livestock gross margin-dairy craig thomas msu-extension dairy educator sanilac, huron, tuscola, st....
TRANSCRIPT
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Livestock Gross Margin-Dairy
Craig ThomasMSU-Extension Dairy EducatorSanilac, Huron, Tuscola, St. Clair, Lapeer, Genesee, Macomb, & Oakland Counties
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Dairy Price Risk Management
Coop-sponsored forward (fixed) price contracts: Similar to Class III short hedge: Locks in a price, no
upside potential, no daily margin requirements, flexible contract size, administrative cost
Coop-sponsored minimum price contracts: Similar to Class III put option: Establish a milk price
floor, retain upside potential, no margin requirements, flexible contract size, cost of insurance + administrative cost
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Dairy Price Risk Management
Traditional hedging and options strategies: Broad range of alternative strategies: lock in a Class III
price, establish a minimum Class III price, etc.
Contract size “lumpiness” May be subject to margin calls & may need margin loc Puts/calls: cost of “insurance” may be quite high Requires established contract with a broker
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Dairy Margin Risk Management
Margin risk management establishes a floor (minimum) on income over feed costs (IOFC). Class III put options: Creates milk revenue floor
Feed call options: Establishes feed cost ceiling
Bundled options strategy: you establish an IOFC floor
$/cw
t
Minimum IOFC
Milk revenue floor
Feed cost ceiling
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Dairy Margin Risk Management
Revenue risk management establishes a floor on income over feed costs (IOFC). Class III put options: Creates milk revenue floor
Feed call options: Establishes feed cost ceiling
Bundled options strategy: you establish an IOFC floor
$/cw
t
Minimum IOFC
Milk revenue floor
Feed cost ceiling
No margin calls, but pay an “insurance
premium”
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Dairy Margin Risk Management
$/cw
t
IOFCM
Class III Put Option
Feed Call Options
Does Not Limit Upside Milk Price Potential
Announced Class III Put option not
exercised
IOFCAIOFCA > IOFCM
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Dairy Margin Risk Management
$/cw
t
IOFCM
Class III Put Option
Feed Call Options
Does Not Limit Upside Milk Price Potential
Announced Class III Put option not
exercised
IOFCAIOFCA > IOFCM
Only out the cost of the insurance
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Dairy Margin Risk Management
Does Not Limit Downside Feed Price Potential
$/cw
t IOFCM
Class III Put Option
Feed Call Options
Feed Price Feed call options not
exercised
IOFCA
IOFCA > IOFCM
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Dairy Margin Risk Management
Does Not Limit Downside Feed Price Potential
$/cw
t IOFCM
Class III Put Option
Feed Call Options
Feed Price Feed call options not
exercised
IOFCA
IOFCA > IOFCM
Only out the cost of the insurance
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Overview of LGM-Dairy
Livestock Gross Margin Insurance for Dairy (LGM-Dairy) Insurance policy to guarantee a minimum IOFC
Administered by USDA/RMA but purchased from firms selling Federal crop insurance
Crop insurance agents must be certified to sell LGM-Dairy and have ID number on file w/Federal Crop Insurance Corporation (see handout of approved agents)
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Overview of LGM-Dairy
Similar to bundled options (Class III put/feed calls) except: LGM-Dairy has no minimum size limit
LGM-Dairy upper limit of 240,000 cwt over any insurance period (10 months) or insurance year
No actual options market activity Cheaper than bundled options due to subsidized
premiums Premium not due until after contract matures
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Overview of LGM-Dairy
LGM-Dairy is customizable with respect to: Number of months insured w/one contract: 1-10 months
Farm specific in regards to milk production & feeding profiles (amounts & types of feeds)
Percentage of monthly IOFC (production) covered 0-100% of certified milk production each month
Percent coverage can vary across months
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Overview of LGM-Dairy
LGM-Dairy premiums are subsidized Premiums equal long run expected indemnity + 3%
Premium subsidyDeductible Subsidy Deductible Subsidy
($/cwt) (%) ($/cwt) (%)
$0.00 18% $0.60 31%
$0.10 19% $0.70 34%
$0.20 21% $0.80 38%
$0.30 23% $0.90 43%
$0.40 25% $1.00 48%
$0.50 28% $1.10-$2.00 50%
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GMGGross Margin Guarantee
AGMActual Gross Margin
EGMExpected Gross Margin
DLDeductible Level
EFCExpected Feed Cost
EMPExpected
Class IIIPrice
EMRExpected Milk Revenue
ECCExpected
Corn Cost
ESCExpected
SBM Cost
CMEClass IIIFutures
CMECorn
Futures
CMESBM
Futures
AGMActual Gross Margin
AFCActual Feed Cost
CMEActualClass III
PriceSettlement
AMRActual Milk Revenue
CMEActualFeedsCosts
Settlement
TMTarget Marketings
PREMPremium
Cost
EFQExpected Feed Quantity
INDIndemnity
Producer Data/Decision
Policy Rules
Exogenous Data
Overview of LGM-Dairy
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Overview of LGM-Dairy
Expected Gross Margin (GM) = expected market value of milk minus expected feed cost
One GMG (and GM) per contract
Gross Margin Guarantee (GMG) = GM minus deductible
Evaluated over entire contract period
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Overview of LGM-Dairy
Actual Gross Margin (AGM) = Actual market value of milk minus actual feed cost
One AGM per contract
Indemnity (payout) occurs if:
Evaluated over entire contract period
AGMT < GMGT
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Overview of LGM-Dairy
Class III, corn, and SBM futures markets used as information source to determine: Expected prices
Importantly…
Actual prices
No actual farm prices are used No futures market transactions No local basis used to adjust prices
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Overview of LGM-Dairy
Once LGM-Dairy is purchased you have established an IOFC floor for the insured milk production
Determined using expected prices Feed usage based on corn & SBM equivalents (adjustable)
IOFC floor also adjusted by deductible selected
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Overview of LGM-Dairy At sign-up producer declares milk production and
feed equivalents to be insured Must certify milk production when contract matures
Producer defines expected feed usage using corn (energy) and SBM (protein) equivalents Wide range for allowable declared feed equivalents
Corn: 0.13 – 1.36 bu/cwt of milk (7.28-76.2 lbs/cwt of milk) SBM: 1.61 – 26.00 lbs/cwt of milk
Program defaults (Corn, 0.5 bu/cwt; SBM, 4.0 lbs/cwt)
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Overview of LGM-Dairy At sign-up producer declares milk production and
feed equivalents to be insured Must certify milk production when contract matures
Producer defines expected feed usage using corn (energy) and SBM (protein) equivalents Wide range for allowable declared feed equivalents
Corn: 0.13 – 1.36 bu/cwt of milk (7.28-76.2 lbs/cwt of milk) SBM: 1.61 – 26.00 lbs/cwt of milk
Program defaults (Corn, 0.5 bu/cwt; SBM, 4.0 lbs/cwt)
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LGM-Dairy: Expected Gross Margin
All feed valued as if purchased even if homegrown Feed prices: Corn (CME futures), SBM (CME futures)
Importantly: the gross margin guarantee (GMG) is for the entire contract period whether contract is for 1, 2, …9, or 10 months
Milk price: CME Class III futures Standardized milk: 12.5% solids (3.5% fat, 3.1% protein, 5.9% OS)
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LGM-Dairy: Purchasing
LGM-Dairy is available for purchase each month 12 contracts offered each year
Each contract covers 1 to 10 months Purchase period starts at end of last business Friday of
each month (after numbers crunched ~6:00 PM EDT) Feb 25th, Mar 25th, Apr 29th, etc.
Purchase period ends at 9:00 EDT the next day (Saturday) ~27 hour sign-up window Work with your agent well ahead of time!
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LGM-Dairy: Coverage Calendar
Hypothetical insurance strategy: Purchase insurance at the end of March
Contract Length: 1-10 monthsBy rule: no coverage the month after purchase
Mar '11 Apr '11 May '11 Jun '11 Jul '11 Aug '11 Sep '11 Oct '11 Nov '11 Dec '11 Jan '12 Feb '12
1 2 3 4 5 6 7 8 9 10
Purchase
at End of
Month
No
CoverageInsurance Contract Period
Production
Coverage
No
Coverage50% 0% 80% 40% 30% 0% 0% 0% 0% 0%
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LGM-Dairy: Coverage Calendar
All 10 months of expected prices are known at sign-up
Expected milk, corn, and SBM prices are the average of last 3 days of futures settlement prices for each month/commodity including the sign-up Friday
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MarchSunday Monday Tuesday Wednesday Thursday Friday Saturday
1 2 3 4 5
6 7 8 9 10 11 12
13 14 15 16 17 18 19
20 21 22 23 24 25 26
27 28 29 30 31
LGM-Dairy: Coverage Calendar
Futures market settlement prices on
these 3 days determine expected
prices
Insurance sign-up period:
~27 hrs from 6:00 PM Friday till 9:00 PM Saturday (EDT)
Limited funds, first come, first served; sign-up early!
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LGM-Dairy: Coverage Calendar
Producer chooses amount of gross margin not covered by insurance (i.e., deductible) Portion of gross margin (GM) unprotected
Program allows $0 to $2.00/cwt deductible on GM
Higher deductibleLower premium
Producer assumes more risk
Subsidy increases with higher deductible
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LGM-Dairy: Premium Subsidy
No subsidy for a 1-month contract. To receive subsidy must have target marketings in 2 or more months of an insurance period. The subsidy % is the percentage by which premium is reduced.
Deductible Subsidy Deductible Subsidy
($/cwt) (%) ($/cwt) (%)
$0.00 18% $0.60 31%
$0.10 19% $0.70 34%
$0.20 21% $0.80 38%
$0.30 23% $0.90 43%
$0.40 25% $1.00 48%
$0.50 28% $1.10-$2.00 50%
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Determining Actual Prices and Gross Margin
Actual prices determined as futures contracts expire over insurance contract period Actual price = Class III, corn & SBM average futures
settlement prices from 1st, 2nd, and 3rd days prior to futures contract last trading day
Actual gross margin (AGM) = Actual milk revenue – Actual feed
costs If total GMG > total AGMindemnity paid Total refers to sum over all insured months in contract Only 1 possible indemnity per contract
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MarchSunday Monday Tuesday Wednesday Thursday Friday Saturday
1 2 3 4 5
6 7 8 9 10 11 12
13 14 15 16 17 18 19
20 21 22 23 24 25 26
27 28 29 30 31
Determining Actual Prices and Gross Margin
Last March corn/SBM trading day
Settle prices used to calculate actual March
corn/SBM prices
Last March Class III trading day
Settle prices used to calculate actual March
Class III price
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Premium Billing/Indemnity Payment
Clarification of USDA Memo: PM-10-067 Assume contract purchased in March 2011 w/coverage
chosen for May, July, Aug, and Sep w/$5,500 total premium.Mar '11 Apr '11 May '11 Jun '11 Jul '11 Aug '11 Sep '11 Oct '11 Nov '11 Dec '11 Jan '12 Feb '12
1 2 3 4 5 6 7 8 9 10
Purchase
at End of
Month
No
CoverageInsurance Contract Period
Production
Coverage
No
Coverage50% 0% 80% 40% 30% 0% 0% 0% 0% 0%
Assume indemnity of $4,500.
Two options: 1) producer pays net due ($1,000) end of Sep, or 2) producer receives $1,000 indemnity ~late Oct and pays premium ($5,500) Mar 2012.
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Premium Billing/Indemnity Payment
Must file a marketing report to receive indemnity Must submit a marketing report within 15 days of a notice of
probable loss
Marketing report must be supported by milk sales receipts showing evidence of actual marketings each month
In the event that the total of actual marketings are less than 75 percent of the total of targeted marketings for the insurance period, indemnities will be reduced by the percentage by which the total of actual marketings for the insurance period fell below the total of target marketings for the period.
No limits on milk production, but indemnities limited to covered milk (240,000 cwt max)
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LGM-Dairy: Summary LGM-Dairy is a flexible insurance program
Don’t have to insure all months or all production
Similar to bundled options strategy using Class III puts and corn/SBM calls
Drawbacks Short sign-up window at end of each month
May overlap contracts Substantial premium subsidies & variable deductible
Coverage amount much more flexible (no lumpiness)
Must wait for indemnity until end of last covered month; after last actual price is determined
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LGM-Dairy: Example
Farm characteristics:
Estimate premium costs for March 2011 contract
Expected monthly feed use
500 milk cows w/25,200 lbs. milk sold per cow
For simplicity assume 2,100 lbs/cow/month (2,100 x 0.85 x 500 = 8,925 lb. milk per month)
170.4 tons corn eq.; 42.6 tons SBM eq.
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LGM-Dairy: Example
Target marketings: May, July, August, September
Mar '11 Apr '11 May '11 Jun '11 Jul '11 Aug '11 Sep '11 Oct '11 Nov '11 Dec '11 Jan '12 Feb '12
1 2 3 4 5 6 7 8 9 10
Purchase
at End of
Month
No
CoverageInsurance Contract Period
Production
Coverage
No
Coverage50% 0% 80% 40% 30% 0% 0% 0% 0% 0%
Only partial coverage for four
months
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LGM-Dairy: Example
Expected Gross Margin (GM) = expected market value of milk minus expected feed cost
One GMG (and GM) per contract
Gross Margin Guarantee (GMG) = GM minus deductible
Evaluated over entire contract period
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LGM-Dairy: Example
Expected Gross Margin (May) = (8,925 cwts X $17.27/cwt X 50%) – .5*(170.4
tons corn X $7.08/bu + 42.6 tons SBM X $358.90/ton)
Gross Margin Guarantee (GMG) = GM minus deductible
Expected Gross Margin (May) = $77,076 – $21,543 – $7,645
Expected Gross Margin (May) = $47,888
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LGM-Dairy: Example
Gross Margin Guarantee (GMG) = GM minus deductible
Expected Gross Margin (May) = $47,888
Gross Margin Guarantee (GMG) = $47,888 – (8,925 cwts X 50% X $1.00/cwt)
Gross Margin Guarantee (GMG) = $47,888 – $4,463
Gross Margin Guarantee (GMG) = $43,416
Same process used to calculate GMG’s for other months
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LGM-Dairy: ExampleCoverage Gross Margin
Month Guarantees (GMG's)
May-11 $43,416
Jun-11 $0
Jul-11 $66,479
Aug-11 $34,356
Sep-11 $26,756
Oct-11 $0
Nov-11 $0
Dec-11 $0
Jan-12 $0
Feb-12 $0
Total $171,007
One GMG (and GM) per contract Evaluated over entire contract period
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LGM-Dairy: Example
Actual Gross Margin (May) = (8,925 cwts X $16.64/cwt X 50%) – .5*(170.4 tons
corn X $7.35/bu + 42.6 tons SBM X $364.20/ton) Actual Gross Margin (May) = $74,264 – $22,365 –
$7,757 Actual Gross Margin (May) = $39,679
Actual Gross Margin (AGM) = actual market value of milk minus actual feed cost
Same process used to calculate AGM’s for other months
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LGM-Dairy: Example
One GMG and one AGM per contract Evaluated over entire contract period
Coverage Gross Margin Actual GMG minus
Month Guarantees (GMG's) Gross Margins AMG
May-11 $43,416 $39,679 $3,737
Jun-11 $0
Jul-11 $66,479 $55,028 $11,451
Aug-11 $34,356 $25,951 $8,405
Sep-11 $26,756 $32,220 ($5,464)
Oct-11 $0
Nov-11 $0
Dec-11 $0
Jan-12 $0
Feb-12 $0
Total $171,007 $152,878 $18,129
Indemnity = GMGT - AGMT = $171,007 - $152,878 = $18,129
$23,593
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LGM-Dairy: ExampleCalculating Feed Equivalents
Understanding Dairy Markets(future.aae.wisc.edu)
LGM-Dairy(tab)
SupportingSoftware
Spreadsheet-Based Grain/Concentrate/Forages Feed
Conversion Program
Save to your hard disk if you have Microsoft Excel
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UWFeed Conversion
Excel Spreadsheet
Concentrate lb/cow/day tons/month1
Shelled corn 15.0 101.8
SBM 5.0 33.9
HMSC 8.0 54.3
Wet Distillers 3.0 20.4
WCS 4.0 27.1
1A 3% loss factor added to total.
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LGM-Dairy: ExampleEstimating Premiums
Understanding Dairy Markets(future.aae.wisc.edu)
LGM-Dairy(tab)
SupportingSoftware
LGM-Dairy Analyzer (V 2.0)
Opens in your browser window
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LGM-Dairy: Example
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LGM-Dairy: Example
Select program to use
Use previously saved data
Contract to analyze
DeductibleMethod for entering
feed
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LGM-Dairy Analyzer (V 2.0)
Only need to supply four pieces of
information
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LGM-Dairy Analyzer (V 2.0)
Only need to supply four pieces of
information
Calculate LGM Premium
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LGM-Dairy Analyzer (V 2.0)
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LGM-Dairy Analyzer (V 2.0)
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LGM-Dairy Analyzer (V 2.0)
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LGM-Dairy Analyzer (V 2.0)
CalculateOptions
Cost
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50% coverage; $1 deductibleLGM-Dairy Analyzer(V 2.0)
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50% coverage; $1 deductibleLGM-Dairy Analyzer(V 2.0)
LGM Bundled
Item Dairy Options
Total Premium $5,604 $28,967
Premium/cwt
Covered Milk $0.31 $1.70
Difference $1.39
% Difference 543%
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LGM-Dairy
LGM-Dairy is definitely worth every producers consideration regardless of farm size, production level, etc.
Find an LGM-Dairy agent and establish a relationship
Work with your LGM-Dairy agent well in advance of the sign-up period so if you do use LGM-Dairy you can get your application in early.
The LGM-Dairy program has limited funds, RMA recently increased LGM-Dairy funds, but still limited (first come, first served); get it while it’s hot!