Outlook for Wisconsin andOutlook for Wisconsin andU.S. Dairy MarketsU.S. Dairy Markets

FARM TeamFARM TeamAgricultural Prices ConferenceAgricultural Prices Conference

Brian W. GouldBrian W. GouldAssociate ProfessorAssociate Professor

Department of Agricultural and Applied EconomicsDepartment of Agricultural and Applied EconomicsUniversity of Wisconsin-MadisonUniversity of Wisconsin-Madison

August 27, 2008August 27, 2008

Presentation OutlinePresentation Outline

Where have we beenWhere have we been Dairy commodity pricesDairy commodity prices Wisconsin Mailbox pricesWisconsin Mailbox prices U.S. milk productionU.S. milk production Dairy product stocksDairy product stocks

Dairy industry outlook Dairy industry outlook What do the futures markets tell us?What do the futures markets tell us? Overview of most recent USDA dairy forecastsOverview of most recent USDA dairy forecasts

A brief overview of the Livestock Gross Margin A brief overview of the Livestock Gross Margin Insurance Program for Dairy: A new risk management Insurance Program for Dairy: A new risk management tooltool

http://future.aae.wisc.edu

FMMO system: Plant sales prices of cheddar cheese, FMMO system: Plant sales prices of cheddar cheese, NFDM, butter and dry whey prices determineNFDM, butter and dry whey prices determine minimumminimum milk milk component valuescomponent values Formulas/commodities used vary by milk classFormulas/commodities used vary by milk class Class III milk component values based on cheddar Class III milk component values based on cheddar

cheese, butter and dry whey pricescheese, butter and dry whey prices

Wisconsin Mailbox prices closely tied to Class III price Wisconsin Mailbox prices closely tied to Class III price with difference due to: with difference due to: Over-order premiums paid by plantOver-order premiums paid by plant Milk qualityMilk quality Utilization of milk across the 4 FMMO milk classesUtilization of milk across the 4 FMMO milk classes

Where Have We Been: Class III PriceWhere Have We Been: Class III Price

5

FMMO Commodity Average Prices

$0.75

$0.97

$1.19

$1.41

$1.63

$1.85

$2.07

$2.29

$0.10

$0.20

$0.30

$0.40

$0.50

$0.60

$0.70

$0.80

Cheddar Butter Dry Whey

Avg. Since 2002Cheddar: $1.480Butter: $1.356Dry Whey: $0.299

$/lb Cheddar & Butter

$/lb DryWhey

Source: USDA, NASS

Where Have We Been: NASS Market PricesWhere Have We Been: NASS Market Prices

Wisconsin Mailbox Prices

10.50

11.50

12.50

13.50

14.50

15.50

16.50

17.50

18.50

19.50

20.50

21.50

22.50

Mailbox price does not include MILC payments

2

(11.02) (57.06)Mailbox = 2.481 + 0.913Class III R 0.974

Source: USDA, AMS, Dairy Division

July $10.61 July $11.70

Dec $21.92

Where Have We Been: Wisconsin MailboxWhere Have We Been: Wisconsin Mailbox

Predicted

$/cwt

Level of milk production has direct influence on Level of milk production has direct influence on milk pricemilk price Milk needs to go somewhereMilk needs to go somewhere If growth rate exceeds increase in demand If growth rate exceeds increase in demand →→

downward pressure on pricedownward pressure on price

The U.S. dairy farmer has provided evidence of an The U.S. dairy farmer has provided evidence of an incredible ability to increase outputincredible ability to increase output Until recently we have observed a pattern of Until recently we have observed a pattern of

year-over-year decreases in U.S. herd sizeyear-over-year decreases in U.S. herd size Dramatic increases in per cow productivityDramatic increases in per cow productivity

Where Have We Been: U.S. Milk ProductionWhere Have We Been: U.S. Milk Production

Per Cow Milk Production (30-Day Months, Lbs/Cow)

1,525

1,550

1,575

1,600

1,625

1,650

1,675

1,700

1,725

1,750

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2005 20062007 2008'04-'07

Source: USDA, NASS

July '08: 57 lbs over ′04-′07 average, a 3.56% ↑

Where Have We Been: U.S. Milk ProductionWhere Have We Been: U.S. Milk Production

Milk Cows on Farms (1,000 Head)

8,9759,0009,0259,0509,0759,1009,1259,1509,1759,2009,2259,2509,2759,300

Source: USDA, NASS

Continual ↑ in herd size sinceApril ′07Jan. ′04

Where Have We Been: U.S. Milk ProductionWhere Have We Been: U.S. Milk Production

July '08: 128,000 morecows than July '07 (1.40% ↑)

Source: USDA, NASS

Where Have We Been: U.S. Milk ProductionWhere Have We Been: U.S. Milk Production

Year over Year % Change in Milk Production

0.00

0.75

1.50

2.25

3.00

3.75

4.50

5.25

Jan

Feb

Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

Dec Jan

Feb

Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

Dec Jan

Feb

Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

Dec Jan

Feb

Mar

Apr

May Jun

Jul

2005 2006 2007 2008

Prod. Per Cow

No. of CowsTotal Milk Production Year Over Year % Change

%Change

As noted above, Class III prices determined by Cheddar, As noted above, Class III prices determined by Cheddar, Dry Whey and Butter pricesDry Whey and Butter prices Supply of products can come from immediate Supply of products can come from immediate

production or from stocksproduction or from stocks Growth in stocks would place downward pressure on Growth in stocks would place downward pressure on

commodity pricescommodity prices

Where Have We Been: Dairy Product StocksWhere Have We Been: Dairy Product Stocks

Source: USDA, NASS

June '08 value a 1.0% ↓ of '04-'07 average

Where Have We Been: Dairy Product StocksWhere Have We Been: Dairy Product StocksTotal American Cheese Stocks (Mil. Lbs)

475.0

487.5

500.0

512.5

525.0

537.5

550.0

562.5

575.0

587.5

600.0

612.5

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2005 20062007 2008'04-'07

Total Butter Stocks (Mil. Lbs)

50

75

100

125

150

175

200

225

250

275

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

July '08 value a 13.5% ↑ over '04-'07 average

Total Whey Stocks (Mil. Lbs)

25.0

31.3

37.5

43.8

50.0

56.3

62.5

68.8

75.0

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2005 20062007 2008'04-'07

Source: USDA, NASS

June '07 value a 40.2% ↑ of '04-'07 average

Where Have We Been: Dairy Product StocksWhere Have We Been: Dairy Product Stocks

Since the mid-1990’s we have had a viable futures Since the mid-1990’s we have had a viable futures market for dairy productsmarket for dairy products

We can use these markets to give us some idea as to We can use these markets to give us some idea as to possible future conditionspossible future conditions Based on that day’s market opinionBased on that day’s market opinion

As examples lets look at Class III and Dry Whey As examples lets look at Class III and Dry Whey Use cash price history to determine what is a Use cash price history to determine what is a goodgood

priceprice

Dairy Industry Outlook: Futures MarketsDairy Industry Outlook: Futures Markets

Derivation of a “Good” Class III PriceDerivation of a “Good” Class III Price

33% probability33% probability

33% probability33% probability

Class III Top 3Class III Top 3rdrdClass III Bottom 3Class III Bottom 3rdrd

Average Class IIIAverage Class III

Monthly Class IIIPrice Distribution(Assumed NormallyDistributed)

Class III Futures vs. Cash Market Values

11.00

12.00

13.00

14.00

15.00

16.00

17.00

18.00

19.00

$/cwt

Class III Futures Avg. Class IIIClass III Top Third Class III Bottom Third

Dairy Industry Outlook: Futures MarketsDairy Industry Outlook: Futures Markets

Data as of August 22nd

Projected Wisconsin Mailbox Prices Using Various Class III Futures Settle Prices

17.25

17.60

17.95

18.30

18.65

19.00

19.35

19.70

20.05

20.40

20.75

21.10

$/cwt

Aug. 22nd July 18th June 19th

Projected Wisconsin Mailbox:Projected Wisconsin Mailbox:Lots of UncertaintyLots of Uncertainty

2

(11.02) (57.06)Mailbox = 2.481 + 0.913Class III R 0.974

Dry Whey Futures vs. Cash Market Values

18.0

19.5

21.0

22.5

24.0

25.5

27.0

28.5

30.0

31.5

33.0

34.5

cents/lb

Dry Whey Futures Avg. Dry WheyDry Whey Top Third Dry Whey Bottom Third

Dairy Industry Outlook: Futures MarketsDairy Industry Outlook: Futures Markets

Data as of Aug. 22nd

Western Dry WheyUsed for Cash Data

USDA Quarterly Forecasts (WASDE, Aug. 12USDA Quarterly Forecasts (WASDE, Aug. 12thth)) Milk Production (Bil. lbs, % over previous year)Milk Production (Bil. lbs, % over previous year)

2008 III2008 III 46.7 (1.30%)46.7 (1.30%) 2008 IV2008 IV 46.546.5 (1.09%) (1.09%) AnnualAnnual 189.5 (2.10%)189.5 (2.10%) 2009 I2009 I 47.647.6 (0.02%) (0.02%) 2009 II2009 II 48.948.9 (0.04%) (0.04%)

U.S. All Milk Price ($/cwt, % over previous year)U.S. All Milk Price ($/cwt, % over previous year) 2008 III2008 III $18.90 $18.90 (-12.8%) 2008 IV2008 IV $19.05 $19.05 (-11.8%) AnnualAnnual $18.95 $18.95 (-0.94%) 2009 I2009 I $18.75 $18.75 (-2.50%) 2009 II2009 II $18.40 $18.40 (-0.92%)

Outlook for the Dairy IndustryOutlook for the Dairy Industry

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

Outlook for the Dairy IndustryOutlook for the Dairy Industry

20062006 20072007 20082008 20092009

$/lb$/lb

CheeseCheese 1.2471.247 1.7381.738 1.9301.930 1.9051.905

ButterButter 1.2191.219 1.3441.344 1.4351.435 1.4201.420

WheyWhey 0.3290.329 0.6000.600 0.2800.280 0.3150.315

NFDMNFDM 0.8930.893 1.7081.708 1.3951.395 1.5201.520

$/cwt$/cwt

Class IIIClass III 11.8911.89 18.0418.04 17.9517.95 17.6017.60

Class IVClass IV 11.0611.06 18.3618.36 16.1016.10 16.9516.95

How can producers attempt to control milk price risk?How can producers attempt to control milk price risk? Enter into forward contract with processing plantsEnter into forward contract with processing plants

Private firms are now allowed to offer forward Private firms are now allowed to offer forward contracts under 2008 Farm Billcontracts under 2008 Farm Bill

Farm Bill Website:Farm Bill Website: http://future.aae.wisc.edu/farm_bill.htmlhttp://future.aae.wisc.edu/farm_bill.html

Use minimum price contracts with processing plantsUse minimum price contracts with processing plants Similar to individual use of a putSimilar to individual use of a put

Use traditional hedging and options strategies if large Use traditional hedging and options strategies if large enough to cover contract sizesenough to cover contract sizes

Futures and options tutorials available: Futures and options tutorials available: http://future.aae.wisc.edu/tutorhttp://future.aae.wisc.edu/tutor

Managing the OpportunitiesManaging the Opportunities

August 2008: A new risk management instrument: August 2008: A new risk management instrument: Livestock Gross Margin Insurance for Dairy (LGM-Dairy)Livestock Gross Margin Insurance for Dairy (LGM-Dairy) Protects against unanticipated declines in Protects against unanticipated declines in Gross MarginsGross Margins

Gross margin = milk revenue – feed costsGross margin = milk revenue – feed costs Available to dairy farm operations in 32 statesAvailable to dairy farm operations in 32 states

Managing the OpportunitiesManaging the Opportunities

LGM-Dairy analogous to combined use of:LGM-Dairy analogous to combined use of: Put options to account for milk price downside riskPut options to account for milk price downside risk Call options to control for feed cost upside riskCall options to control for feed cost upside risk

In contrast to futures and options, LGM-Dairy available to In contrast to futures and options, LGM-Dairy available to any size operation up to 240,000 cwt over 10 monthsany size operation up to 240,000 cwt over 10 months

LGM-Dairy is customizableLGM-Dairy is customizable Months insuredMonths insured Percent of monthly Gross Margins coveredPercent of monthly Gross Margins covered Flexible Gross Margin deductible availableFlexible Gross Margin deductible available

$0 - $1.50/cwt allowable deductible range$0 - $1.50/cwt allowable deductible range

Managing the OpportunitiesManaging the Opportunities

At the UW we have undertaken a project to develop At the UW we have undertaken a project to develop educational materials/decision tools centered on LGM-educational materials/decision tools centered on LGM-DairyDairy We will be conducting half-day workshops tentatively We will be conducting half-day workshops tentatively

planned for early 2009planned for early 2009 Have developed a website devoted to LGM-Dairy:Have developed a website devoted to LGM-Dairy: http://future.aae.wisc.edu/lgm_dairy.htmlhttp://future.aae.wisc.edu/lgm_dairy.html Have written a briefing paper explaining LGM-Dairy:Have written a briefing paper explaining LGM-Dairy:

USDA’s Gross Margin Insurance Program for Dairy: USDA’s Gross Margin Insurance Program for Dairy: What is it and Can it be Used for Risk ManagementWhat is it and Can it be Used for Risk Management, B. , B. Gould, P. Mitchell and V. CabreraGould, P. Mitchell and V. Cabrera Available via LGM-Dairy WebsiteAvailable via LGM-Dairy Website

Managing the OpportunitiesManaging the Opportunities

Contact InformationContact Information

Univ. of Wisconsin Dairy Marketing Website: Univ. of Wisconsin Dairy Marketing Website: http://future.aae.wisc.eduhttp://future.aae.wisc.edu

Brian W. GouldBrian W. Gould(608)263-3212(608)263-3212bwgould@wisc.edubwgould@wisc.edu