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Perspective:
Market Insight

Detailing Revenue Protection

Andy Faulman

Cheese Market News® Contributor Andy Faulman is a risk management advisor with Rice Dairy LLC*, a brokerage firm in Chicago that specializes in dairy and markets at dairy’s periphery.

Starting Oct. 9, dairy producers will have another tool in their risk management toolbox courtesy of Farm Bureau. The Dairy Revenue Protection Program (Dairy RP for short) is a government-subsidized crop insurance program tailored to the dairy producer. On the surface, this program has the nuts and bolts to make some waves in the dairy risk management space.

What is Dairy RP? Modeled after crop insurance, Dairy RP will be a revenue-based program protecting dairy producers from unexpected declines in milk sales. Put another way, it will protect against unexpected declines in the milk price.

The keyword in this program is revenue. This program will not be accounting for the input side of the equation. This is strictly a revenue-based product. Breaking the program down from start to finish, there are a couple of decisions the producer will need to consider.

The first thing to consider: How are they going to value their revenue? There are two different ways to do that: a class base or a component base. Going the class base route, producers can allocate a percentage of their revenue toward Class III and Class IV at their discretion. For higher component herds, a producer can use declared butterfat, protein and other solids to value their revenue. At the maturity of the policy, the values reported into the National Dairy Products Sales Report will be used to determine the settlement price of the policy, which in turn determines whether an indemnity is to be paid to the producer.

Moving further down the decision tree, a couple more things come into play. Coverage will be offered on a quarterly basis for up to five quarters at a time. The price that will be quoted on the policy will be a quarterly average price rather than prices for individual months. From a production standpoint, producers will be allowed to cover as much of their production as they would like per quarter. There will be no cap on coverage.

Along with that, there will be a protection factor included that allows producers to increase their level of protection by a factor of up to 50 percent in 5 percent increments. For an additional premium cost, this protection factor will allow for increased coverage without having to add more cows. Essentially, a producer milking 100 cows can use the protection factor to purchase up to an additional 50 percent of production or, put another way, protect themselves as if they were milking up to 150 cows.

How are the policies going to be priced? Both class and component will be priced off daily settlements for dairy futures at the Chicago Mercantile Exchange. For example, if a producers was looking to go 100 percent Class III for coverage, the quarterly average of the Class III futures market the producer is looking to cover will be the starting point for coverage. After that price has been established, a coverage level of 70-95 percent of that price will need to be selected by the producer. Let’s assume a producer is looking to cover the first quarter of 2019, and on the day they go to purchase a policy through Dairy RP, the average Class III futures price in the first quarter settled at $16.00. Assuming the producer opts for the 95 percent coverage level, they would take that $16.00 price and multiply it by the percent coverage level. In this case, they would get a revenue protection price of $15.20. Unlike other government protection programs like the Margin Protection Program and Livestock Gross Margin, the Dairy RP program will be offered seven days a week except for days where futures have a limit up or down move along with USDA dairy report days (Milk Production, Dairy Products, etc.).

How the Dairy RP will affect the market is yet to be seen. Regardless of what kind of impact Dairy RP will have on the physical milk market or futures market, one thing is for sure. This program has the capacity to change the landscape of dairy risk management for years to come.

CMN

The views expressed by CMN’s guest columnists are their own opinions and do not necessarily reflect those of Cheese Market News®.

*The risk of loss trading commodity futures and options can be substantial. Investors should carefully consider the inherent risks in light of their financial condition. The information contained herein has been obtained from sources believed to be reliable; however, no independent verification has been made. Information contained herein is strictly the opinion of its author and not necessarily of Rice Dairy and is intended to be a solicitation. Past performance is not indicative of future results.

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