It’s less than a year and a half old, but the USDA’s new Dairy Revenue Protection program has already led farmers across the U.S. to hedge an estimated 12% of the national milk supply.
Blimling and Associates‘ Phil Plourd, Tiffany LaMendola and Katie Burgess join Ted and T3 to explain how this price risk management tool works and discuss why quick adoption of the program bodes well for the industry.
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Anna: Welcome to The Milk Check, a podcast from T.C. Jacoby & Company, where we share market insights and analysis with dairy farmers in mind.
T3: Hello everybody, this month on The Milk Check we have another guest on our panel, Phil Plourd is President of Blimling and Associates. And he and his team are here to help us learn about DRP or the Dairy Revenue Protection program recently created by the USDA to help dairy farmers protect downside milk price risk. Well, we’re excited today to be here with Phil Plourd, Phil’s got two other members of your team that have joined us.
Phil: Yes. So we have on the line today Tiffany LaMendola, who’s the Vice President of our risk management practice and she is based in the Modesto, California area. And also Katie Burgess, who is one of our Risk Management Leads. And the two of them have spent a lot of time over the past year working on the DRP insurance program. So been out in the field, working with dairy farmers and getting them enrolled and getting them going in the program.
T3: So what I thought today would be a great topic to discuss with Phil in town was the dairy revenue protection program, which is a great program that’s been set up for dairy farmers, but a program also that I have to admit I don’t know a lot about.
Ted: And I have to concede, I don’t know anything about it either.
T3: So I thought we’d go ahead and have Tiffany, and Katie, and Phil, kind of give us their view of what the program is all about, how it works. And Dad, you and I can just ask questions, and it’s gonna be an educational experience for us as well as for the farmers that listen.
Ted: It can’t help but be educational for me.
T3: Phil, Katie, Tiffany, what is it?
Tiffany: It’s a relatively new program for dairy producers to manage milk price risk. It was first rolled out in October of 2018. There was a slight delay while the government was shut down. And so it really is quite new. So don’t feel bad if you don’t know much about it. We’re finding actually a lot of producers are still learning about it themselves. At its simplest terms, it is the ability to buy a milk price floor at subsidized levels, it’s very customizable by… So, you know, obviously different producers in different regions have different milk price risk, you know, based on how their milk prices are determined. And this allows a producer to go in and sort of do their best to mimic how their milk is determined with some combination of Class III and Class IV. And look out into the future and set milk price floors kind of based on where the markets are at, at a quarter-by-quarter. And really kind of dial in as close as we can to, again, how their milk price is determined. It is offered through the Risk Management Agency of USDA as a crop insurance program. So you do have to buy essentially the program through a crop insurance agent, so producers kind of across the U.S. will be working with crop insurance agents to access this program.
Ted: So where are these agents located, in the local extension service?
Tiffany: They’re kind of all over. So we have agents on our team. You know, we’d like to think we have the dairy expertise piece of it that’s been quite important. So when we first got involved, we found a lot of crop insurance agents are, you know, tremendous at what they do, have long histories in insuring row crops and so forth, but maybe not as much dairy expertise. As you know, our markets are unique and so we got involved, we talked to a lot of dairy producers and can really help them kind of on the dairy piece of it understanding exactly how their milk prices are determined and help them put that strategy together. So there’s agents everywhere, no doubt some with more dairy expertise, some with none.
Phil: The program is insurance is a heavily regulated industry. And so, you know, you have to be chartered in different states. Actually, Tiffany, if it all goes south, Tiffany and Katie are eligible to sell property and casualty insurance as well, because to become a licensed crop insurance agent, you have to go get an insurance license. And so while it’s open to all it is a process to be able to become a licensed crop insurance agent.
T3: So Phil, we’re not dairy farmers. So there’s certain parts of the agriculture industry we’re not familiar with. Crop insurance is pretty common for those farmers who are growing corn and grain and things like that.
Phil: I can’t cite the specific history of, “Oh, it started in 19-whatever.” But for many, many years USDA through the risk management agency has partnered with insurance carriers to offer subsidized insurance and some of that insurance is revenue insurance for grains. Some of it is disaster insurance for grains. So this year, we saw a lot of…there was something called Prevent Plant Insurance, for example. So if for some reason you can’t get your crop in the ground, there’s insurance that you can buy from crop insurance agents that will compensate you for your lost planting. And so we saw a lot of those policies actually used I mean, cashed in, if you will, this year, so.
And there’s stuff on grapes, there’s all kinds of different crop insurance products out there. Tiffany and Katie, I forget how many licensed carriers, there are about eight or ten big insurance companies that have crop insurance practices. And through a lot of rules, regulations through USDA, RMA, but subsidies on premiums, it’s sort of a public-private partnership in terms of crop insurance generally. So dairy was tacked on, if you will, to the crop insurance universe. And the program was largely dreamed up by Marin Bozic at the University of Minnesota and John Newton who works for Farm Bureau Federation. I think it came out of their thinking and became part of the USDA, RMA program, or package.
T3: And so how does it protect dairy farmers? What exactly does it do?
Phil: Katie, why don’t you tackle that one?
Katie: Yeah, so the way the program works is that the producers can insure a price floor or a trigger price. So how it works is when the market’s trading you take 95% of the current price and that’s the level that the farmer can protect. So for instance, today, the January through March Class III Futures average is $17.63 a hundredweight. We take 95% of that number which is $16.75, and essentially for the first quarter of 2020, producers can protect the floor of $16.75 per hundredweight. That’s the program in its simplest terms, there are definitely some other things that go into it like yield per cow in your state. But for each quarter all the way through the first quarter of 2021, as of today, producers can lock in these milk price floors.
T3: And the premium is on that first quarter 2020 premium, you said $16.75 coverage, and what’s the premium for that just generically speaking?
Katie: So the premium on a $16.75 price floor for Q1 is somewhere between $0.04 to $0.07 a hundredweight dependent upon where you’re located. So pretty cheap, it’s cheaper than you can go out and buy $16.75 Class III productions in the futures market today.
T3: And what’s the second quarter just for illustration purposes.
Katie: So right now as we look out through 2020, for the second quarter of 2020 April through June, the price floor is $16.17 for about $0.10 a hundredweight. And if we just keep going further out, the third quarter the floor you can lock in at $16.59 for about $0.15. And for the fourth quarter of 2020, it’s $16.57 for about $0.20 a hundredweight. So basically for all of 2020 today, you can go out and insure a milk price floor of something above $16.00 per hundredweight, all for less than $0.20 a hundredweight. So it’s a pretty good deal. That’s I think one of the reasons it’s been so popular as of late, is because given the low prices we have seen in the market over the past three or four years, having a price floor at $16.00 seems like a pretty comfortable place for a lot of dairy producers to be.
And one of the reasons the program is so popular is that when you’re buying insurance, it’s just a price floor. So the same way that when you buy car insurance, you hope that you don’t get into an accident and need to collect on it. It’s the same thing with this dairy revenue insurance. Using the program, you’ve got yourself a price floor of around $16.00 a hundredweight or higher, and you hope that you never collect. So if the market is at $18.00, or $19.00 per hundredweight, you get that milk price, pay your premium. And that’s it. But if something bad happens the same way as if you get into an accident, you’re going to collect on your car insurance. If the market takes a turn south in 2020, you’re going to get a payout because you have a price floor in place.
Ted: You know, it seems from what you say that the mechanics of this are based on the Class III price. Is that correct?
Katie: Yeah, so there are actually a couple different ways for producers to think about it. So the more common route that we see is using the Class III and the Class IV prices. So people tend to start there because it’s pretty simple. The prices mimic exactly what we see at the CME every day. But the one interesting piece that has brought some other folks into the mix, is you can actually match the program to your own farm milk component. So if we think of a standard Class III contract, it assumes 3.5% butterfat. But if you’re milking jersey cows, there’s a good chance your milk fat’s running a lot higher than that. And so producers actually have the opportunity through this DRP insurance to customize to their exact component levels. So they can go up to 5% butterfat or 4% protein to better mimic what’s actually happening on their dairy. And this is the first program we’ve seen in the dairy industry that allows producers to customize because we know every herd is different. And so this allows farmers to mimic that.
Ted: Well, there’s a lot more to milk pricing than just Class III and component pricing. We have PPDs and we have different regional advantages, we have premiums in various regions and so on that vary. So how do we account for these various regional differences?
Phil: Much like any dairy producer who’s accessing a futures market product or a Forward contract through their co-op, I mean, you’re operating on a national base. So it’s not a 100% forward contract like, you know, if you sold corn to the elevator today, you’re guaranteed $3.725 per bushel. So it operates under the same base price premise that most other dairy risk management products imitate. So sure, if you’re in Wisconsin, and you’re getting paid $1.00 over as a matter of plant premiums, that doesn’t change, I mean, this is just basically an insurance product underneath your base price.
Ted: But you’ve got your price. In this case, the example says $16.75 including freight or not?
Phil: It’s just…
Ted: Is that a delivered somewhere price?
Phil: It just mimics…it’s measured against the actual Class III price. So it’s just the Class III price base. So if you typically get paid $1.50 over, you know, you would say, “Oh, I’m buying a $16.50 product,” you’re likely locking in $18.00 assuming premiums, you know, persist. So it is not an actual contract price for your milk. It’s a revenue protection insurance product.
T3: So you’re not gonna be able to lock in your freight costs and you’re not gonna be able to lock in whatever the mailbox overages or the PPD or the blend price is. But what you are able to do if I understand it’s not just Class III, there’s a Class IV component too…
T3: …if you’re in an area which has a heavy Class IV component.
Phil: And you can insure your actual, you know, theoretical component level. So you’re going beyond your base three, five price up to, you know, to mimic your own herd. But in that regard, it’s no different than most risk management products that are out there. The advantage of this is that it’s very convenient. And it’s pretty heavily subsidized by the federal crop insurance program.
Tiffany: Your questions definitely identify where a lot of our time and our discussions have been with dairy producers because they need to kind of understand how this relates to their actual pay price and what this means. So we’ve spent a good deal of time going through all these things you just identified. And I guess that’s why I would stress definitely speaking with somebody with some dairy expertise can help answer just those questions. “Okay, well, what’s this PPD and how do I protect against that? And how do I, you know, deal to the fact that I ship to a processor that actually depooled and my pay price is different?” You know, all of those scenarios we’ve seen, and this program is flexible enough, that it allows us to just kind of mix and match the different avenues to best mimic their pay price as we can, it’s not gonna be perfect, but it’s gonna get pretty close. So that’s been a very appealing part of this program as well, the flexibility.
Ted: Well, maybe the right question to ask for me the novice is how do you establish what you would have got? I don’t understand that, okay.
Phil: Well, but it’s no different today. So let’s just say you were a dairy farmer today shipping to co-op XYZ. Or let’s say you were a dairy farmer today, and you had your own individual futures account someplace. And you said, “Hey, I wanna manage my own price risk. And I’m gonna sell Class III milk futures to protect myself in case of falling prices.” Well, if you were acting on your own in the marketplace, all you could do is protect that Class III base, right? If the Class III price goes down, $1.00, you get $1.00. If it goes up $1.00, you get $1.00.
Ted: So you’re not protecting your own costs, you’re protecting the futures value?
Phil: More or less, sure.
T3: But think of it this way…
Phil: And you’re not protecting cost, you’re protecting income.
Ted: Well, that’s okay. That’s another way of saying the same thing. In other words, what you’re hedging is the $16.75 futures closing price for that quarter?
Phil: Yes, more or less, yes.
T3: But think about it this way. Let’s say you’re in Federal Order 33 in Michigan, which is…and in Federal Order 33, your utilization typically is between Class III and Class IV. In Class I and II, off the top of my head, I’m gonna say it’s what, about 35% Class III, maybe 30% Class IV.
Phil: It’s probably 40/60 Class III, IV.
Phil: I mean, Class III, 60%, 40% Class IV.
T3: Exactly, your Class II is almost very highly correlated with Class IV. So you think about that as a Class IV type of hedge. Your Class I is now 50/50 between Class III and Class IV, and so you can devise a balance between Class III and Class IV let’s say it’s 60/40. And then they use a 60/40 balance on their DRP hedge. And that’s what they lock in. And then, you know, they should know what their hauling is gonna be. And that’s gonna be static, it’s not gonna change with the market. And yes, your overage could change over the course of the year. But there’s really no way, you know, to hedge that.
Phil: Anywhere else.
Phil: Yeah. And I think that the neat thing. So the advantage of this program versus a traditional market traded option, or futures contract, is that you do have that ability to create a price that more closely mimics your local blend price, again, net of PPD…your local III, IV mix, so you can match up utilization. And if you are…you know, you have to worry about, “Oh, I got 14 Class III contracts and 7 Class IVs, and how does it all come together?” Under the umbrella of one product you can dial in that Class III, IV mix appropriately, and you can do it to reflect your component values that you estimate that you have in your farm. So there’s a level of customization that takes it beyond the utility of just conventional futures and options. And then there’s a whole notion of…and it’s subsidized. You know, you’re paying less than what actual traded instruments would cost you.
T3: This year, what is the Class III average so far in 2019? Has it been about $16.50 this year? I think it has, hasn’t it?
Ted: I think it’s higher than that.
Phil: It’s a little higher now.
T3: I think, yeah, we had a couple months of $20.00 milk. So maybe it’s a little bit higher. But where I’m going with this is right now, a dairy farmer has the ability to lock in a floor for 2020 that isn’t too dissimilar to what their price for the year was in 2019. Is that correct? And they’re gonna pay $0.10, maybe $0.12 a hundredweight for the opportunity.
Phil: Yeah, that’s pretty close to right.
T3: It seems like a no-brainer to me if I’m a dairy farmer, especially with corn at, what, $3. and…
Phil: 75 cents.
T3: …75 cents right now a bushel?
Phil: Yeah, so now you’re looking at pretty stout margins. I mean, if you look at what that $16.50 base insurance level, you know, translates to in terms of profitability. It ain’t…I mean, it’s not too bad. I mean, you’re looking at, you know, pretty significant dollars per hundredweight against that, you know, again, you have to go manage your grain price risk. I mean, there’s all kinds of ifs and buts around that. But sure, it’s super competitive in terms of what kind of level you can protect. And I think that’s why the numbers are so big. I think, you know, Tiffany has or Katie has the numbers. I mean, we have seen massive amounts of milk booked through this program.
T3: What percentage of the milk in the United States right now do you think has been hedged for 2020 using the DRP program?
Katie: So it is a massive amount, especially for a program that is just more than a year old. So, since the program rolled out last October, more than 50 billion pounds of milk have been enrolled. And when we look at what seems to me more or less on the books for 2020, it’s about 27 billion pounds of milk. So on an annualized basis, that’s about 12% of the U.S. milk supply. So especially for a program that is pretty new, that’s a pretty impressive uptake. And when you compare that 27 billion pounds that’s been booked between July 1 and today, that amounts to about 130,000 futures contracts. We look at how much Class III open interest is on the books as of today, it’s only 20,000. So we’re about six times more in terms of how much DRP is on right now compared to Class III open interest.
T3: Wow. So that’s 12…so we haven’t even hit January 1 of 2020 yet. And 12% of the national milk supply is already hedged.
Katie: More or less.
T3: What are your expectations? What percentage of the milk supply…just this is a guess, I know it is. But what percentage of the milk supply do you think ultimately will be hedged for 2020 with the DRP program, any idea?
Katie: I think we should get close to 30% to 40%. In some states, though, we’ve already seen pretty massive uptake. So for instance, in South Dakota more than 40% of the milk on an annualized basis has been hedged since July 1. So that’s really impressive. It does vary by state. So we’re up to more than 30% in Kansas as well. And in states like Wisconsin, or Minnesota, we’re at 10% to 20%. So it’s been pretty impressive. Plus, I think one of the main drivers of it is just that the prices are so good today. So when you figure you can lock in prices, between $16.00 to $16.50. The five year average for Class III is about $15.50 a hundredweight. So you’re already doing $0.50 cents to $1.00 better than the long run average. And because of that people have really jumped on it.
Phil: You have to be careful about making generalizations, but I would say that for the average large dairy producer in the United States, I would guess that they’re happy over $14.50. You know, they’re delighted over $15.50 and they’re really making pretty good money over $16.50. Again, on average, so the numbers that you can lock in today are not just marginally profitable. I think they’re, you know, modestly to really nicely profitable in terms of where producers are at. And I would say that, you know, one thing to keep in mind and we don’t wanna get too far down the alphabet soup of risk management products.
But the other government program would be the dairy margin contract program, the old… So that’s a different program. And that has super appeal for farmers of 200 cows or less. So if you came to us and said, “Hey, I’ve got 200 cows, what should I do?” We would point to the DMC program because it’s basically free, and you can cover really big margins. And so you’re up to 5 million pounds of milk per year. So we’re not likely to see a lot of smaller producers gravitate towards DRP because they have a better and even cheaper avenue of coverage under the DMC program.
T3: So they didn’t get rid of the DMC program when they instituted the DRP program?
T3: Both programs are in existence?
T3: Does a dairy farmer have to choose whether they use one or the other?
Tiffany: I’d like to piggyback on that just a little bit too. Same kind of theme. But I think a big reason we’ve seen such large uptake, at least definitely from a Western perspective, is that this program is scale neutral. So it is the same price per hundredweight, you know, regardless if you have 50 cows or 50,000 cows. And it’s kind of the first government-ish programs we’ve seen operate that way to Phil’s point, you know, the other programs have been more appealing to mid-sized, smaller farms. And so that has definitely been looked upon favorably.
Anna: On The Milk Check podcast, we tackle questions and share ideas that move dairy forward. Now we’re making it easier for you to get answers to your lingering questions. Do it with one click, submit your questions online at jacoby.com/askted.
Phil: You know, just that if you were at Dairy Forum last year, Marin Bozic, you know, who had a big hand in crafting this program, one of the things he talked about, you know, in terms of safety…you know he was talking about the safety net. And he said, “You know, it’s one thing to talk about a safety net.” But in essence, what we’re creating here is almost a safety cocoon for a good portion of the dairy production community. So smaller producers with DMC, which is really, really strong in terms of what kind of margin level you can protect. And then DRP going beyond that for larger producers, now, DRP is only as good as the market. So if milk produce were at $13.50 right now, you know, I don’t think we would see 25 billion pounds of milk under management, right? So I mean, DRP is market dependent. It’s only gonna be as good as the market at any given time, right? If futures were at $15.00 bucks, there’d be no $16.50 insurance for $0.20 cents.
T3: So it sounds like what DRP is doing is that there are a lot of producers that haven’t been hedging that now that DRP is available, they’ve started using this tool to hedge?
Tiffany: Yeah, we’ve seen…I would say 90% of the clients we’ve worked with are totally new to the milk risk management space, there have been things that have precluded them from participating before. And we’re finding that this program is answering a lot of those concerns. And so it’s really exciting because we’re having conversations with a lot more dairy producers that I think otherwise we just couldn’t have had. It’s encouraging for maybe general market participation, you know, that this is the first step and maybe it’ll progress more. So you know, folks fearing about loss of liquidity in the futures and options markets, I kind of think it’s the opposite. I think we see new players coming in and thinking about this more than they ever were. So there’s opportunities for the future.
T3: So when you buy it’s essentially a put option. But when you buy a put option, you have to put the money up front. Is it the same With the DRP program?
Ted: How do you pay for it?
Katie: Sure. No, you don’t have to pay for it up front. And that’s one of the other reasons that people really like the program. So let’s say today, you wanted to take some coverage for the first quarter of 2020. So we have to wait to see what the milk prices are January, February, March. So we get to the end of March, there’s also a milk production component. So we have to wait for the milk production data that comes out in March. So essentially, if you’re receiving a bill, you don’t have to pay for it until the beginning of April. And because of the deferred payment, that’s one of the reasons it’s been popular. So if there is a payment, then your premium is just deducted from the payment that you’re owed. Whereas if you do owe money you owe as a premium, then you’ve had a few months in advance to plan for that. And if the program doesn’t pay out, that means that milk prices were good. And so because of that, it’s a little bit delayed, so there’s no money needed upfront.
T3: So let’s say you’ve paid $0.10 to lock in a $16.17 price floor for the second quarter. Let’s say you’ve got 10 million pounds of milk a month. So that would cost you if it’s $0.10 a hundredweight, $10,000.
Phil: Yeah, basically.
T3: So if the milk price in that quarter, or let’s pick the month of April…
Phil: No, it has to be the quarter, average for the quarter.
T3: It has to be the whole quarter?
Phil: Average for the quarter.
T3: So it’s the whole quarter?
Phil: Average for the quarter.
T3: Average for the quarter. So if the milk price comes in at a $20.00, average for that quarter, it’s $10,000. No more than that.
T3: And if the milk price comes in at, let’s say, $14.17. So they’d owe you $2.00 a hundredweight, which is $200,000 minus the $10,000, is that correct?
Phil: Taking out the $10,000, yeah.
T3: So basically, you’d get a check for $190,000?
T3: So the most you can lose is the $10,000 that it cost you but the most you can gain to however low the milk price could go?
T3: So I gotta ask this, I’m not a dairy farmer, but in our business, we’ve got a little bit of price risk too, can I access this program? Or do I have to be a dairy farmer?
Phil: Oh, you have to be a dairy farmer. Yeah.
T3: So your friendly neighborhood broker can’t access the DRP program, it’s too bad…
T3: …because this is a great program.
Ted: Let me pose a question. How do you keep the milk production from going through the roof in 2020?
Phil: I think that’s a fair question. I think that, you know, again, if you’re talking about a safety net, safety cocoon, I mean, I think you’re providing a pretty high floor on your milk production. I think what you do is, I don’t know, if you encourage production so much, if prices do come down, it gives you a little bit more…you know, it takes a longer time to wash production out on the downstroke more… You know, I think if you’re a producer, you know, you might have more confidence to expand if you have the $16.50 insurance program, whatever, I mean, but I would say that it’s more about preserving production on the down-tick than it is about encouraging milk production in a high price climate. You’re gonna do that anyway, right? $20.00 milk is going to make more milk. What this does is if we start to slide because farmers have insurance, theoretically you would say it gives them more longevity in a down market than otherwise would be the case.
T3: How far out can you hedge? Can people be hedging 2021 right now?
Katie: Yes, right now you can go up to the first quarter of 2021. And we’ll be loading up the second quarter for sale here before the end of the year.
T3: So what will happen is, just back to your question, Dad, about will it encourage oversupply? It will mean it will cause drops in income to be slower, because every year or every…you know, right now they could hedge 2021, soon they’ll be able to…let’s say in nine months, they’ll be able to hedge 2020, start hedging 2022. But if you keep stimulating more and more milk production, or are preventing farmers from going out of business, maybe the better way to put it, the more likely scenario is that your cheese price is gonna start coming down, because you’re gonna make more cheese, your powder price is gonna start coming down and your butter price is gonna start coming down. So next year, you’re not gonna be able to lock in at $16.50. It may be more like $15.50. And the year after that, it maybe $14.50…
Phil: Yeah, you’re gonna get a progressively worse market signal, right, you’re gonna get a progressively deteriorating market signal, that cocoon starts to fray as the markets go down.
Phil: So it’s not self-perpetuating. Now, DMC is a little bit different. Because that’s a fixed margin. But on the DRP program, again, yeah, six months from now, if we have lower milk prices, well, that next tranche of DRP coverage going forward is not gonna be as exciting as what we’re looking at today. So there’s a deterioration factor. So I think it can differ. It can tie people over for longer than otherwise would be the case, which is, you know, accretive to production. But it can’t perpetuate forever because at some point, you get to a point, a price point that the insurance isn’t worth…it’s not worth insuring $14.00 milk for these guys, right?
T3: But it also sounds like ultimately, whatever hole we may dig with overproduction is gonna be that much harder to get out of too.
Phil: I think that’s…I mean, again, it’s all theoretical. But I mean, from an economics perspective, yeah, I mean, I think that at some point, you’re subsidizing supply and you get more supply, right?
T3: Yeah, the cure for high prices is high prices.
Phil: So it just adds…I think it adds…theoretically adds a longer tail to the whole process. Now, we’ve not seen it in motion. So we don’t know. But I think that theoretically, if you got a bunch of producers with $16.50 price insurance out there, you know, they’re gonna be able to withstand more $14.00 markets. If that’s, you know, ultimately what happens, but then the next time around, they’re not gonna be able to insure quite as good a price.
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T3: So what other questions about the DRP program have we not asked that we should be asking or that the farmers would wanna know? What about volume? Like is there a limit on the volume that they’re able to hedge? I’m assuming it’s the amount of milk they can produce in a given year?
Tiffany: And you can do up to 100% of your volume. What will happen is if for any quarter there’s an indemnity owed to you. They will ask for copies of milk statements to confirm that you produce at least 85% of what you’ve insured on milk volume, or 90% of your components. So there’s even a little wiggle room there, and you can insure 100% through this program, you can also participate in DMC at the same time, and you can participate in your creameries forward contracting program as both futures and options, no limitations. The only limitations are DRP alongside LGM Dairy, you would not be able to double up those two programs.
T3: And you have to be Grade A producer, right?
Phil: And you have to have…I mean, because it’s part of USDA is risk management, and it runs through FSA, I think you have to have certain…there are certain things you have to have been enrolled in. You have to be all square with FSA to get the green light and get the subsidy.
Ted: Aren’t the banks gonna love this program?
Phil: I think the banks…well, yes, the banks definitely love this program. Some of the banks sell crop insurance. So they especially love the program, the farm credit system, many of your farm credit banks are chartered co-op insurance agents.
T3: So they’re pushing it.
Phil: Yeah, I think they’re definitely pushing it.
Ted: I could see the banks saying, “If I’m gonna make you a loan, you’re gonna be a member of this program.”
Phil: Yeah, I think that’s legit.
T3: Is it legal for a bank to do that?
Phil: Well, I mean, I don’t think it’s likely straight up coercion, but I think it could be, you know, we strongly suggest you have crop insurance, whether you buy it from them or somebody else.
Ted: Sure it’s legal.
Phil: Yeah. I mean, it’s the only secure decision.
Ted: It doesn’t matter where you buy it from, but it’s the fact that you got it.
Phil: It’s an element of securitization, right?
Phil: I know, Tiffany, you were mentioning earlier today, you thought there were five things that dairy farmers really liked about this program? And maybe we’ve touched on those points. But maybe you’d be a good summary for the listeners to hear what those five points are.
Tiffany: Yeah, we have kind of touched on them. But I think there really are…I mean, traditionally, producers have been very concerned about leaving money on the table, right, in the good time so folks that have come and maybe flat price their milk in years like 2014 when we saw dairy prices run high left money on the table. And then haven’t been back to do it since because they need those good years to kind of recover from the bad. So the fact that this program is just about securing milk price floor, a minimum price that leaves all the upside open has been huge. So if you say, “Well, traditionally they could have done that by buying puts,” right, but as we touched on, puts can be very expensive, particularly for lots of milk and further out and you have to, you know, pony up some money the next day. The fact that these are subsidized and the premiums aren’t due ’til after the quarter have also been tremendously popular.
The fact that, you know, it’s scale neutral, we touched on that, it doesn’t matter what size your dairy is, it’s the same price per hundredweight has been very favorable. We also touched on, “Well, this just doesn’t work for my region.” Well, the program is customizable enough as we’ve spoken to, to get that mix of Class III and IV and dial in on your component. So we can get pretty close, fairly, very flexible in that regard. And I think finally, dairy producers have often said, “Oh, risk management, it’s just too complicated. I don’t know how to get at it. I don’t know how to structure it?”
This program, if you read about it, it can sound complicated, I think quite honestly, it’s because of crop insurance jargon and lingo, but really, it’s just kind of five simple decisions. “How much of my milk do I wanna cover? How far out, at what floor level, and my mix and match of Class III and Class IV.” And it’s really that simple. We just don’t need to make it any more complicated than that. And so once we can kind of talk through that with them. Those are the reasons there that have driven participation and brought new folks into the space.
Phil: I would say that crop insurance generally has a favorable impression, dairy farmers generally have a favorable impression of crop insurance writ large, you know. So a lot of dairy producers that are using this program are using…you know, if they’re growing row crops, they already are familiar with crop insurance. And I would say, as a general statement, they view crop insurance positively.
T3: So if a dairy farmer who’s never…who maybe is hearing of the DRP program for the first time, or has been thinking about it, but didn’t know where to start, where’s the best place for them to start? If they have a crop insurance guy, would it be to give them a call? Or would it be to call Blimling?
Phil: I have a better idea?
Phil: You know, I think one of the first things you can do is go to drp.blimling.com, and you’ll find a calculator there that shows, it actually shows you a calculation of today, “I live in this state, I wanna do this many million pounds, and I wanna do Class III,” and it shows you the rates. So that’s a very handy tool just to scope it out. I would prefer people call us. But if you call the Blimling team or get in touch with us with that calculator, we can certainly help. But yeah, crop insurance agents of all stripes can help, but just like I am a licensed commodity broker and I could trade crude oil. I don’t know a lot about crude oil, you’d be better off with a crude oil broker. We’d like to think that, you know, for dairy producers, understanding the dairy nuance I think is the value add for people like us who are also selling DRP versus the guy on the street, so to speak.
T3: If they wanted to reach out to you, how would they do it?
Phil: I think the best way is to call us at 608-249-5030.
T3: Well, I think it’s a fantastic program. And I think I would encourage every dairy farmer to get involved because this is a great way for them to hedge their downside risk and the ultimate cost is tiny compared to the benefit they can get from it.
Phil: We all are looking for the crystal ball to predict exactly what’s gonna happen in 2020 and, you know, how will these forces unfold. And we don’t know, we don’t know if that $16.00 policy for Q2 or $16.50 for Q3 is ever gonna pay off. But I think if it doesn’t that’s even better news, right? That means that price strength is continuing. But I think all of us have been around long enough to know that the good times don’t tend to last forever. And so for, you know, a relatively modest price you can protect against that event. And you can save yourself a lot of heartache and financial difficulties for a year, year and/or more out, so.
T3: I would agree. I think we’re good. Katie, Tiffany, thank you very much for joining us. We really appreciate it.
Tiffany: You bet. Thanks, guys.
Anna: We welcome your participation in The Milk Check. If you have comments to share or questions you want answered, send an e-mail to email@example.com. Our theme music is composed and performed by Phil Keaggy. “The Milk Check,” is a production of TC Jacoby and Company.
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