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An Important Lesson in Milk Marketing

Carig Thomas
Extension Dairy Educator, Michigan.

Calendar year 2009 was very difficult for Michigan dairy producers. According to data collected by Michigan State University, the average gross cash margin for Michigan dairy producers was $1.83/cwt in 2008 and plummeted to -$1.81/cwt in 2009. As a result, profits fell, accounts payable soared, and large slices of equity evaporated. Average annual Class III milk price fell 35% from 2008 to 2009 ($17.44/cwt to $11.36/cwt). Perhaps the most unfortunate aspect of this situation was that if Michigan dairy producers had employed moderate and conservative milk marketing strategies in 2008, they could have avoided some of this financial disaster.

At the beginning of 2008 the annual average Class III futures price for 2009 at the Chicago Mercantile Exchange (CME) was $15.73/cwt (Figure 1). As indicated in Figure 1 this average futures price continued a steady climb peaking at $20.65/cwt on June 18, 2008. Hindsight is 20/20, but theoretically it would have been possible on June 18, for a dairy producer to have forward contracted 2009 milk production and received $9.20/cwt greater milk price than what was eventually received ($11.36/cwt Class III average). Every experienced marketer knows that hitting that high is very unlikely. Also, hitting the high is not the goal of a realistic marketing plan. A realistic plan takes into account the cost of producing milk and whether milk prices in the futures market are offering a realistic margin over that cost. When the market is offering a positive margin and is continually strengthening, as it did for 2009 Class III milk prices during much of 2008, a strategic marketer could have “sold into a rising market.”

One way to determine whether the futures market is offering truly attractive milk prices is to look at Class III milk prices from a cumulative probability perspective. Figure 2 (on page 9) is a cumulative probability graph of actual monthly Class III milk prices from 1995-2010 (before 2000 Class III was designated as the Basic Formula Price or BFP).
milk_lesson

The horizontal axis of Figure 2 is price, and the vertical axis represents percentiles (i.e., cumulative probability). The curved line begins on the left at the lowest monthly Class III price during that time period, $8.57/cwt (November 2000), and ends on the right at the highest monthly Class III price, $21.38/cwt (July, 2007).

As you move from left to right along the curved line you are simply placing each actual monthly Class III price during that time period in order of increasing magnitude. Thus, during that time period 100% of monthly Class III milk prices fell between $8.57/cwt and $21.38/cwt. The average was $13.20/cwt and the 50th percentile was $12.83/cwt. So 50% of the Class III prices were below $12.83/cwt.

milk_lessonfig2

A Class III price of $16.94/cwt is at about 90th percentile. This means that from 1995-2010 the monthly Class III price was only higher than $16.94/cwt 10% of the time. Recall that the CME Class III futures average for 2009 peaked on June 18, 2008 (Figure 1), however, that price remained at, or above, the 90th percentile ($16.94/cwt) from March 7, 2008 to September 09, 2008 as shown by the horizontal line at $16.94/cwt on Figure 1. Thus, dairy producers had over 6 months in which to sell all 2009 milk on the futures market, or use forward contracting, at extremely attractive prices. Therefore, I would advise dairy producers to strongly consider forward selling milk anytime the annual average Class III futures price hits the 90th percentile. This does not mean a producer would sell 100% of future milk production when the Class III price hits this point. Rather, producers can use this price level as a point to trigger a marketing plan into action. Such a plan sets price trigger points for small portions (e.g., 10 to 30%) of annual production as the market peaks and declines.

If a dairy producer had used this strategy in 2008 for selling 2009 milk production, the results would have been dramatically beneficial. For instance, assume that the “average” Michigan dairy producer forward contracted 50% of his/her 2009 production at or above the 90th percentile as the futures market rose and fell during the summer of 2008. Assume also that the average Class III price of milk marketed in the future was halfway between $16.94/cwt and $20.65/cwt. Ultimately, the forward contracted milk would have sold for $18.80/cwt (Class III). This would have increased the average price (Class III) of all milk sold by the farm to $15.08/cwt, an increase of $3.72/cwt.

The average Michigan dairy herd in 2009 had about 162 cows, producing about 22,445 lb/cow. This marketing strategy would have produced over $135,500 more total revenue for 2009. Ironically, the 2011 CME Class III futures average was $16.94/cwt on February 25, 2011.

Have you considered a marketing plan to sell some 2011 milk ahead?


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