management.
"There are all kinds of tools available, but there is no single strategy that reduces risks for all farms," said a University of Missouri dairy economist at the Heart of America Dairy Expo in Springfield. "Each farm must develop its own plan."
Scott Brown said fluctuations plague producers on input costs for feed and energy. Now, milk prices are becoming more volatile due to government programs and world prices.
"We won't see volatility reduced in the near term," Brown added.
While milk prices trend upward, they take wild swings getting there. Monthly all-milk prices touched $22 per hundredweight in 2008, and then fell almost by half to near $11 in 2009.
At the same time, feed costs made a steadier upward trend, putting pressure on profits.
Switching into "economist talk," Brown said, "Dairy is very price-inelastic and is becoming more inelastic. Fluid milk is one of the most inelastic products, as there are few substitutes for dairy products."
Small shifts in supply--or demand--bring big shifts on prices.
Years ago, when there were many small dairy herds, supply would adjust quickly. However, as dairy farms become fewer and bigger, there is less flexibility.
In 1970, there were 650,000 dairy farms. That fell to 90,000 in the 2000s.
Now, large operations don't fold as quickly.
Besides input costs and dairy prices, there are many uncertainties facing today's milk producers.
They must watch dairy demand, the U.S. economy and related job growth, world trade, exchange rates, and the farm bill.
More uncertainty is brought by weather, which is beyond producer control.
However, each farm can control quantity of milk produced at least costs. "Being an efficient producer remains the best risk-management tool in your kit. That is huge," Brown said.
"Your first focus must be on cost of production. Low-cost farms cover all economic costs," he said. "However, high-cost farms require other sources of income."
There are management tools, including futures market and forward contracts, to reduce risks. But futures must be used for risk management, not speculation trying for market tops.
"Your plan must be to reduce volatility, not hit highest prices," Brown said. "If you can guess the highs, you should give up dairying and become a market trader."
Some producers aim for relief on feed costs by growing crops. "Feed costs are a major input. However, for success, you must be a low-cost producer of corn and soybeans. Both enterprises, dairy and crops, must be efficient."
Brown urged producers to take advantage of services from their dairy cooperatives. "They have all kinds of tools and experience in risk management through futures and contracts. Use their advice.
"It all comes back to tailoring risk management to the individual farm."
Government policy plays a role in risk reduction. A proposed Dairy Security Act in the farm bill would have allowed producers "buy-up options." That would have been similar to current crop insurance.
However, that act did not make it through the year-end legislative crunch. Instead, a farm bill extension keeps the current Milk Income Loss Contract in place for nine months.
In all management systems, better data collection--and use--will be important to producers, Brown said.
In the end, Brown thanked dairy farmers for their work in providing needed dairy products for U.S. consumers--and those around the world.
Dipping into outlook, Brown said his projection for average milk price in 2013 was up slightly, to $19.40 per hundredweight. That compares to $18.63 in 2012.