December 20, 2010
Market Update: MILC Payment Rates: A Look Behind, a Peek Ahead
By Bob Yonkers, Ph.D., IDFA Chief Economist
The Milk Income Loss Contract (MILC) program, operated by the U.S. Department of Agriculture's Farm Service Agency (FSA), has its roots in the 2002 Farm Bill. This program was first designed to make direct payments to dairy producers when farm milk prices fell below a target price specified by Congress, namely any time the federal order Class I price in Boston fell below $16.94 per hundredweight (cwt).
Changes to MILC made in the 2008 Farm Bill included a small step toward tying the payments to the concept of dairy farm net income rather than just the farm milk price. This change requires USDA to increase the target price above $16.94 whenever a pre-set measure of dairy feed costs exceeds $7.35 per cwt. This change made the MILC program look more like a margin insurance program; however, there is never a downward adjustment in the target price should feed costs fall below $7.35, and the program only allows payments on the first 2.985 million pounds (29,850 cwts) of milk per farm each federal government fiscal year (Oct. 1 - Sept. 30).
With this feed cost adjuster, the MILC payment rate calculation has become one measure of dairy farm profitability, much like the milk:feed price ratio. Figure 1 below shows the calculated MILC payment rate since January 2008. (Note that the feed-cost adjustment did not become part of the MILC program until October 1, 2008, when the provisions of the 2008 Farm Bill took effect.)
Due to high milk prices and relatively low dairy feed costs in 2008, there were no months in which MILC payments were made by FSA. However, starting in February 2009, much lower milk prices without a corresponding drop in dairy feed prices did trigger such payments every month through November, and the monthly-payment rate for the year averaged $1.15 per cwt. The return to higher milk prices and lower feed costs in 2010 resulted in an MILC payment in only one month, April, this past year.
Looking ahead, MILC payments can be estimated using the future contract prices for milk, corn and soybeans (along with the assumption that alfalfa hay prices will start at $120/ton and increase 2 percent annually, as there is no futures contract for this input). As seen in Figure 1, current futures market prices (as of December 14, 2010) expect that MILC payments will be made every month but one, November 2011, as well as every month in the first half of 2012.
While the estimated MILC payment rates for the next 18 months are, on average, far below the levels seen in 2009, actual market prices for farm milk, corn, soybeans and alfalfa hay in the coming months may be much different than the futures contract prices today. Despite the futures markets indicating lower dairy farm profitability in the near future using this measure, conditions could change and in turn lead to a change in the actual MILC payment rates for 2011 and early 2012 in either direction.
The combination of low farm milk prices and high dairy feed costs in 2009 was unprecedented for the U.S. dairy industry. The dairy farm financial situation has not yet recovered from that extended period of negative net dairy farm income, and another period of reduced dairy farm profitability like that predicted by the estimated MILC payments for the next 18 months has many in the dairy industry concerned. While MILC payments will help some dairy operations if the margin between farm milk price and dairy feed costs is low, the relatively low payment limit means that those payments will end before the need for them does for many.
It is not too late for dairy producers to manage their margin risk through the use of futures markets or forward contracts on farm milk and dairy feed. In addition, the limitations of current federal dairy policies like the Dairy Product Price Support Program and MILC to address the challenges of today's dairy farming systems mean the industry must seek a more effective dairy farm safety net in the future.