Dairy policy and risk management
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Dairy Policy and Risk Management. A Comfortable Coexistence?. Phil Plourd • Minnesota-Wisconsin Dairy Policy Conference • April 3, 2012. What Policy Reform?. Are we talking about “margin management” with a compulsory “supply management” component? Meaningful reform of Federal Order System?

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Dairy policy and risk management

Dairy Policy and Risk Management

A Comfortable Coexistence?

Phil Plourd • Minnesota-Wisconsin Dairy Policy Conference •April 3, 2012


What policy reform

What Policy Reform?

  • Are we talking about “margin management” with a compulsory “supply management” component?

  • Meaningful reform of Federal Order System?

  • Something not yet contemplated?

  • It is difficult to discuss implications without knowing the proposed policy.

    • So: let’s take a step back and study the nature of the “problem” confronting the industry…


A puzzling path

A Puzzling Path

Problem

Solution


The choices

The Choices

  • We can be Canada or we can be New Zealand…trying to find solutions “in the middle” will ultimately lead to frustration…and failure.

  • Risk can be managed in one of two ways:

    • Individually in the markets with best managers rewarded and industry makes most progress (most commodities!)

    • Blanket fashion through policy with better managers limited in their ability to outperform and poorer managers supported – and this assumes the policy “works” as anticipated


Risk is being managed

Risk is Being Managed


Lots of markets utilized

Lots of Markets Utilized


Elegance in simplicity

Elegance in Simplicity

The Corn Model

FUTURES MARKET


Not simple not elegant

Not Simple, Not Elegant

FUTURES MARKETS

SPOT MARKETS

NASS SURVEYS

CHEESE

CME CHEESE

BUTTER

CME BUTTER

NDM

AMS NDM

AMS WHEY

WHEY

COMPONENT PRICES

PROTEIN

FAT

OTHER SOLIDS

CLASS PRICES

BLEND PRICE

CLASS I

BASE

CLASS II

CLASS III/4b

PPD/OVERBASE

CLASS IV/4a


Two big improvements

Two Big Improvements

  • Consolidate classes

    • Less complexity

    • More, deeper liquidity pools

    • In our opinion, the single best change

  • Find a better way for spot pricing

    • Current structures create volatility, complicate risk management, foster distrust

  • To the extent current risk management tools are “not working” it is because the dairy system is flawed, not because producers are uninterested or incapable.


Too many pools

Too Many Pools


Cme spot market

CME Spot Market


Cme spot market1

CME Spot Market


Riding only one horse

Riding Only One Horse


Volatility

Volatility


Preventing another 2009

“Preventing” Another 2009

  • The main motivation for a risk management safety net for producers is the 2009 disaster.

  • Reality: 2009 was much bigger than dairy.

  • No dairy policy would have protected producers from the demand meltdown of 2009 and allowed the flexibility to serve the resurgent demand of 2010 and 2011.

  • We may be trying to fix a problem that is not really “fixable” – and may no longer be a threat.


Globalization and volatility

Globalization and Volatility

  • US entrance in to world market should have reduced volatility by exposing the US to many different supply and demand curves.

  • Reality: there are only a small number of supply and demand points that matter in the global market…

  • Consequence: volatility reduction has been minimal (and maybe elevated) as weather in New Zealand has become a primary driver of US export prospects.


What drives expansion

What Drives Expansion?

  • Strong returns in high price periods drive producers to invest in their businesses (to avoid paying taxes) thereby preordaining the trailing period of low prices and over-production.

  • Proposals to guarantee margins will not address this issue and may in fact exacerbate the problem by raising overall profitability.

  • Proposals for tax-deferred saving accounts would seem more sensible.


Margin management

Margin Management

  • “Margin Insurance” and LGM mimic being long calls on feed and long puts on milk…and can provide useful coverage.

  • However: positions are addressed on an actuarial basis, bypassing the traded markets.

  • Result: good for producers, but will potentially hamper end-user risk management activity because sell-side liquidity may be reduced – perhaps materially.


Margin management1

Margin Management

  • Some argue: if producers have guaranteed margin, prices will remain low so the buyers have little reason to worry.

  • Might be true if the support price program were maintained and years of strong production resulted in large inventories. Neither is likely.

  • Ignores the fundamental truth that weather issues are the main driver of production shortages.

  • Setting up for a market with little reduction in volatility/high prices and compromised tools?


Dairy policy and risk management

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MADISON, WISCONSIN

608-249-5030

Phil [email protected]

Mark Morningstar [email protected]

Dallas Sipes [email protected]

Lori Strong [email protected]

Theresa [email protected]

Katelyn [email protected]

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©2012

BLIMLING AND ASSOCIATES, INC.

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This information is carefully compiled but not guaranteed to be complete or free from error, nor does it constitute a solicitation to buy or sell futures/options contracts. Past performance is not indicative of future results This has been prepared for the exclusive use of clients. Redistribution and reproduction in part or in whole without written permission is strictly prohibited.


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