Forever linked: Risk and reward
Tuesday, May 2, 2017
Posted by: Lauren Brey, director of marketing and research
By Phil Plourd, president, Blimling & Associates
Do I take a chance on avoiding an expensive speeding ticket (and potentially a harrowing accident) to get to my destination faster? Do I put my money in treasury bills that offer safety but low returns or in biotech stocks that offer high returns but little safety? Do I offer a friend helpful, but possibly hurtful, advice or dodge the question?
Conscious or unconscious, long-term or short-term, major or minor, we all make risk/reward calculations and decisions every day. For dairy farmers, that can mean… Figuring whether the benefits of switching to a less expensive feed ration will outweigh the cost in lost milk production or components; weighing the work and time it takes to transition to organic against the potential for higher income; or, closer to where I live, balancing the certainty of a forward milk price agreement against the opportunity to potentially do better by remaining unhedged.
The tricky thing: We won’t know the outcome until later. Sometimes hours. Sometimes weeks. Sometimes years. Worse yet: There may not be a definitive “right” answer. An avenue that leads to, say, more money, may also involve more sleepless nights. Did I win or did I lose?
For all that uncertainty, we hope we can count on one dimension of the risk/reward relationship. We hope that the higher the risk, the higher the reward. We hope that if being wrong means losing it all, being right yields equally outsized returns.
While we may appreciate the dynamics on an individual or farm level, do we get it on an industry level? For some time, we have been thinking and talking about the risk/reward equation as it relates to exports. The recent dairy trade strife between the U.S. and Canada brings the conversation to center stage.
In just a decade, U.S. dairy exports moved from nothing to something. By some measures, export volume more than doubled between 2004 and 2014. That year, cheese and milk powder exports added up to roughly 10 percent of U.S. milk production. For U.S. dairy farmers, prices and profits reached all-time highs, with an All-Milk Price average at just under $24 per hundredweight and margins as measured by MPP at more than $13. Trade is great!
Until it’s not. Since 2014, China’s dairy import appetites have waned. European milk production has soared. Last year, U.S. cheese exports totaled 633 million pounds, down from 812 million in 2014. The All-Milk Price in 2016 averaged just over $16 per hundredweight, with MPP margins averaging just over $8. That’s not as much fun.
Three years ago, in 2014, U.S. dairy producers enjoyed rewards tied to trade. The past year and half, they are encountering the risks. The challenge is simply stated, if not simply solved: How do we deal with 1 percent or 2 percent more milk staying home? And, of course, we see the situation hitting home – hitting hard – with the change in access to Canada.
So, is dairy trade good or bad for U.S. farmers? Are the rewards worth the risks? We don’t know. But my guess is that we should prefer to be positioned to service faster-growing populations beyond our borders, to bring high-quality U.S. dairy products to people enjoying rising incomes and opportunities in Asia and Africa.
Consider this: China is starting to consume more cheese. A lot of it is delivered via restaurant brands familiar to you and me. Pizza Hut. McDonald’s. Taco Bell. American brands. Last year, China imported 214 million pounds of cheese, more than triple the 2011 pace. That’s not as much as Mexico (278 million pounds), but the gap is closing. And, of course, China has 1.4 billion people, Mexico 130 million. There’s a lot of upside. Upside the U.S. industry is trying to capture. Do we choose to ride out the current storm, figuring the long-term rewards make sense?
Phil Plourd is president of Blimling and Associates, Inc., dairy consulting, research and risk management firm based in Madison, Wis. He is also president of the Services Division of Dairy.com.