Marketing: Setting up a hedge line of credit

By Matt Mattke

Q:  I’m interested in setting up a hedge line of credit with my bank for milk marketing, but I’m not sure how much to request.  Any suggestions?

A: Setting up a hedge line of credit with your bank is an important step toward successful milk marketing. Here is why.

When money must be pulled from cash flow to meet marketing expenses, it can burden producers financially in the short run, because that is money that needs to be used to fund the day-to-day operational expenses of your dairy.  If cash flow is tight, there is the tendency to implement the risk management strategies that are the “cheapest.”  This means that, rather than implementing the best position that provides you the best floor, you’re getting mediocre price protection with a subpar position.

Also, frequently having to write out personal checks to fund your hedge positions can have a negative psychological impact, and lead to irrational marketing decisions fueled by emotion.  Often, producers that fund their marketing expenses from cash flow reach a threshold –- either cash flow-wise or psychologically — where they cannot stand to write out another check to fund their hedge positions, and instead request that all hedge positions be lifted.  This usually occurs right before the bottom falls out of the market, and the producer is left 100% exposed to the totality of the price drop.  A hedge line of credit helps to mitigate the cash flow and psychological impact on the producer, and provides greater longevity to hold hedge positions until their expiration.

The amount to budget for marketing expenses is not what it was two or three years ago.  Prior to 2007, a producer could easily budget 50¢/cwt. for a hedge line of credit.  The tremendous increase in milk price volatility over the last two years has made 50¢/cwt. an insufficient amount to budget in order to maintain hedge positions through large price swings.  In order to have enough cushion, a producer should budget about $1.75/cwt. for their hedge line of credit.  The average daily price swing is about three to four times what it was back in 2006.

The majority of banks are more than willing to extend credit to dairy producers to fund their milk marketing, especially in the extremely volatile environment we find ourselves in today.  Implementing risk management strategies “can” remove volatility from your future revenue stream, provide more revenue certainty, lock in positive cash flow, and aid in budget development.   A sufficient hedge line of credit, established to back up your hedge positions, will allow you to see them through to expiry and help to make your milk marketing more successful.

FYI
■ To have your marketing questions answered in this column, contact Matt Mattke, Market360® adviser at Stewart-Peterson. Contact him via e-mail: mmattke@stewart-peterson.com, phone: 800-334-9779 or visit www.stewart-peterson.com.

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