managing risk and seizing opportunity in 2012 and beyond dr. marin bozic nebraska state dairy...
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Managing Risk and Seizing Opportunity in 2012 and
Beyond
Dr. Marin BozicNebraska State Dairy Association│ March 13, 2012
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1) Recent events in the dairy markets
2) Risk factors in 2012
3) Hedging margin risk
4) Long-run risk management
Topics for today
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June 2012 Class III Futures
1/12
/201
2
1/16
/201
2
1/20
/201
2
1/24
/201
2
1/28
/201
2
2/1/
2012
2/5/
2012
2/9/
2012
2/13
/201
2
2/17
/201
2
2/21
/201
2
2/25
/201
2
2/29
/201
2
3/4/
2012
3/8/
2012
3/12
/201
2$14.00
$14.50
$15.00
$15.50
$16.00
$16.50
$17.00
$17.50
$18.00
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June 2012 Class III FuturesComponents contribution to decline
1/12/2
012
1/20/2
012
1/28/2
012
2/5/2
012
2/13/2
012
2/21/2
012
2/29/2
012
3/8/2
012
-$1.80
-$1.60
-$1.40
-$1.20
-$1.00
-$0.80
-$0.60
-$0.40
-$0.20
$0.00
Butter
Dry Whey
Cheese
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Term structure of futures prices
Based on options data, there is 20% chance Class III price will settle below the shaded area, and 20% it will settle higher.
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15$10.00
$11.00
$12.00
$13.00
$14.00
$15.00
$16.00
$17.00
$18.00
$19.00
$20.00
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Dow
nsid
e Ri
sk
12.2
12.4
12.6
12.8 13
13.2
13.4
13.6
13.8 14
14.2
14.4
14.6
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
June 2012Futures: $15.80 (as of 3/12/2012)
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Dow
nsid
e Ri
sk
10.9
11.1
11.3
11.5
11.7
11.9
12.1
12.3
12.5
12.7
12.9
13.1
13.3
13.5
13.7
13.9
14.1
14.3
14.5
14.7
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
Dec 2012Futures: $16.75
(as of 3/12/2012)
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Risk factors
• U.S. recovery to stop?• Eurozone collapse?• War with Iran?• Runaway inflation? • Three year cycles? (2009 + 3 = 2012)
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Implied Probabilities of Uncertain Events:1. U.S. Economic Recovery
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Implied Probabilities of Uncertain Events:2. Dropping out of Euro zone
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Implied Probabilities of Uncertain Events: 4. War with Iran
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Implied Probabilities of Uncertain Events: 4. War with Iran
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Can we make use of prediction markets in dairy?
Information discovery:• E-verify to become mandatory before
12/31/2012• Farm bill to pass before 9/30/2012
Risk transfer:• “The Secretary of Agriculture to announce
that the stabilization program is in effect for June 2012”
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Expected Inflation: Evidence from Treasury Securities
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Expected Inflation: Evidence from Treasury Securities
Jan-
08
Apr-0
8
Jul-0
8
Oct-08
Jan-
09
Apr-0
9
Jul-0
9
Oct-09
Jan-
10
Apr-1
0
Jul-1
0
Oct-10
Jan-
11
Apr-1
1
Jul-1
1
Oct-11
-2.00
-1.50
-1.00
-0.50
0.00
0.50
1.00
1.50
2.00
2.50
3.00
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Historical Milk-Feed Margin 2010-2011
$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
$12.90
$5.72
$7.57
$15.46
$7.54
$16.56
$3.55
$6.28
$13.10
Margin - Historical Top 50% Percentile
Source: Katie Krupa, Rice Dairy, LLC.
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1 cwt of milk
- 0.80575 bu of corn
- 0.0087 ton of SBM
2/8/2012
Rice Dairy Milk-Feed Margin Formula
Source: Katie Krupa, Rice Dairy, LLC.
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1 cwt of milk
- 0.80575 bu of corn
- 0.0087 ton of SBM
3/12/2012
Rice Dairy Milk-Feed Margin Formula
Source: Katie Krupa, Rice Dairy, LLC.
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Three year cycles? Evidence from forward margins
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
$18.00
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Three year cycles? Evidence from forward margins
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
$18.00
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Historical Perspective
$7$8$9
$10$11$12$13$14$15 $14.15
Dec '07 Margin Trade Data
Source: Katie Krupa, Rice Dairy, LLC.
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Historical Perspective
$2$3$4$5$6$7$8$9
$10$11$12
$10.63
$3.62
Feb '09 Margin Trade Data
Source: Katie Krupa, Rice Dairy, LLC.
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Forward Dairy Profit Margins 1998-2011
17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
$18.00
Margin = Class III Milk -0.80575*Corn -
0.0087*Soymeal
9-12 Months:Consistently Stable and
Sustainable Margins
Months to maturity
Inco
me
Ove
r F
eed
Mar
gin
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Hedging by any other name…
There are (at least) three very different way dairymen can manage risk:• Contracting – i.e. futures and options, forward pricing
through the coop, cash contracts for feed
• Strong equity/fast growth – increasing efficiency to keep costs below national average, possibly by attracting investors to keep debt/equity ratio low in face of fast expansion
• Dairying as a hedge – low cash-flow costs, but high opportunity costs of feed. Dairying as a hedge against lower future value of land/crops
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S
D
D′
Quantity
Price
Short run (wish there was a fifth udder)
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S
D
D′
Quantity
Price
Long run (eight udders are better than four)
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What does the long run U.S. milk supply look like?
130 140 150 160 170 180 190$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
$18.00
Annual U.S. Milk Production (3 year moving average) - Billion Pounds
U.S
. All
Milk
Pri
ce, 3
-yea
r M
ovin
g A
vera
ge
Data period: 1980-2010
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Change in Dairy Farm Technology
1993
1995
1997
1999
2001
2003
2005
2007
2009
10
12
14
16
18
20
22 100-200: Peak in 1997 @
20%
200-500: Peak in 2000 @
18%
500-1000: Peak in 2005
@ 14.3%
1000-2000: Peak in 2007
@ 16.1%
100-200 200-500 500-1000 1000-2000
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Percent of U.S. Milk Production by Large Dairy Farms
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
0
10
20
30
40
50
60
2000+ 1000-2000
Percent of US milk production by farms with 2000+ cows grows on average by 2.2% a year.
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Flat supply curve – what are the implications?
In the long run…• Dairy Darwinism: dairyman to businessman, or out
of business.• Demand-enhancing activities boost quantity, not
price (think exports, check-off, product research & development)
• Increase in price of one milk fraction decreases the price of another (think whey vs. cheese) until returns to dairying revert to average
• Uncertainty = higher average returns• Vertical integration as the 21st century version of
“cooperative revolution”
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Support from these companies is greatly appreciated
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Managing Risk and Seizing Opportunity in 2012 and Beyond
presented at the I-29 Dairy ConferenceSioux Falls, February 8, 2011
Dr. Marin [email protected] of Applied EconomicsUniversity of Minnesota-Twin Cities317c Ruttan Hall1994 Buford AvenueSt Paul, MN 55108
You may download this presentation at http://marinbozic.info/