LegiStorm

Summary:

Managing price and income risks can be a major challenge for dairy farmers. In 2011, the farm price of milk has rebounded from lows in 2009, but the price of corn, a major feed ingredient, has reached record highs. The volatile nature of commodity markets presents opportunities for profits and losses when milk prices or feed costs change. In dairy and in agriculture generally, farm-level risk management tools are provided through both the private and the public sectors. By using these tools, dairy producers transfer risk to either the private sector or the government through programs that offer payments when milk prices decline. Risk management tools can also be categorized as either short-run or long-run tools. In the short run (up to about a year or so), producers can lock in what they may view as favorable prices and/or margins (the milk price minus feed cost) using forward contracts with milk buyers and feed dealers. Producers might also use brokers to establish hedges using futures or options that would lock in those favorable prices or margins. Livestock Gross Margin—Dairy (LGM-Dairy) is an insurance product administered by the U.S. Department of Agriculture's Risk Management Agency (RMA) but sold by private insurers. The short-run tools typically offer price or margin protection at whatever level the market determines. Sometimes producers can lock in favorable (high) margins, while at other times margins may be low or even negative. Long-run risk management strategies might include diversifying the farm operation, perhaps by growing more feed (thus avoiding feed purchases at market prices) or by adding enterprises, such as a trucking operation. The intent behind such a strategy would be to generate income streams that do not fluctuate in the same way as dairy income. Another option is participation in the federal Milk Income Loss Contract (MILC) program, which makes payments to producers when milk prices drop below levels established in the 2008 farm bill (P.L. 110-246). As Congress prepares to deliberate dairy policy in the next farm bill, policymakers might consider a number of options to address the risk management needs of individual dairy producers. These include facilitating the use of private hedging, expanding the LGM-dairy margin insurance, establishing "farm savings accounts" to encourage cash reserves, implementing a national margin insurance program, modifying the existing MILC program, and helping secure additional lines of credit for margin accounts used in hedging. Regarding both private marketing tools (e.g., hedging) and public programs, policymakers will likely consider whether the margin provided by markets (and determined essentially each day that the futures market is open) is sufficient for producers, or whether a minimum margin needs to be set through a government program. Policymakers may also consider the implications of removing "too much" risk, and the possibility that high levels of margin protection could potentially lead to excess milk production and unfavorable returns for dairy producers. Many in the dairy industry, producers and processors alike, generally support the federal government's policies promoting the use of risk management tools by individual producers. In contrast, the industry is divided over potential changes to other, more traditional dairy policies, including the addition of a supply management program, elimination of price support, and changes to the federal milk marketing order system. For information on a broader range of current programs and options for dairy policy, see CRS Report R41141, Previewing Dairy Policy Options for the Next Farm Bill.