An important lesson in milk marketing

Milk prices in 2009 tumbled drastically, lowering profitability and teaching valuable lessons in milk marketing.

Calendar year 2009 was a very difficult year for Michigan dairy producers.  According to data collected by Michigan State University, the average gross cash margin for Michigan dairy producers was $1.81/cwt in 2008 and plummeted to -$1.81/cwt in 2009.  Profits fell, accounts payable soared and large slices of equity disappeared as a result.  The average Class III milk price fell 35% from 2008 to 2009 ($17.44/cwt to $11.36/cwt).  Perhaps the most unfortunate aspect of this situation was Michigan dairy producers could have avoided some of this financial disaster if they had employed moderate, conservative milk marketing strategies in 2008.

At the beginning of 2008, the annual average Class III futures price for 2009 at the Chicago Mercantile Exchange (CME) was $15.73/cwt.  This average futures price continued a steady climb peaking at $20.65/cwt on June 18, 2008.  Hindsight is twenty-twenty, but it would have been theoretically possible on June 18, 2008 for a dairy producer to have marketed their 2009 production and received $9.20/cwt higher milk price than what eventually took place ($11.36/cwt).  Every experienced marketer knows hitting that high is impossible and is not the goal of a realistic marketing plan.  A realistic marketing plan takes into account the cost of producing milk and whether future milk prices are offering a realistic margin over their costs.  When the market is offering a positive margin and the market is continually strengthening, as it did for 2009 milk prices during the first half of 2008, a smart marketer will “sell into a rising market.”

One way of making decisions as to whether the market is offering truly attractive milk prices is to look at Class III milk prices from a cumulative probability perspective.  From 1995 to 2010, annual average Class III milk prices ranged from $9.74/cwt (2000) to $18.04/cwt (2008).  The average of the annual averages is $12.91/cwt.  An annual average Class III price of $16.94/cwt is at the 90th percentile.  This means for the past sixteen years the average annual Class III price has only been higher than $16.94/cwt 10% of the time (i.e., 2 years, 2007 and 2008).  Recall the CME Class III futures average for 2009 peaked on June 18, 2008; however, that price remained at, or above, the 90th percentile ($16.94/cwt) from March 7 to September 9.  Thus, dairy producers had over six months in which to sell 2009 milk at very attractive prices.  Therefore, I would advise dairy producers to strongly consider forward selling milk anytime the annual average Class III futures price hits the 90th percentile.  This does not mean a producer would sell 100% of future production when the Class III futures price average hits this point.  Rather, producers can use this price level as a point to trigger a marketing plan into action.  Such a plan sets price trigger points for small portions (e.g., 10-30%) of annual production as the market peaks and declines.

If a producer had used this strategy in 2008 for selling 2009 milk production, the results would have been dramatic.  Even if one assumed that a producer sold only 50% of 2009 production at the 90th percentile and none at the market’s high, it would have amounted to an increase of $2.79/cwt on all of their 2009 milk production.  The average Michigan dairy herd in 2009 milked about 162 cows producing about 22,445 pounds of milk per cow.  This marketing strategy would have produced over $101,000 more total revenue for 2009.  Ironically, the 2011 CME Class III futures average was $16.94/cwt on February 25, 2011.  Have you considered marketing some 2011 milk?

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