To date, there has been an amazing run up in milk prices. The drivers are both domestic and international demand, with the most amazing demand coming internationally. We are now exporting nearly 16 percent of total milk production. Given this fact and the general easing of input inflation, everyone should be happy. Right?
Well, this accountant is worried. My reasons revolve around history, current world events and vulnerability of demand.
Since parity was taken away back in the 1980s, milk has been no different than any other farm commodity, the price received has its ups and downs. Who can forget what happened to prices in 2008 and 2009? In 2008, everything aligned perfectly and the price took off. Then, the 2009 worldwide recession, led by the U.S., happened and the price crashed. The result was that in a very short period of time, dairy farming in general went from feast to famine as the price went from about $20 per hundredweight to about $14 per hundredweight.
Current world events
With nearly 16 percent of total milk production going to exports, everyone connected with dairy should be watching with great interest events in the Middle East and Ukraine, as well as the Pacific Rim. Should exports for any reason suddenly dry up, there would be no market for the former exports other than domestic supply. Place 16 percent more milk into the U.S. market and the price received by farmers will drop dramatically. The 2009 drop was caused by 5 percent to 8 percent of production being placed into the U.S. market, meaning the risk today is greater.
Vulnerability of demand
Assuming cooler heads prevail in the Middle East and Ukraine, and nothing comes of the tensions building in the Pacific Rim, why do I believe export demand is still vulnerable? My concern actually comes down to too high of an export reliance on unstable and/or non-democratic destinations. The very reasons for the outstanding demand are also what makes the sustainability of demand volatile in my mind.
One only has to look at the history of corn, when we were the world’s absolute dominate player back in the 1970s, to see what I mean. The USSR was the big worldwide buyer; the U.S. had some issue with the USSR; our government, to “punish” the USSR, limited exports to the USSR; with the result being a drastic drop in corn prices. Could this same scenario play out with milk exports? Why not?
So what is a dairyman to do?
I have the figures from our approximately 1,000 dairy farms for 2013 and the average profit numbers are very good. Then consider the price run up. Now add the fact that nothing of a definite nature points to this changing in the coming months, and every manager of a dairy farm has some serious financial management tasks in front of them.
In 2008, the general dairy manager attitude was that the good times were here to stay. So, far too many dairymen spent far too much and took out too many new loans. Cash reserves were not established. Debts increased instead of decreased. Listening to those like me that warned of the coming downturn did not happen. The result was the 2009 devastation.
History has shown me that the depth of any pricing downturn is usually directly proportional to the extreme heights of any price run up. Given that we are in the midst of one of the great price run ups of all time, history tells me that when it comes to an end, the drop will be a large one. Sitting here in the spring of 2014, I see no rational reason (given the nationwide lack of cow culling and overall production increases just to mention two coming problems on the production side) to expect 2015 to see other than a price downturn. Then add in history, current world events and vulnerability of demand and nothing currently looks good for 2015 prices.
To mitigate all this, every dairy farm manager should be taking the following actions:
1. Eliminate all accounts payable and, when available, sign up for the new USDA Dairy Margin Protection Program.
2. Retire all lines of credit and nearly paid off loans.
3. Establish two reserve cash accounts. The first equal to six months living expenses and the second equal to three months operating expenses.
4. Then, if the purchase of any asset must be made and the three items above have been taken care of, borrow as little as possible toward the purchase.
Are these extreme? Perhaps they are, but I look at it this way — If 2015 is as bad as it potentially can be, followers of these ideas will make it through. But, if 2015 and beyond do not see the downturn, what have you lost by getting your business onto a solid financial footing?
Editor’s note: Michael Evanish is the manager of MSC Business Services, a member service of the Pennsylvania Farm Bureau. For more information, call 717-731- 3517.