2013 Farm Bill: What does it mean for Dairy Lenders?

2013 Farm Bill: What does it mean for Dairy Lenders? Dr. Marin Bozic University of Minnesota Agriculture Credit Association Conference October 24, 2013 Saint Paul, MN

Agenda • Is there a case for dairy safety net? • Nuts and bolts of proposed new programs • What are the implications for ag lenders? • The Bottom Line.

Is there a case for dairy safety net?

Competing Dairy Policy Proposals • Two alternatives: • Senate Bill No. 954 “Dairy Security Act” • House Bill. 2642 • “Goodlatte-Scott Amendment”

No more price floors – milk powder prices will integrate with the rest of the world

MILC gone – was a big help for small producers

Income over Feed Costs Margin • All-Milk ($/cwt) - 1.0728 x Corn ($/bu) - 0.00735 x Soybean meal ($/ton) - 0.0137 x Alfalfa hay ($/ton) • Feed ration per cwt of milk: • 30 pounds of shell corn, • 106.4 pounds of corn silage, • 14.7 pounds of soybean meal • 27.4 lbs of alfalfa hay

Income over Feed Costs Margin: 2004-2012

Subsidized Margin Insurance • Official name: Dairy Producer Margin Protection Program (PDMPP) • Two layers: • Basic Margin Protection – “Free” protection at $4.00 margin • Supplemental Margin Protection – Can buy up from $4.50 to $8.00 margin in 50 cents increments (called “Coverage Level”)

Basic Margin Protection

Supplemental Margin Protection: $6.50 Coverage Level

Supplemental Margin Protection: $8.00 Coverage Level

DPMPP: What triggers it exactly? • Calendar year is divided into consecutive two-month periods • Average margin must be below the purchased coverage level in order for indemnities to be due.

DPMPP: What is the payment rate? • Basic Margin Protection • The difference between the actual margin and $4.00, except that, if the difference is more than $4.00, the Secretary shall use $4.00 • Example: Jerry subscribed for basic margin protection. For Jul-Aug, payment rate was $1.14 per cwt. If Jul-Aug margin was -$0.50, payment would have been $4.00 per cwt.

DPMPP: What is the payment rate? • Supplemental Margin Protection: • The difference between coverage level and the greater of actual margin and $4.00. Example: Jerry also subscribed for supplemental margin protection at $6.50 coverage level. For Jul-Aug, the payment rate on supplemental was $6.50- max($4.00, $2.86) = $2.50

DPMPP: What is the payment base? • Basic Production History • Used in Basic Margin Protection • Equal to the highest annual milk marketings in any 1 of the 3 calendar years immediately preceding the calendar year in which the participating dairy signed up • 80% of BPH is covered. • Annual Production History: • Used in Supplemental Margin Protection • Equal to the actual milk marketings of the participating dairy during the preceding calendar year • 25-90% of APH can be insured

Dairy Market Stabilization Program Trigger: • Actual margins of $6.00 or less for each of the immediately preceding two months • Actual margin of $4.00 or less for the immediately preceding month

DMSP: What is the stabilization base? • Volume of average milk marketings for the three months immediately preceding the announcement that the stabilization program is activated OR • Volume of monthly milk marketings for the same month in the preceding year as the month in which DMSP is declared active

DMSP: Stabilization base for a growing dairy

DMSP: What is the ‘penalty’? • Producer is not going to be paid for more than the greater of… • If margins were $5.00-$6.00: • 98 percent of stabilization base • 94 percent of the marketings of milk • If margins were $4.00-$5.00 • 97 percent of stabilization base • 93 percent of the marketings of milk • If margins were less than $4.00 • 96 percent of stabilization base • 92 percent of the marketings of milk

Designing dairy safety net • Agreement: • Price floors should be abolished. • Instead of milk price, focus should be on profit margins. • Producers should not be asked to make long-term insurance commitments. • Disagreement: • Supply management of some form is an essential policy pillar.

Pro and contra supply management • Why it might be a good idea: • It could reduce government costs, accelerate margin recovery in low-margin states of the world. • Does not present a long-term obstacle for milk production growth, even for farms with aggressive growth plans • Why it might not be such a good idea: • Unquantifiable unknowns. It could end up being just an ineffective nuisance.

Estimating expected effects using market information All-milk price CME Corn Futures & Options CME Class III Milk Futures & Options NASS Corn Price CME Class IV Milk Futures & Options AMS Soybean Meal Price CMESoybean Meal Futures & Options NASS Alfalfa Hay Price Historical correlations

A Numerical Example 2013 Expected production: 91,618 cwt Happy IOFC margin: $8.00/cwt Happy IOFC revenue: $732,944 Basic Production History: 89,821 cwt Annual Production History: 89,821 cwt Bad memories: 2009 IOFC margin: $4.52 2012 IOFC margin: $5.31

What would $6.50 coverage level mean under different margin scenariosif we get DSA

What would $6.50 coverage level mean under different margin scenariosif we get G-S

Expected impacts of DSA on a 360 cow farm in 2013 (based on information on Jan 15)

Expected impacts of G-S on a 360 cow farm in 2013 (based on information on Jan 15)

Let’s play a game… Imagine that it is January 15, 2008. Dairy Security Act has just become a law. You are the owner of ‘North Star Dairy’ a fictional large dairy operation in Minnesota that had grown to about 2000 cows at the end of 2012. You have made a decision to participate in the DPMPP/DMSP in 2008. Let’s see how did the program work for you over 2008-2012 period.

Please take a look at this device… (forget everything from 2008+)

North Star Dairy has been growing…

Information as of January 2008…

Actual Income Over Feed Cost Margin in 2008

This is how 2008 turned out for you…

Subsidies are embedded in timing, not primarily premium levels

What else do we (think we) know about the new programs? • Under the Milk Income Loss Contract program (MILC), farms with less than 100 cows (76% of farms; 18% of milk production) account for 42% of net payments and farms over 1000 cows (2% of farms; 42% of milk production) account for 6% of net payments. • Under the new policy regime farms with fewer than 100 cows will get 17-21% of net program benefits, and farms over 1000 cows will get 36-43% of benefits.

2013 Farm Bill: What does it mean for Dairy Lenders?