April 3, 2023

After years of stagnant dairy prices, 2022 crashed through previous records. In May, the U.S. All Milk price rose to a whopping $27.30/cwt (CME Group). At the same time, the margin of milk sold less feed costs (Income Over Feed Cost or IOFC) was $11.52/cwt (USDA, CME Group) nearly $3/cwt higher than the 20-year average. Not surprisingly, many operations expanded herd size and production to capitalize on these exceptional prices and margins. And therein lies the rub. Increased supply from the 2022 boom has put downward pressure on milk prices. Export demand has scaled back closer to the five-year average and feed costs remain high. In light of all of this, the USDA has already lowered their 2023 All Milk price forecast. Rather than the start of a new era in milk prices, 2022 now seems like an outlier, leaving many farmers facing tighter margins in support of larger herds.

 

 

Still, with the recent cushion on your margin being so high, you wouldn’t be alone wondering how detrimental the tightening might really be to overall farm profitability. As we’ll discuss, those margins disappear much more quickly than you might expect, and you need to be prepared.

 

Margins Can Erode Quickly Even with Higher Milk Revenue

 

As you well know, a dairy farmer’s fixed costs include land and basic infrastructure. As herd size increases, you need to invest in new equipment and/or increasing employee costs, both exacerbated by the impact of inflation. Furthermore, a significant percentage of your profitability is directly tied to variable market costs that are not necessarily correlated to what you receive for the milk you produce.

 

To sum it up, even the best margins like the ones you’ve likely been enjoying lately can quickly deteriorate if farm expenses rise—especially those set by market prices—as milk prices slow down or retreat.

 

Let’s review an example of how quickly margins can tighten.

 

Say a hypothetical dairy farm of 730 cows produces 20 million pounds of milk annually at an average 75 pounds of production per day. The herd consumes roughly 73,000 bushels of corn and 1,440 tons of soybean meal annually, and the farm uses 40,000 gallons of fuel per year.

 

In Scenario A, this farm enjoys the 2022 IOFC margin of $11.52/cwt, earning net revenue of $2.304 million after feed costs. In Scenario B, our farm starts at the new revenue as in Scenario A, but suffers from market disruptions affecting revenue and expense.

Note: while other expenses not detailed in the accompanying table such as employee costs, loan payments, and equipment costs are not subtracted from the scenarios, they impact the scenario bottom lines equally.

 

 

Based on your experience, do the market changes outlined seem plausible? If so (and even if you consider them worst case), the revenue difference between our two scenarios could add up to nearly a half million dollars gone in Scenario 2 by market moves that play out nearly every year. That’s nearly a quarter the starting margin of our hypothetical farm. And remember, that’s on top of other expenses that we did not yet subtract from net profitability, such as loan payments, equipment and farm maintenance expense, veterinarian fees, and employee salaries. No matter what your situation, would your farm weather a half million swing with ease?

 

This example highlights a unique challenge to dairy farmers. As a dairy farmer, your margins are easily squeezed on both revenue and expense by the whims of the market, and the advantages you have today can easily be gone tomorrow. So what can you do?

 

Managing the Margin

 

The question, then, is how to take steps to maximize your farm profitability. It all starts, of course, with your expertise: on-farm management to manage expenses, such as herd health via comfort and nutrition, employee training and development, and year-over-year equipment maintenance.

 

The other critical step is farm marketing—managing commodity market-driven prices and costs with consistency and discipline. Farmers that can manage those costs and revenue better than the next in any market condition are the farmers who are better prepared to win over the long term. Consider this: according to the Farm Bureau, in 2003 there were 70,375 licensed dairy herds in the U.S. By 2020? Only 31,657. That’s more than a 50% decrease over 17 years. Every advantage you can make for yourself in this highly competitive industry increases your odds of being the operation that makes it.

 

Strategic farm marketing will help you manage your revenue and costs through an array of tools, such as:

• Forward contracts with a milk plant or feed supplier
• Options and futures via your hedge account
• Government programs like Dairy Revenue Protection (D-RP), Dairy Margin Coverage (DMC), and Livestock Gross Margin (LGM)

 

Total Farm Marketing Can Help

 

At Total Farm Marketing, we have decades of experience helping dairy farmers successfully balance the risks and rewards of farm marketing in an industry that requires discipline and knowledge specific to the milk industry. We take a total weighted average philosophy toward price, making sure that any recommendation considers the costs of hedging and the expected outcomes across a variety of scenarios.

 

Being a dairy producer has never been easy, and the market itself continues to change and evolve. Build a team around you to help navigate the complex world of marketing and risk tolerance.

 

If you have any questions about market conditions and how to plan for whatever the market may bring, please contact your advisor or the Total Farm Marketing team at 800.334.9779.

 

 

 

©April 2023. Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. No representation is being made that scenario planning, strategy or discipline will guarantee success or profits. Examples of seasonal price moves or extreme market conditions are not meant to imply that such moves or conditions are common occurrences or likely to occur. Futures prices may have already factored in the seasonal aspects of supply and demand. The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Reproduction of this information without prior written permission is prohibited. This material has been prepared by a sales or trading employee or agent of Total Farm Marketing and is, or is in the nature of, a solicitation. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Total Farm Marketing. Total Farm Marketing refers to Stewart-Peterson Group Inc., Stewart-Peterson Inc., and SP Risk Services LLC. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of National Futures Association. Stewart-Peterson Inc. is a publishing company. SP Risk Services LLC is an insurance agency. A customer may have relationships with any of the three companies. Total Farm Marketing is an equal opportunity provider.