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From The MPC Newsletter
Friday, August 5, 201
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Continuing to Look at the Facts Behind Rep. Peterson's Dairy Legislation
By Rob Vandenheuvel, General Manager

As I noted in last week’s MPC Newsletter, it’s been a few weeks now since Congressman Collin Peterson (D-Minnesota) unveiled a “discussion draft” of legislation he plans to introduce in the U.S. House of Representatives in the near future.  The draft legislation largely mirrors the proposal called “Foundation for the Future,” as outlined by the National Milk Producers Federation (NMPF).  Since Rep. Peterson unveiled his draft bill, there’s been a lot of information disseminated among the industry – some of it true, some of it not, and some of it technically true, but certainly intended to sell a specific message.

In an effort to shed some light on the facts surrounding Rep. Peterson’s draft bill, last week I began by looking at the “Dairy Market Stabilization Program” (DMSP), which is one of the three pieces in Rep. Peterson’s bill.  If you missed that article, you can find it at:  http://www.milkproducerscouncil.org/072911_factsondmsp.htm.

This week, I’ll be taking a look at the Dairy Producer Margin Protection Program (DPMPP), the second of the three pieces in the bill.  This is the part of the bill that would create what many are calling the “margin insurance program.”

Before going into the details of the DPMPP, we need to understand how our current federal dairy policies serve as a “safety net” for the nation’s dairy farmers.  Most of the federal funds spent on the dairy industry are spent on two programs, the Milk Income Loss Contract (MILC) and Dairy Price Support programs.  When milk prices begin to fall (due to falling values for butter, nfdm, cheddar cheese and dry whey), it’s a general indication that our national milk supply is exceeding the demand for the dairy products that milk is being used to manufacture.  When that happens, the first program that triggers in is the MILC program.  This program provides a direct payment to dairy farmers when milk prices drop below a certain level.  Because the program does nothing to address the underlying reason for the drop in milk prices (supply exceeding demand), Congress has instituted a cap on the amount of money available under this program.  That cap is currently 2.985 million lbs of milk production (about the annual production of a 125-cow dairy producing 65 lbs of milk per cow per day; or  about 6 weeks worth of production for a 1,000-cow dairy also producing 65 lbs of milk per cow per day).  Because of budgetary concerns during the last Farm Bill discussion, the MILC program is actually set to have a more restrictive cap of 2.4 million lbs starting in September 2012.

The second main program of the dairy “safety net” is the Dairy Price Support program, which is available to buy butter, nfdm and cheddar cheese at specified prices.  While the program is designed to help clear excess inventories of these products, the resulting milk prices paid to dairy farmers when all three of these products are at “government support levels” is about $9-$10 per hundredweight.

So clearly, these programs do not provide an acceptable “safety net” for the dairy industry.  And neither of the programs addresses the supply-side of the supply/demand equation.  In fact, one could argue that the MILC program slows down the recovery for the dairy industry by providing additional revenue to dairies – albeit capped by the production limits – without creating any direct incentive to bring supply back into balance with demand.

So now let’s look at Rep. Peterson’s draft legislation.  Rep. Peterson is proposing that the dairy industry take on a new strategy in setting up our federal “safety net.”  He’s proposing that when we are facing a milk supply that is outpacing demand, our first line of defense be a program to directly address that imbalance, i.e., the temporary activation of the Dairy Market Stabilization Program (again, more details on that in last week’s newsletter: http://www.milkproducerscouncil.org/072911_factsondmsp.htm).  And if that program is unable to act quickly enough to turn the falling dairy farmer margins around, Rep. Peterson has included the Dairy Producer Margin Protection Program to provide direct cash payments to dairy farmers during those periods of low dairy farmer margins.  Since he is including a program to directly address the supply/demand balance, Rep. Peterson and the Congressional Budget Office have been convinced that hard production caps are not necessary for this new direct subsidy program.  Instead, all dairies – regardless of size – would be able to receive payments on 75% of their historical milk production.

So here is how the DPMPP would work:

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Cash payments would be paid when the national milk-price-minus-feed-cost calculation goes below $4 per hundredweight.

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Every dairy would be able to receive payments on 75% of their historical milk production (when the program is implemented, your historical milk production will be determined by your dairy’s highest annual production in the past three years).

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The payment would be based on the average margin over a two-month period (January-February, March-April, etc.).

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If the average margin over a particular two-month period is less than $4 per hundredweight, the payment will be the difference between $4 and the announced margin calculation.  For example, if the margin was $3.50 per hundredweight for the July-August 2011 period, a cash payment of $0.50 per hundredweight would be paid on 75% of your historical production.

The bullets above pertain to the “base program,” which is paid entirely by the federal government.  A “supplemental program” is also included in Rep. Peterson’s legislation, which gives individual dairies the option of receiving payments when that margin calculation is higher than $4 per hundredweight.  Dairies that choose to participate in this supplemental program can elect to have it cover up to 90% of their historical milk production, but it will carry an annual premium.  For instance, dairies choosing to collect cash payments whenever the calculated milk-price-minus-feed-cost margin falls below $6 per hundredweight would pay an annual premium of $0.155 per hundredweight on the percentage of milk they choose to cover in this supplemental program.

You might be curious how the DPMPP compares to the MILC payment structure.  To illustrate that, let’s look at how a fictional U.S. dairy would have fared in 2009 – the year in which dairies needed a cash influx more than any other year in recent history.  And for this example, let’s assume that this fictional dairy chose only to participate in the “base program,” at no cost to the dairy.  Of course, this will be an incomplete example, since in 2009, no program existed to quickly generate temporary milk production cutbacks (like the Dairy Market Stabilization Program), but for comparison purposes, we’ll ignore that important fact for now.  For the months of January – August 2009, the average margin calculation under this program would have been about $2.57 per hundredweight, well below the trigger of $4 per hundredweight used in the base program (I say “about $2.57” because USDA could implement the program in a couple different ways, but $2.57 per hundredweight is a conservative estimate). 

During those 8 months when the calculated margin is less than $4 per hundredweight, a 1,000-cow dairy producing 65 lbs of milk per day per cow would have received about $170,000 in direct payments.  Under the MILC program – assuming that same dairy was fortunate enough to select the highest paying months (since they would only receive payments for about 6 weeks worth of production), it would have received about $55,800, or less than one-third of the amount under the DPMPP outlined above.

With Congress scrambling to cut spending anywhere it can, a logical question is why they would be willing to implement a program that is so much more generous than the current MILC program?  The answer to that question is explained above – Rep. Peterson and the Congressional Budget Office believe that by implementing a program (the Dairy Market Stabilization Program) to temporarily and quickly cut back the national milk production – even by only 2 or 3 percent – it is much less likely that dairy farmer margins would fall to the levels we saw in 2009, thereby avoiding some, if not all, of the payments under the DPMPP.  That is a huge difference between what we saw actually happen in 2009 and what Rep. Peterson is proposing in his draft legislation.

Now while my illustration of a 1,000-cow dairy makes sense out here in the Western U.S., I can already hear my friends in other parts of the country telling me that for their much smaller dairies – particular those under 125-cows that fall under the production limits in the MILC program – the current system provides a pretty reasonable cash payment system.  No argument here.  But what Rep. Peterson is proposing in his draft legislation is a very valuable tool for dairy producers: a program to quickly cut back milk production when necessary.  And on a pounds-per-dairy basis, those temporary cutbacks will be coming primarily from the larger dairies in the country. The MILC program may have provided some significant cash payments for those smaller dairies in 2009, but it did absolutely nothing to incentivize those larger dairies to temporarily cut back their milk production, which ultimately is what we needed to re-gain supply/demand balance.

One final point.  As I’ve traveled throughout California, I’ve heard from a number of folks that they are concerned that since the DPMPP would calculate a national milk-price-minus-feed-cost margin using national average costs and prices, an area like California with higher-than-average feed costs and lower-than-average milk prices would be treated “unfairly” when compared to other regions of the country that have different milk and feed economics.  I certainly understand the argument being made, but as you can see in the example above, the DPMPP actually does a much better job of providing direct payments to the larger dairies more common in California and the Western U.S.  Further, we need to remember that any dairy legislation must be approved by at least 218 Members of the U.S. House of Representatives and 60 Members of the U.S. Senate – an impossible hurdle to jump if we’re taking such a California-focused policy position.

Rep. Peterson is proposing a set of safety net programs that would first-and-foremost give us the tools to get our supply and demand back into balance more quickly, which will result in our dairies generated market-based revenue, not government checks.  That’s a vast improvement over the current system, and one that we as an industry should support.

 

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