Understanding the Margin Protection Program for Dairy

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Imagine that you bought a brand new car using mostly borrowed money. Because of the financial risk involved you buy insurance from the ACME Insurance Company. One month later, you get a check for $15 in the mail from ACME.

This is not a whole lot of money so you just take the whole family out to an ice cream treat. A couple months go by; sometimes you get a little check in the mail from ACME and sometimes you don’t. Six months later, your teenager loses control of the tractor and runs it right through your new car, totaling it in the process.

“No problem,” you think, “the car is insured.”

But the answer that you get from ACME Insurance regarding your claim is startling: “The national average automobile losses during the last 2 months were less than the calculated threshold for your policy: your claim is denied.”

You get zilch for the loss of your car! This made-up story may seem strange to you, but it is actually pretty close to how the Milk Protection Program for Dairy (MPP-Dairy) actually works.

MPP-Dairy: a national index

What many people do not fully understand is that the program has nothing to do with the financial situation that you are experiencing on your own farm. It is based on a national index that acts as a proxy for dairy profitability averaged across the whole nation. Although it presumably was designed with the intent of protecting the gross margins over feed costs, even a quick examination of the details involved reveals that its implementation is closer to a Las Vegas gamble than a margin protection program.

What milk price?

The price used to calculate the milk revenues is the U.S. All-Milk Price issued by the U.S.D.A. Although this price is probably very close to the actual average price being paid for milk across the country, it does not account for regional differences and for milk composition differing from the U.S. average.

The relative value of milk components changes through time. Last month, butterfat was highly priced, milk protein price was about average, while milk other solids were priced at a dismal 4.65 a pound, a pricing situation vastly different than what we were experiencing just a few months ago.

In short, the index for milk revenue has little to do about what price you are receiving for your milk, whether you milk Holstein, Jersey, or crossbred cows: it just approximates the national average.

What feed costs?

The index calculates an index of feed costs based solely on the cost of corn grain (what corn: whole, ground, flaked?), soybean meal (assuming that this is dehulled, solvent extracted soybean meal), and alfalfa hay.

On the concentrate side, this is based on the fallacious assumption that prices of feed byproducts (which the U.S. dairy industry feeds large amounts of) move in perfect synchrony with corn and soybean meal prices. Most don’t. Hence, summertime brings superb bargains for such feeds as wheat middling and brewers grains, while surges in ethanol production result in heavily discounted distillers’ grains at other times.

More puzzling is the use of alfalfa hay prices to serve as a proxy to forage costs. First, alfalfa hay is now a minor component of most dairy rations. Corn silage, whose price is much more closely linked to that of corn grain in late summer, generally contributes 2 to 3 times more to the amount of forages fed than alfalfa hay. Also, alfalfa hay sold in Ohio or Pennsylvania is nutritionally vastly different than Western premium alfalfa hay grown under irrigation. And USDA prices for alfalfa hay frequently lead to substantial head scratching.

As an example, USDA alfalfa hay prices in August were $88/ton in Wisconsin, $190/ton in Ohio, and $240/ton in Pennsylvania, with a national average price of $169/ton. This implies that Pennsylvania producers would be paying $2.09 more per hundredweight (cwt) of milk than Wisconsin producers just for the forage portion of a cow’s diet.

In fact, for the forage alone, Wisconsin dairy producers would be making an additional $250/cow per year than Pennsylvania producers. These numbers are just not in line with the real numbers that we see on farms.

What cows?

The diet that is implied by the index is targeting what animals? Is the index trying to track feeding costs of just the lactating cows, or does it also include the dry cows and the replacement herd? I wish I could tell you, but I am still completely baffled as to which animals the index is “feeding.”

Based on the index, it takes 60 pounds of corn, 14.7 pounds of soybean meal, and 27.4 pounds of alfalfa hay to produce a cwt of milk, or 89.8 pounds of dry matter (DM) fed to produce a cwt of milk. This equates to a gross feed efficiency of 1.11 (i.e., 100  89.8). If this “ration” is just for the lactating cows, then one shouldn’t worry about dairy margins: there wouldn’t be any, as a normal target for gross feed efficiency in lactating cows is more in the 1.4 to 1.5 range.

If it also includes the dry cows and the replacement herd, then someone will have to explain to me why the resulting diet must contain nearly 20% crude protein. Heck, we don’t even feed that much protein to cows at peak lactation.

The Bottom Line

Because the USDA is subsidizing a portion of the premium that dairy producers must pay to participate in the DPP-Dairy program, then it does make sense for most producers to participate. But think of it as being the equivalent of buying an insurance policy for your house to ensure against a meteorite hitting the United States.

MPP-Dairy is more a partial protection against catastrophic losses than an effective risk management tool. Whenever it will pay, it will reduce your losses, but understand that you still will be bleeding profusely. You still need to put in place an effective risk management program for your dairy. This does require knowing your cost of production.

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