Margin Protection Program (MPP-Dairy) ONLINE DECISION T L

DNMC Dairy Summit 214 Margin Protection Program (MPP-Dairy) ONLINE DECISION T L John Newton University of Illinois 217-3-11 jcnewt@illinois.edu @New1_AgEcon Professional Background USDA, Ag. Economist (Federal Milk Marketing Orders) 24 to 214 Senate Agriculture Committee, Fellow 214 USDA Office of Chief Economist, Policy Advisor 214 The Ohio State University MS, MA, and Ph.D. University of Louisville BS Dairy Tool Access New: ARC & PLC & Dairy Tools Use the tool at www.fsa.usda.gov/mpptool Use the tools at www.fsa.usapas.com Educational material www.dairymarkets.org/mpp 1

Did Dairy Have a Safety Net? Milk Income Loss Contract (MILC) Benefit Concentration in MILC MILC 29+ Covered 18 Bil Lbs and paid $1.6 billion to 47K farmers ($.86/cwt) 2.98 Million Pound Benefit Cap 42% of US Milk Supply Covered by MILC $/hundredweight 2 1 1 - U.S. Income Over Feed Costs Margin = U.S. All-Milk Price NASS Corn Price x 1.728 + AMS SBM x.73 + NASS Alfalfa x.137 21 Secretary s Dairy Advsy C mte Recommends Margin Insurance 214 Farm Bill Dairy Production Margin June 29 $2.2/hundredweight 2 21 22 23 24 2 26 27 28 29 21 211 212 213 May 211 Senate First Hearing on Farm Bill Source: USDA National Agricultural Statistics Service and Agricultural Marketing Service MPP-Dairy: How it Works Voluntary program designed to protect dairymen from downturns in the dairy margin Makes payments when US dairy margin falls below the farmer-selected coverage option Price floors available from $4 to $8 hundredweight Can cover 2% to 9% of production Farm operators pay $1 administrative fee and premiums based on farmer-selected coverage Consecutive 2-month average margins determine indemnity: Jan/Feb,, Nov/Dec No eligibility constraints (income or production) 2

Margin Protection Program (MPP) as the Replacement MPP: A New Way to Think About a Government Safety Net Farms Can Cover: Max(211,212,213) Milk Lbs. 182 Billion Lbs Key farmers decisions: 1) How much milk to protect (2% to 9%) 2) What margin level to protect ($4 to $8) Coverage Level $ 8. $ 7. $ 7. $ 6. $ 6. $. $. $ 4. $ 4. Coverage Options* *126 Possible Coverage Choice Combinations 2% 3% 3% 4% 4% % % 6% 6% 7% 7% 8% 8% 9% Coverage Percentage Premium Rates May Alter Participation Incentives Premium Rates $1.6 $1.4 $1.2 $1. $.8 $.6 $.4 $.2 $. $6. to $7. coverage has $.4 increase in Tier 2 premium $. FREE $.2 $.4 $.1 $.16 $4. $4. $. $. $6. $6. $7. $7. $8. First 4 M lbs PH $.29 After 4 M lbs PH $.83 $1.6 Tier 1: First 4M #s / Tier 2: After 4M #s $1.36 3

MPP-Dairy Payment Frequency Where Will Margins Go? $4. $4. $. $. $6. $6. $7. $7. $8. 2 % % % % % % % 33% % 21 % % % % % % % % % 22 % % % % % 17% % 67% 83% 23 % % % % 33% % % % 67% 24 % % % % % % % % 17% 2 % % % % % % % % % 26 % % % % % % 33% % 67% 27 % % % % % % % % % 28 % % % % % % % % 33% 29 67% 67% 67% 67% 83% 83% 83% 83% 83% 21 % % % % % % % 17% 33% 211 % % % % % % % % 17% 212 33% 33% % % % % 83% 83% 1% 213 % % % % % 67% 67% 67% 67% $/cwt 14. 12. 1. 8. 6. 4. 2.. 2 22 Actual IOFC Margin Avg. $8.26 24 26 28 WASDE Estimates Avg. $11.88 Baseline 21 212 214 216 ERS Baseline Avg. $11.82 213 CBO Baseline Avg. $9.4 218 22 222 Catastrophic Coverage How Accurate Were Farmers w/ MILC?* MPP: USDA Funded Producer Decision Education Project Margin Protection Program (MPP) ONLINE DECISION T L Including the LGM-Dairy Analyzer 8 Extension Economists ---- 7 Land Grant Institutions *Farms Marketing More than 3M # s per month 4

Easy Cross-Program Comparison ONE CLICK Switch between the MPP- Dairy Tool & the Award Winning LGM-Dairy Analyzer Built With Farmers in Mind Only one data point needed Farm s Milk Production History 4 CLICKS TO GET THE INFORMATION YOU NEED FOR MPP ENROLLMENT 4 Steps of the Decision Tool Windows PC, ios, & Android WORKS WITH ALL ELECTRONIC DEVICES All calculations are performed in the cloud to maximize efficiency.

Advanced Users Name Your Own Prices Milk & Feed Price Customization Secure and 1% Free DATA SECURITY Farmer Data is Not Collected 1% Free 24/7 Access Always Available & Free to Use Online Educational Material Find videos, PowerPoints, printed material, and links to other Farm Bill decision tools online. Margin Protection Program (MPP) ONLINE DECISION T L Demonstration www.dairymarkets.org/mpp 6

Margin Protection Program (MPP) ONLINE DECISION T L Appendix U.S. MPP-Dairy Margin Index (red) and State-Level Margin Approximations, 27-213 $/hundredweight $2 $16 $12 $8 $4 $ -$4 27 Basis Will Move the Price Floor State-Level Margins 28 29 21 Year U.S. MPP-Dairy Margin 211 212 213 $/hundredweight State-Level Basis Approximations, 27-213 $3 $1 -$1 -$3 -$ 27 28 29 21 211 212 213 Year Volatile Basis Increase Uncertainty in Price Floor Mailbox Milk Price Hedge Ratio With Class III Futures Optimal Hedge Ratio (Hedge 6-Months Out) 8% 8% 3% Decline 8% in Class III 7% Hedge Ratio 7% 6% 6% % % 2% Estimated using 21-213 data $2 $2 $1 $1 $ $ 21 22 23 Protecting With MPP (21-213) Support during price declines Protecting Mailbox Milk Price with MPP (4M PH/$8/9%) 24 2 26 27 28 29 21 Less Variability Avg. No MPP $16.7 Avg. W/ MPP $16.41 Base Wisconsin Mailbox MPP-Dairy Net Premium MPP-Dairy Net Indemnity 211 212 213 For Demonstration Only For Demonstration Only 7

$2 Using Both Futures and MPP (21-213) Double support during price declines $2 Risk Management Switching (28-213) Reduces Downside Risk $2 $2 $1 $1 $1 $ $ 21 Protecting Mailbox Milk Price at 18 days with Class III and MPP (4M PH/$8/9%) 22 23 24 2 26 Base Wisconsin Mailbox Loss from Futures Gain from Futures MPP-Dairy Net Premium 27 28 MPP-Dairy Net Indemnity Variability lower than MPP Alone Avg. No Double Up $16.7 Avg. W/ Double Up $16.2 29 21 211 212 213 For Demonstration Only $1 $ $ 28 Protecting Mailbox Milk Price at 18 days by Switching Futures & MPP (4M PH/$8/9%) 29 21 Base Wisconsin Mailbox Loss from Futures Gain from Futures MPP-Dairy Net Premium 211 MPP-Dairy Net Indemnity Best of Both Worlds Avg. No Protection $17.67 Avg. w/ MPP $18.7 Avg. Double Up $18.68 Avg. Switching $18.83 212 213 For Demonstration Only Integrating MPP and LGM-D Philosophically Different Approaches Available Price Floors Using LGM-Dairy Nov PY Purchase Date (1-Month Contract) Target Deficiency Payment Program Dairy Margin Protection Program 1. Provides protection against multi-year losses from $4 to $8 cwt 2. Is not actuarially fair and is not based on milk and feed market prices 3. Indemnity payments only when margin falls below user selected coverage level 4. No payment limitations or AGI caps on eligibility Futures & Options Based Risk Management LGM-Dairy 1. Protects average gross margin at prevailing market prices, price floor moves up or down 2. Is designed to be actuarially fair pre-subsidy 3. Indemnity payments when actual margins are below guarantee at end of coverage period 4. Lacks sufficient underwriting capacity for continuous coverage 8

$/cwt 1 9 8 7 6 4 3 Guaranteed Price Floor Using LGM-Dairy Nov PY Purchase Date (1-Mo Contract) Average $7.46/cwt Jan Mar May Jul Sep Average $7.32/cwt Jan Mar May Jul Sep Average $4.8/cwt Jan Mar May Jul Sep Average $.93/cwt Jan Mar May Jul Sep Average $.43/cwt Jan Mar May Jul Sep Average $7.91/cwt Jan Mar May Jul Sep 29 21 211 212 213 214 LGM-Dairy Summary Statistics Reinsurance Year Premium ($M) Indemnity ($M) Net Benefit ($M) 29.29.72.43 21.78.28 -. 211 2.1.7-24.94 212 19.18 1.39-17.79 213 16.87 2.63-14.24 214 11.64 *???? Total 73.77.9-7.4* * As of 7/29/214 Source: USDA Risk Management Agency MPP: Skin in the Game MPP can provide revenue support during singleor multi-year losses in farm equity Passive strategy may not work for all dairymen Dynamic strategies can be creative (may involve alternating coverage choices annually) Can be integrated with futures/options and forward to improve risk management at farm What level of integration is best? Goal to shift dairymen into new era ( Skin in the Game ) MPP is uncoupled from market supply and demand fundamentals to increase ease of use (i.e. fixed premiums and coverage levels). Tool Margin Ranges are Based on Futures Markets Economists think of futures markets as the best available forecast Many players have skin in the game Futures are generally considered to be unbiased estimators of future price Not consistently off in one direction or the other 9

Corn Price ($/bu) 8 6 4 2-2 Using CME to Forecast NASS Corn 3/1/21 1/1/21 /1/22 12/1/22 7/1/23 2/1/24 9/1/24 4/1/2 11/1/2 6/1/26 1/1/27 8/1/27 3/1/28 1/1/28 /1/29 12/1/29 7/1/21 2/1/211 9/1/211 4/1/212 11/1/212 6/1/213 1/1/214 NASS Corn CME Corn Settlement Basis Coybean Meal Price ($/ton) 6 4 3 2 1 - (1) (2) Using CME to Forecast AMS SBM 1/1/21 9/1/21 /1/22 1/1/23 9/1/23 /1/24 1/1/2 9/1/2 /1/26 1/1/27 9/1/27 /1/28 1/1/29 9/1/29 /1/21 1/1/211 9/1/211 /1/212 1/1/213 9/1/213 /1/214 AMS SBM CME Settlement Price Basis Using CME to Forecast AMS All-Milk Regression Price Inputs and Outputs Milk Price ($/cwt) 3 2 2 1 1 1/1/21 9/1/21 /1/22 1/1/23 9/1/23 /1/24 1/1/2 9/1/2 /1/26 1/1/27 9/1/27 /1/28 1/1/29 9/1/29 /1/21 1/1/211 9/1/211 /1/212 1/1/213 9/1/213 /1/214 NASS All-Milk Price CME CIII CME CIV US All Milk Price Class III Milk, Class IV Milk, Lagged Prices, Seasonal Dummy US Corn Price CME Corn, Lagged Prices US Alfalfa Hay Price NASS Corn, AMS Soybean Meal, US All Milk Price, Lagged Prices AMS Soybean Meal CME Soybean Meal Prices 1

Deviates in 6th Nearby Soybean Meal Contract Are Corn & SBM Prices Correlated? (Futures Cash Deviation) SBM Price Decrease 1 1 Corn Price Increase - - SBM Price Increase -1-1 -2-2 -3 Deviates in 6th Nearby Corn Contract Corn Price Decrease y = 18.923x - 29.12 R² =.167 Deviates in 6th Nearby Corn Contract ($/bu) Are Milk & Corn Prices Correlated? (Futures Cash Deviation) 4 Milk Price 3 Milk Price Increase Decrease 2 1-1 -1 1 2-2 -3-4 Feed Price Decrease Feed Price Increase y =.1828x -.13 R² =.21 Deviates in 12th Nearby Class III Milk ($/cwt) Deviates in 6th Nearby Soybean Meal Contract ($/ton) Are Milk & SBM Prices Correlated? (Futures Cash Deviation) 1 1 Milk Price Increase -1-1 2-1 -1-2 -2-3 Feed Price Decrease Feed Price Increase y = 7.84x - 2.96 R² =.182 Deviates in 12th Nearby Class III Milk ($/cwt) Milk Price Decrease Example Probabilities CME Feed.4.3.3.2.2.1.1. September 1 Corn Price PDF 1 2 3 4 6 7 8 9 Corn Price CME futures and options prices provide a forecast of the expected price and uncertainty 11

Example Probabilities CME Feed Example Probabilities CME Milk.4 September 1 Corn Price PDF 7 x 1-3 September 1 SBM Price PDF.12 September 1 Class III Price PDF.12 September 1 Class IV Price PDF.3 6.1.1.3.2 4.8.8.2 3.6.6.1.1 2.4.4. 1.2.2 1 2 3 4 6 7 8 9 Corn Price 1 2 3 4 6 7 Soybean Meal Price 1 1 2 2 3 3 Class III Price 1 1 2 2 3 3 Class IV Price Simulate from CME corn and soybean meal price distributions to get NASS and AMS prices Simulate from CME class III/IV milk price distributions to get NASS all-milk price CME Probabilities Combined September 21 MPP-Margin.12 September 1 Class III Price PDF.4 September 1 Corn Price PDF 4 September 21 MPP Margin Histogram.1.3.3 3.8.6.4.2 Class III 1 1 2 2 3 3 Class III Price September 1 Class IV Price PDF.12.2.2.1.1. Corn 1 2 3 4 6 7 8 9 Corn Price 7 x 1-3 September 1 SBM Price PDF Frequency 3 2 2 Generate a probability distribution of MPP-Dairy Margin (for all coverage months).1 6 1.8 4 1.6 3.4 2.2 Class IV 1 1 2 2 3 3 Class IV Price 1 SBM 1 2 3 4 6 7 Soybean Meal Price 1 1 2 2 MPP-Margin Price 12