LGM-Dairy margins above historical averages

With expiration of MILC, 2008 Farm Bill, fewer safety nets available

By Dave Natzke

The first sales of fiscal year (FY) 2013 Livestock Gross Margin-Dairy (LGM-Dairy) margin insurance policies begin Oct. 26, and participation is expected to be brisk.

On Oct. 23, USDA’s Risk Management Agency (RMA) allocated $14.9 million in underwriting capacity for the Oct. 26 LGM-Dairy sale. Expenses considered for underwriting capacity purposes include premium subsidies, as well as administrative and operating expenses. The $14.9 million represents about nearly 75% of the total $20 million available for RMA livestock insurance plans in FY 2013.

While sale conditions of the sale will be the same as those offered last fall, federal dairy policies designed to help mitigate dairy producer risk are not, noted Alan Zepp, Risk Management Program coordinator with Pennsylvania’s Center for Dairy Excellence.

“The conditions that have changed are the expiration of the Milk Income Loss Contract (MILC) program, no certainty regarding a 2012 Farm Bill, nor certainty of the dairy title of that Farm Bill,” Zepp explained during his monthly conference call, Oct. 24. “While the Dairy Security Act will likely be enacted, there’s no assurance of its final form.”


Expected margins for the upcoming sales period

Zepp said current expected margins available under LGM-Dairy are at historic highs, above $15/cwt. for December and January 2013, and between $14-$15/cwt. from February-October 2013. The expected margin for the entire December 2012-September 2013 period, at $14.52/cwt., averages $2.20/cwt. more than the 5-year average margin ($12.32/cwt.) for the same entire period. The 10-year average margin for the period is $12.11/cwt.


Coverage costs

Insuring the $14.52/cwt. margin with a “$0 deductible” LGM-Dairy policy, using default feed values, would cost 75¢/cwt. A “$1 deductible” policy – insuring a $13.52/cwt. margin – would cost about 25¢/cwt.

Compared to other risk management tools, LGM-Dairy costs are favorable. On Oct. 24, CME March corn was $7.56/bushel, with a $7.50 call costing 45¢. March soybean meal contracts were at $454.40/ton, with a $460 call costing $16.90/ton. March Class III settled at $18.95/cwt. on Oct. 23, with a $19 put costing $1/cwt.

“I think dairymen around the country will see that spending 75¢/cwt. to protect a margin that is $2.20/cwt., or 18% above the 5-year average, is a good deal,” Zepp said. “Even more likely, spending 25¢ for a $1 deductible policy will protect a margin that is still $1.20 above the five-year average.”


Northeast frustrations

Northeast dairy producers, especially in Pennsylvania, have expressed disappointed over LGM-Dairy’s performance last year. Last October, producers buying LGM-Dairy were able to insure a margin of about $12.79/cwt. The actual national actual average margin came in at $12.50/cwt., yielding a 29¢ indemnity on all milk covered.

The situation was worse in the Northeast, where feed prices averaged much higher than the national average used to calculate estimated margins. Almost simultaneously, federal order producer price differentials (PPDs) were lower than normal, putting an even larger squeeze on Pennsylvania producer milk prices than the Chicago Mercantile Exchange (CME) averages would suggest.

“The producers in the East are understandably frustrated with LGM-Dairy failing to represent their ‘world,’ but hopefully they do not overlook an opportunity to protect 2013’s profits,” Zepp said. “Don't throw the baby out with the bath water. Recognize the margins that are here and the opportunities that exist. Basis risk is a part of risk management. That's the long-term lesson from 2012. But no two years are the same.”

Due to the popularity of the program and because of this statutory cap on funding, RMA anticipates the sales period for LGM-Dairy will be very short.

Oct. 26 sales will not begin prior to 4:30 p.m. (CST).  Sales will begin on the half hour after the information to determine the expected gross margins becomes available.  For example, if the expected gross margins have not been released by 4:30 p.m. (CST), sales will begin at 5 p.m. (CST), and so on.

Dairy producers can find an LGM-Dairy specific agent on the LGM-Dairy website maintained by Prof. Brian Gould (bwgould@wisc.edu) of the Department of Agricultural Economics at the University of Wisconsin-Madison (http://future.aae.wisc.edu/lgm_dairy.html). The LGM-Dairy Analyzer software system contained within the software section (http://future.aae.wisc.edu/lgm_analyzer/) is being used extensively across the U.S. by insurance providers and dairy farm operators to help plan for the Oct. 26 LGM-Dairy contract offering, and to examine the performance of previously purchased contracts.