Milk, Feed, and MPP Margin Price Forecasting

John NewtonUniversity of Illinois jcnewt@illinois.edu

@New10_AgEcon

Chuck NicholsonPenn State University

cfn10@psu.edu

MPP Margin Historical Perspective

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

-

5

10

15

20

$/h

undre

dw

eig

ht

2014 Farm Bill Dairy Production Margin

Source: USDA National Agricultural Statistics Service and Agricultural Marketing Service

June 2009$2.25/

hundredweight

Margin = U.S. All-Milk Price – NASS Corn Price x 1.0728 + AMS SBM x 0.00735 + NASS Alfalfa x 0.0137

May 2011Senate First

Hearing on Farm Bill

2010Secretary’s DIA Committee Recommends

Margin Insurance

Contribution to the MPP Ration

49%

27%

24%CornSoybean MealAlfalfa Hay

MPP: A New Way to Think About a Government Safety Net

Key farmer decisions: 1) How much milk to protect (25% to 90%) 2) What margin level to protect ($4 to $8)

8.00$

7.50$

7.00$

6.50$

6.00$

5.50$

5.00$

4.50$

4.00$

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

Cov

erag

e Le

vel

Coverage Percentage

Coverage Options*

Greater Protection at a greater cost

*113 Possible Coverage

Choice Combination

s

Expectations of MILC Payments (Using Futures Prices)

START IN MARCH 2009 START IN OCTOBER 2010

START IN MARCH 2013START IN APRIL – JUNE 2012

How Accurate Were Farmers?*

*Farms Marketing More than 3M #’s per month

Information Needed for MPP Decisions

• Production history for a farm (one data point)– Can be calculated with the tool– Pretty straightforward

• Expected MPP margin during covered period– Not the margin for an individual farm (or its IOFC)– Harder to predict but tool provides a range– Requires a FORECAST of the MPP margin

Sources of Expected MPP Margin (Forecasts)

• Cooperatives• Risk management firms• Academic “price”

forecasters• Futures markets for milk

and feed prices• Dart Board?

3 Characteristics of a Forecast

• It will be wrong (there will be some error)– So a range of values with likelihood is useful

• It will be less accurate farther into the future (longer time horizon)

• Multiple methods (forecasts) can be useful to give a range– Analyzing market fundamentals (supply and

demand)– And are usually more accurate

How the Decision Tool Makes Margin Forecasts

It’s really very simple…

Tool Margin Ranges are Based on Futures Markets

• Economists think of futures markets as the “best available forecast”– Many players have skin in the game– Futures are generally considered to be unbiased

estimators of future price• Not consistently off in one direction or the other

Using CME to Forecast NASS Corn

3/1/

2001

1/1/

2002

11/1

/200

2

9/1/

2003

7/1/

2004

5/1/

2005

3/1/

2006

1/1/

2007

11/1

/200

7

9/1/

2008

7/1/

2009

5/1/

2010

3/1/

2011

1/1/

2012

11/1

/201

2

9/1/

2013

-2

0

2

4

6

8

NASS Corn CME Corn SettlementBasis

Co

rn P

rice

($

/bu

)

Using CME to Forecast AMS SBM

1/1/

2001

11/1

/200

1

9/1/

2002

7/1/

2003

5/1/

2004

3/1/

2005

1/1/

2006

11/1

/200

6

9/1/

2007

7/1/

2008

5/1/

2009

3/1/

2010

1/1/

2011

11/1

/201

1

9/1/

2012

7/1/

2013

5/1/

2014

(200) (100)

- 100 200 300 400 500 600 700

AMS SBM CME Settlement PriceBasis

Co

ybe

an

Me

al P

rice

($

/to

n)

Using CME to Forecast AMS All-Milk

1/1/

2001

11/1

/200

1

9/1/

2002

7/1/

2003

5/1/

2004

3/1/

2005

1/1/

2006

11/1

/200

6

9/1/

2007

7/1/

2008

5/1/

2009

3/1/

2010

1/1/

2011

11/1

/201

1

9/1/

2012

7/1/

2013

5/1/

2014

0

5

10

15

20

25

30

NASS All-Milk Price CME CIII CME CIV

Milk

Pri

ce (

$/c

wt)

Regression Price Inputs and Outputs

US All Milk Price• Class III Milk, Class IV Milk, Lagged Prices,

Seasonal DummyUS Corn Price• CME Corn, Lagged PricesUS Alfalfa Hay Price• NASS Corn, AMS Soybean Meal, US All Milk

Price, Lagged PricesAMS Soybean Meal• CME Soybean Meal Prices

-4 -3 -2 -1 0 1 2 3 4 5

-300-250-200-150-100

-500

50100150

f(x) = 18.9232943315676 x − 29.1016779370549R² = 0.166961456411469

Deviates in 6th Nearby Corn Contract

De

via

tes

in 6

th N

ea

rby

So

ybe

an

M

ea

l Co

ntr

act

Are Corn & SBM Prices Correlated?

Corn Price Increases

SBM Price Increases

SBM Price Decreases

Corn Price Decreases

Are Milk & Corn Prices Correlated?

-10 -5 0 5 10 15

-4-3-2-1012345

f(x) = 0.182849588391729 x − 0.00134817733572951R² = 0.215038831797353

Deviates in 12th Nearby Class III Milk ($/cwt)

De

via

tes

in 6

th N

ea

rby

Co

rn

Co

ntr

act

($

/bu

) Milk Price Increases

Feed Price Increases

Feed Price Decreases

Milk Price Decreases

Are Milk & SBM Prices Correlated?

-10 -5 0 5 10 15

-300-250-200-150-100

-500

50100150

f(x) = 7.80038738496982 x − 25.9646725725259R² = 0.182466859011735

Deviates in 12th Nearby Class III Milk ($/cwt)

De

via

tes

in 6

th N

ea

rby

So

ybe

an

M

ea

l Co

ntr

act

($

/to

n)

Milk Price Increases

Feed Price Increases

Feed Price Decreases

Milk Price Decreases

Example Probabilities CME Feed

1 2 3 4 5 6 7 8 90

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

Corn Price

f(x)

September 15 Corn Price PDF

CME futures and options prices provide a forecast of the expected price and uncertainty

Example Probabilities CME Feed

1 2 3 4 5 6 7 8 90

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

Corn Price

f(x)

September 15 Corn Price PDF

100 200 300 400 500 600 7000

1

2

3

4

5

6

7x 10

-3

Soybean Meal Pricef(

x)

September 15 SBM Price PDF

Simulate from CME corn and soybean meal price distributions to get NASS and AMS

prices

Example Probabilities CME Milk

5 10 15 20 25 30 350

0.02

0.04

0.06

0.08

0.1

0.12

Class III Price

f(x)

September 15 Class III Price PDF

5 10 15 20 25 30 350

0.02

0.04

0.06

0.08

0.1

0.12

Class IV Pricef(

x)

September 15 Class IV Price PDF

Simulate from CME class III/IV milk price distributions to get NASS all-milk price

CME Probabilities Combined

1 2 3 4 5 6 7 8 90

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

Corn Price

f(x)

September 15 Corn Price PDF

100 200 300 400 500 600 7000

1

2

3

4

5

6

7x 10

-3

Soybean Meal Price

f(x)

September 15 SBM Price PDF

Corn

SBM

5 10 15 20 25 30 350

0.02

0.04

0.06

0.08

0.1

0.12

Class III Price

f(x)

September 15 Class III Price PDF

5 10 15 20 25 30 350

0.02

0.04

0.06

0.08

0.1

0.12

Class IV Price

f(x)

September 15 Class IV Price PDF

Class III

Class IV

September 2015 MPP-Margin

0 5 10 15 20 250

50

100

150

200

250

300

350

400

MPP-Margin Price

Fre

quen

cy

September 2015 MPP Margin Histogram

Generate a probability distribution of MPP-Dairy Margin (for all coverage months)

MPP-Margin Forecast 9/8/14

0 2 4 6 8 10 12 14 16 188

9

10

11

12

13

14

15

16

17

$8.00

Month

$/C

wt

Estimated IOFC w/ 50% Interval

Mean IOFC

25% Boundary75% Boundary

2015 Forecast

MPP-Margin Forecast 9/8/14

0 2 4 6 8 10 12 14 16 186

8

10

12

14

16

18

$8.00

Month

$/C

wt

Estimated IOFC w/ 90% Interval

Mean IOFC

10% Boundary90% Boundary

2015 Forecast

Tool Users Can Evaluate Historical Accuracy of Forecast

6 out of 7 years MPP Decision Tool Correctly Forecast Positive Net Returns to MPP

Participation

Alternative Forecast Values Can Be Entered in the Tool

• Economists think of futures markets as the “best available forecast”– Many players have skin in the game– But it is not completely accurate as a forecast

• Alternative forecast values can be entered in an “Advanced” version of the tool– Soon to be linked to this tool version

Alternatives to Futures Markets Margins in “Advanced” Tool

Automatically enters the relevant milk and feed prices for MPP margin formula when known

Alternatives to Futures Markets Margins in “Advanced” Tool

Advanced users can enter their own forecast values for the MPP margin calculation components*

*Must be use to use the correct national values

A Complication: MPP Is Likely to Decrease Margins

• The MPP works in a way that will lower margins if the program is active– It will slow the adjustment of milk production

during low price/margin periods– Risk reduction enhances supply

• This could complicate the development and use of margin forecasts

Simulated MPP Margin, 2015-2018

Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-180.00

2.00

4.00

6.00

8.00

10.00

12.00

Current Programs With MPP

$/c

wt

Average MPP decreases $0.91/cwt, margin < $8 most of time

A Complication: MPP Is Likely to Decrease Margins

• Margins are likely to be lower with MPP• How much lower depends on producer

participation– Limited coverage, limited impacts– Widespread coverage, larger impacts

Impacts of MPP Participation Levels on the MPP Margin

Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-180.00

2.00

4.00

6.00

8.00

10.00

12.00

Current Programs With MPPMPP With Less Participation

$/1

00

lbs

(4

5 k

g)

MPP participation decisions will affect the MPP Margin

Implications of Ignoring MPP Impacts on Margins

• If markets do not account for MPP impacts, then margin forecasts will be “too high”…

• Could result in less coverage than is desired..• Or a decision not to participate…• With potentially sizeable impacts on farm

income…

Two Implications

• Forecasted MPP margins should account for the participation decisions of farmers (if the program is likely to be active)

• Expected participation decisions of producers collectively could (should) influence the decisions of an individual producer

Statistical Analysis of MPP Margin through 2018

Questions or Comments?