Monthly Archives: August 2013

This blog post is designed as supplementary resource to Bozic, M., Thraen, C.S. and J. Newton (2013) “Managing Milk Price and Feed Cost Volatility in the United States” in World Dairy Situation 2013 (in press). 

Since 1985, USDA-NASS has reported a milk-to-feed price ratio defined as the number of pounds of 16 percent protein-mixed dairy feed equal in value to 1 pound of milk (Bailey and Ishler, 2008). Analysis by Wolf (2010) demonstrated that milk-to-feed ratio is a good proxy for milk production profitability when the changes are largely driven by a single price series, e.g. when milk prices are volatile but feed costs are fairly constant, as was the case prior to 2006. However, milk-to-feed price ratio will fail to capture profitability implications of a significant change in pattern of underlying price series, such as increased volatility of feed costs since 2007. When both milk price and feed costs are highly variable, income over feed costs margin indices become preferred measures of dairy profitability.

A new IOFC margin formula is introduced in proposed U.S. federal dairy policy legislation (S.954, H.R.2642). Should this legislation be enacted as part of the next U.S. farm bill, this IOFC formula is likely to be used by both government and private industry analysts as a main measure summarizing a complex issue of dairy profitability into a single number. Therefore, it is important to understand the assumptions and derivation of the formula. According to the policy proposals currently debated in the U.S. congress, dairy IOFC margin for a particular month is to be defined as

All-milk Price – (1.0728 × Corn Price + 0.00735 × Soybean Meal Price + 0.0137 × Alfalfa Hay Price)

where U.S. All-Milk price means the average price received by dairy producers for all milk sold to plants and dealers in the U.S.; prices of corn and alfalfa hay are taken from monthly United State Department of Agriculture Agricultural Prices report; and the price of soybean meal is the central Illinois price for soybean meal as reported in the United States Department of Agriculture Market News-Monthly Soybean Meal Price Report (rail price).

The feed ration underpinning this formula was developed by the National Milk Producers Federation with the support of a number of prominent animal nutritionists (NMPF, 2010). Table 1 summarizes herd structure and dairy ration assumptions.
Farm Bill IOFC margin
The ration is based on nutritional requirements of a cow producing 68.85 pounds of milk per day during lactation. In order to calculate the feed costs per hundredweight, a shrink factor of 10 percent is used between the volumes of feed ingredients purchased and the volumes consumed by the animals. Furthermore, it is assumed that the price of corn silage, per ton, is equal to 10.1 times the price of corn for grain per bushel.

Adding the total daily cost of purchasing the four feed ingredients and dividing by the daily volume of milk marketed, 0.6885 cwt per milking cow, we obtain the feed cost per cwt of milk to be the sum of 1.192 x price of corn per bushel, 0.00817 x price of soybean meal per ton, and 0.0152 times the price of alfalfa hay per ton. The 2013 Farm bill formula for IOFC margin is based on these coefficients, reduced each by 10 percent for budgetary reasons.

See the complete derivation of Farm Bill IOFC margin in Excel.

Historical margins and DPMPP payouts, Jan 1980-Jul 2013 here.

Do we need the new dairy policy? That was one of the questions discussed at the symposium that took place as part of the Agricultural and Applied Economics Association’s annual meeting, held earlier this week in Washington, DC. The symposium “Whither Dairy Policy? Economics and Politics of New Dairy Programs” was organized and moderated by Dr. Marin Bozic, assistant professor of dairy foods marketing economics at the University of Minnesota. Distinguished panelists were Dr. Bruce Babcock (Iowa State University), Dr. Scott Brown (University of Missouri), Dr. Andrew Novakovic (Cornell University) and Dr. Daniel Sumner (University of California – Davis).

AAEA Newton_v2_Page_12The symposium was opened by a presentation by John Newton, PhD candidate at the Ohio State University who is studying agricultural policy and dairy economics under Dr. Cameron Thraen. Newton outlined the provisions of dairy programs passed in the House and the Senate Farm Bills, and summarized the results of his most recent analysis with Thraen and Bozic on the distributional effects of new programs. In the paper released last week, authors reported that seventy percent of expected dairy policy benefits would accrue to just ten percent of dairy farms who also produce the majority of nation’s milk.

Newton, J., C. Thraen and M. Bozic (2013) Whither Dairy Policy? Evaluating Expected Government Outlays and Distributional Impacts of Alternative 2013 Farm Bill Dairy Title Proposals

John’s slides here and audio here.

Below you can find the full list of questions discussed and audio links to debate on each question. Full audio is available here and discussion slides are here. Press release summarizing the discussion is here.

  • Q1: Do we need the new dairy policy?

Slide4Writing on the need for the new farm bill in his recent article in The Atlantic, Sumner remarked that “Rationales that might have sounded credible in 1950 – e.g.: farmers tend to be poor; the free market just doesn’t work – were shown over the decades to be weak rationalizations for transfers to the wealthy.” In his reply to the question whether we need the new dairy policy, Sumner reminded the audience that the calls for new dairy policy needs to be justified. If the California Sec. of Agriculture was told by someone that she needs to be setting the price of Cabernet Sauvignon relative to Merlot, it would be dismissed as a silly idea. So, if we want to regulate milk, Sumner says, we need to explain why milk is all that different than Cabernet Sauvignon, bottled water or orange juice. No good reasons for that have been offered, according to Sumner. Dr. Scott Brown is not sure if he agrees or disagrees with Sumner. Brown said his role as an applied economist, as he sees it, is to offer analysis that helps illuminate consequences of public choices, rather than offering justifications and judgments whether some policy is good or bad.

Audio link here.

  • Q2: Who Benefits from the new Dairy Policy? 

How is the new dairy policy to be understood – as a social policy/safety net for dairy producers, or a food security policy? Should we have means testing? What can we learn from crop insurance and what are fragile points of the new dairy margin insurance.

Comments by Andy Novakovic and Bruce Babcock here.

  • Q3: Will New Policy Cause Excess Supply?

Slide6Should we compare the current policy proposals to actions taken in late 1970s that resulted in massive excess milk production? How likely is the standalone margin insurance as proposed in Goodlatte-Scott to result in oversupply? Is DMSP, as proposed in S954 likely to be effective in curbing that?

Comments by Andy Novakovic and Scott Brown here.

  • Q4: What will be the effects of the Dairy Market Stabilization Program?

In 2012, Balagtas and Sumner published an article in the American Journal of Agricultural Economics criticizing proposed mandatory supply management. How do the results of their analysis change now that the DMSP is made voluntary and coupled with margin insurance?

Comments by Dan Sumner here.

  • Q5: What have we learned from LGM-Dairy pilot program? 

Five years after LGM-Dairy insurance was first introduced, the premiums paid in exceed indemnities by close to twenty to one. What are the lessons from LGM-Dairy program and is it really actuarially fair?

Comments by Bruce Babcock and John Newton here.

  • Q6: Will government insurance crowd out CME dairy futures and options?

For several years now, open interest in Class III futures is on the decline, and only about 10 percent of milk marketed in the U.S. is protected through CME dairy futures and options. What would be the effect of new dairy policy on liquidity of the CME dairy markets?

Comments by Scott Brown and Bruce Babcock here.

  • Q7: Will FMMO reform be next? 

Federal Milk Marketing Orders reform was originally envisioned as one of the pillars in the Foundation for the Future, but was later dropped from the current package of dairy reforms. Andy Novakovic chaired the Dairy Industry Advisory Committee and shared his observations on current status and possible future reforms of FMMOs and milk pricing system in the U.S.

Comments by Andy Novakovic and his debate with Dan Sumner here.

  • Q8: What will feed prices do in the next decade?

One of the perceived needs for new dairy policy was the increase in level and volatility of livestock feed prices. What to expect from corn prices over the next five years? Stabilization? At which level?

Comments by Bruce Babcock here.

  • Q9: Whither Dairy Policy? Will we have the farm bill yet this year?

Scott Brown works closely with legislative aids on the Hill. John Newton was a Fellow with the Senate Committee on Agriculture this summer. You can listen to their comments on this question here.