Dairy producers have always carefully managed costs. However, as price takers, most dairy producers have had limited options managing price risk. The new Dairy Revenue Protection (DRP) program gives producers the ability to change that. DRP allows producers to establish a price floor based on current futures markets. This means producers are able to establish a guaranteed minimum price for the milk shipped, without sacrificing any upward market movement.
DRP is a quarterly-based insurance program that protects against sudden declines in the milk price. The policies are priced at the end of every Chicago Mercantile Exchange (CME) trading day. The Risk Management Agency (RMA) uses the final prices at the end of the trading day to establish a quarterly price forecasted through the next five quarters. This gives producers the opportunity to secure a floor up to fifteen months into the future. Another benefit of the program is that it is very flexible, allowing producers of all herd sizes and breeds to secure a floor based their current production and components.
Looking at the historical price of class III milk from January of 2016 to the present day we have seen milk prices range from $12.76/cwt in May 2016 to $17.60/cwt in August 2019. With a $4.84/cwt swing in the class III price it is important for producers to consider building a risk management plan to protect the business from large market swings as shown in the attached chart. The chart shows historical class III prices, as well as current futures prices through October of next year. If a floor is established on class III milk at $17.50/cwt and the class III price climbs to $19.00/cwt in that quarter the producer will still receive the $19/cwt price and would pay roughly $0.20/cwt to guarantee that price floor.
It is important for dairy producers to evaluate what they are protecting with a risk management plan. With every operation having a different cost structure, and analyzing the class III price over the last three and a half years, it is important to look at the big picture. With any risk management plan, the main priority should be protecting the equity of the business by insuring cash flow.
An important way to preserve equity is to protect cash flow. In developing a DRP risk management plan, it is important that the price floor being considered is above, or at least close to, a producer’s cost of production. The current price forecast has allowed many producers to secure a price floor above their current cost of production, insuring profitable margins through a large portion of the 2020 calendar year.
Crop Growers’ staff can help producers develop a risk management plan that works for their operations. Crop insurance products can address a variety of risks and the DRP program can be a good option for dairy producers to mitigate price risk.
Contact Charlie Messenger
, Yankee Farm Credit's Crop Growers agent to enroll, 802-735-5951.
Wondering how DRP and Risk Management can fit into your current plan?
Contact Yankee Farm Credit's Business Consultant, Joanna Lidback
By Tristan Peterson, Crop Growers, LLP