The program was initiated in response to increasing volatility in milk and feed prices, particularly in 2009 when falling milk prices combined with still-high feed prices to impose financial stress on the dairy industry. The Dairy Margin Protection Program was developed to provide farmers with financial protection against adverse movements in milk and feed prices. In contrast to prior dairy policy, the new program targets fluctuations in the difference between milk and feed prices – the margin – and relies on a combination of government support and producer premiums for financing. It offers protection against margin risks for all enrolled dairy operations.
The dairy industry’s structure has changed dramatically in the past two decades, with cows and production shifting to much larger operations. Structural change has likely affected dairy-industry competitiveness in world markets. It also results in a wide range of costs and financial outcomes, which complicates the design and application of dairy policy.
U.S. dairy products also are changing. Beginning in the 1970s, milk use has shifted from beverage products toward cheese and other dairy products used in food service and food manufacturing. International trade in dairy products – concentrated in nonfat dry milk, whey products, cheese and butter – now has greater prominence. Shifts in the dairy-product mix alter the geography of milk production and the price risks that dairy farmers face.
Production costs decrease, exports increase
The shift in production to larger farms has reduced average production costs and contributed to an expansion of dairy-product exports. But increased international exposure creates new sources of price risks for U.S. farmers, and dairy policy has been redesigned in response to these price risks and changing structure.
- Milk production continues to shift to larger farms. In 1987, after decades of consolidation, half of all dairy cows were on farms with 80 or fewer cows. By 2012 the average herd size was 900 cows.
- Costs drive structural change. The largest farms earn substantially higher net returns per hundredweight of milk produced, and have strong incentives to expand. Average costs of production fall sharply as herd sizes increase. Farms with 2,000 or more head have per-hundredweight production costs that are 16 percent below farms with 1,000 head to 1,999 head, and 24 percent below farms with 500 head to 999 head.
- Changes in the size structure of dairy farms reduced national-average milk-production costs by about 19 percent between 1998 and 2012. In turn, lower milk-production costs reduced milk prices.
- The United States has become a major exporter of dairy products, including nonfat dry milk, skim-milk powder, cheese, butter and whey. Total U.S. dairy exports were $7.2 billion in 2014, up from $1 billion in 2003. Expanded exports follow growing international demand for dairy products – particularly from Asia and Latin America – as well as improvements in U.S. dairy productivity, and changes in dairy and trade policies.
- Dairy farmers face substantial financial risks arising from wide fluctuations in milk and feed prices. Farm milk prices have been more volatile since 1995, and the volatility of feed prices increased sharply after 2005. Specific features of dairy markets cause them to be prone to price volatility. Milk supply varies little in response to price changes. Moreover, dairy product demand responds only weakly to price changes. Consequently shifts in demand for dairy products require substantial changes in price to reset the supply-demand balance for farm milk.
- The dairy industry faced a severe financial setback in 2009 when milk prices fell sharply due to declines in domestic and international demand, and feed prices remained high. The margin between milk and feed prices – which must cover labor, utilities, equipment and structures – fell to unprecedented lows in 2009. Dairy farmers lost $10 billion in equity – about $150,000 per farm on average – and assumed more than $4 billion in new debt, largely to finance rather than expand operations.
The Dairy Margin Protection Program is designed to protect producers against adverse movements in milk-feed margins. Enrollees may receive catastrophic coverage, for a $100 enrollment fee, providing payments when national-average margins fall below $4. The average monthly margin was $8.30 between 2004 and 2013. Expanded coverage, which provides payments when national average margins fall between $4 and $8, may be purchased for premiums.
- Almost 25,000 farms – 55 percent of licensed dairy operations accounting for about 80 percent of 2014 U.S. milk production – enrolled in the program for 2015 coverage. Forty-five percent of enrollees – representing more than half of the historic milk production of enrolled farms – chose catastrophic coverage for a $100 administrative fee, while 42 percent of enrollees chose to pay premiums for coverage of $6 and $6.50 margins.
- The Dairy Margin Protection Program provides farmers with the opportunity for greater financial protection under a variety of scenarios than the programs it replaced. But because farmers can change their coverage annually in anticipation of expected price changes, and thereby minimize the premiums they pay, the program also carries the risk of substantial increases in government costs.
- A crucial issue for Dairy Margin Protection Program relates to its effects on milk production. If the program leads to increases in milk production, it can lead to lower average milk prices. And if projected indemnities cause farmers to reduce production less than they might have in response to lower milk-feed margins, it can prolong periods of low margins.
- Finally, while farmers can adjust coverage each year, the adjustments relate only to the share of a farm’s production history and the margin that the farm has chosen to cover. Under current rules, farmers can’t adjust production histories to account for large changes in herd size. Much of the industry’s structural change has been accomplished via such changes.
Study draws on Census and Survey
The study relies on farm-level records drawn from two U.S. Department of Agriculture sources – the Census of Agriculture and the annual Agricultural Resource Management Survey – to summarize and analyze structural change in the industry and to assess the impacts of the 2009 margin crash on dairy farms. It uses data from USDA’s National Agricultural Statistics Service, Agricultural Marketing Service and Economic Research Service for summaries and analyses of trends in milk and feed prices; dairy-product prices and consumption; and international trade in dairy products.
Data provided by USDA’s Farm Service Agency, which administers the Dairy Margin Protection Program, indicate initial enrollment in the program. Finally, an updated quarterly dairy forecasting model was applied. It was developed for earlier analyses at the USDA’s Economic Research Service to assess industry supply responses to price movements and to evaluate the sources of the margin crash in 2009. Visit www.ers.usda.gov for more information.
Source: Agriview