Outlook for Wisconsin and

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Outlook for Wisconsin and U.S. Dairy Markets
FARM Team Agricultural Prices
Conference Brian W. Gould Associate
Professor Department of Agricultural and Applied
Economics University of Wisconsin-Madison August
27, 2008
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Presentation Outline

• Where have we been
• Dairy commodity prices
• Wisconsin Mailbox prices
• U.S. milk production
• Dairy product stocks
• Dairy industry outlook
• What do the futures markets tell us?
• Overview of most recent USDA dairy forecasts
• A brief overview of the Livestock Gross Margin
  Insurance Program for Dairy A new risk
  management tool

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http//future.aae.wisc.edu
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Where Have We Been Class III Price

• FMMO system Plant sales prices of cheddar
  cheese, NFDM, butter and dry whey prices
  determine minimum milk component values
• Formulas/commodities used vary by milk class
• Class III milk component values based on cheddar
  cheese, butter and dry whey prices
• Wisconsin Mailbox prices closely tied to Class
  III price with difference due to
• Over-order premiums paid by plant
• Milk quality
• Utilization of milk across the 4 FMMO milk classes

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Where Have We Been NASS Market Prices
/lb Dry Whey
/lb Cheddar Butter
Avg. Since 2002 Cheddar 1.480 Butter
1.356 Dry Whey 0.299
Source USDA, NASS
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Where Have We Been Wisconsin Mailbox
/cwt
Dec 21.92
Predicted
Mailbox price does not include MILC payments
July 10.61
July 11.70
Source USDA, AMS, Dairy Division
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Where Have We Been U.S. Milk Production

• Level of milk production has direct influence on
  milk price
• Milk needs to go somewhere
• If growth rate exceeds increase in demand ?
  downward pressure on price
• The U.S. dairy farmer has provided evidence of an
  incredible ability to increase output
• Until recently we have observed a pattern of
  year-over-year decreases in U.S. herd size
• Dramatic increases in per cow productivity

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Where Have We Been U.S. Milk Production
July '08 57 lbs over '04-'07 average, a 3.56 ?
Source USDA, NASS
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Where Have We Been U.S. Milk Production
July '08 128,000 more cows than July '07 (1.40
?)
Continual ? in herd size since April '07
Jan. '04
Source USDA, NASS
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Where Have We Been U.S. Milk Production
Change
Source USDA, NASS
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Where Have We Been Dairy Product Stocks

• As noted above, Class III prices determined by
  Cheddar, Dry Whey and Butter prices
• Supply of products can come from immediate
  production or from stocks
• Growth in stocks would place downward pressure on
  commodity prices

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Where Have We Been Dairy Product Stocks
June '08 value a 1.0 ? of '04-'07 average
July '08 value a 13.5 ? over '04-'07 average
Source USDA, NASS
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Where Have We Been Dairy Product Stocks
June '07 value a 40.2 ? of '04-'07 average
Source USDA, NASS
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Dairy Industry Outlook Futures Markets

• Since the mid-1990s we have had a viable futures
  market for dairy products
• We can use these markets to give us some idea as
  to possible future conditions
• Based on that days market opinion
• As examples lets look at Class III and Dry Whey
• Use cash price history to determine what is a
  good price

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Derivation of a Good Class III Price
Monthly Class III Price Distribution (Assumed
Normally Distributed)
33 probability
33 probability
Class III Top 3rd
Class III Bottom 3rd
Average Class III
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Dairy Industry Outlook Futures Markets
Data as of August 22nd
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Projected Wisconsin Mailbox Lots of Uncertainty
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Dairy Industry Outlook Futures Markets
Western Dry Whey Used for Cash Data
Data as of Aug. 22nd
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Outlook for the Dairy Industry

• USDA Quarterly Forecasts (WASDE, Aug. 12th)
• Milk Production (Bil. lbs, over previous year)
• 2008 III 46.7 (1.30)
• 2008 IV 46.5 (1.09)
• Annual 189.5 (2.10)
• 2009 I 47.6 (0.02)
• 2009 II 48.9 (0.04)
• U.S. All Milk Price (/cwt, over previous year)
• 2008 III 18.90 (-12.8)
• 2008 IV 19.05 (-11.8)
• Annual 18.95 (-0.94)
• 2009 I 18.75 (-2.50)
• 2009 II 18.40 (-0.92)

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Outlook for the Dairy Industry

• USDA forecasts of NASS and FMMO prices (WASDE,
  Aug. 12th) vs. historical values

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Managing the Opportunities

• How can producers attempt to control milk price
  risk?
• Enter into forward contract with processing
  plants
• Private firms are now allowed to offer forward
  contracts under 2008 Farm Bill
• Farm Bill Website
• http//future.aae.wisc.edu/farm_bill.html
• Use minimum price contracts with processing
  plants
• Similar to individual use of a put
• Use traditional hedging and options strategies if
  large enough to cover contract sizes
• Futures and options tutorials available
• http//future.aae.wisc.edu/tutor

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Managing the Opportunities

• August 2008 A new risk management instrument
  Livestock Gross Margin Insurance for Dairy
  (LGM-Dairy)
• Protects against unanticipated declines in Gross
  Margins
• Gross margin milk revenue feed costs
• Available to dairy farm operations in 32 states

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Managing the Opportunities

• LGM-Dairy analogous to combined use of
• Put options to account for milk price downside
  risk
• Call options to control for feed cost upside risk
• In contrast to futures and options, LGM-Dairy
  available to any size operation up to 240,000 cwt
  over 10 months
• LGM-Dairy is customizable
• Months insured
• Percent of monthly Gross Margins covered
• Flexible Gross Margin deductible available
• 0 - 1.50/cwt allowable deductible range

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Managing the Opportunities

• At the UW we have undertaken a project to develop
  educational materials/decision tools centered on
  LGM-Dairy
• We will be conducting half-day workshops
  tentatively planned for early 2009
• Have developed a website devoted to LGM-Dairy
• http//future.aae.wisc.edu/lgm_dairy.
  html
• Have written a briefing paper explaining
  LGM-Dairy
• USDAs Gross Margin Insurance Program for Dairy
  What is it and Can it be Used for Risk
  Management, B. Gould, P. Mitchell and V. Cabrera
• Available via LGM-Dairy Website

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Contact Information

• Univ. of Wisconsin Dairy Marketing Website
  http//future.aae.wisc.edu
• Brian W. Gould
• [phone]
• bwgould_at_wisc.edu