Milk, Feed, and MPP Margin Price
Forecasting
John Newton
Chuck Nicholson
University of Illinois
jcnewt@illinois.edu
Penn State University
cfn10@psu.edu
@New10_AgEcon
MPP Margin Historical Perspective
Margin = U.S. All-Milk Price – NASS Corn Price x 1.0728
+ AMS SBM x 0.00735 + NASS Alfalfa x 0.0137
2010
Secretary’s DIA Committee Recommends Margin
Insurance
15
May 2011
Senate First Hearing
on Farm Bill
10
2014 Farm Bill Dairy
Production Margin
Source: USDA National Agricultural Statistics Service and Agricultural Marketing Service
2013
2012
2008
2007
2006
2005
2004
2003
2002
2001
2000
-
2011
June 2009
$2.25/hundredweight
2010
5
2009
$/hundredweight
20
Contribution to the MPP Ration
24%
49%
27%
Corn
Soybean Meal
Alfalfa 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)
Coverage Options*
$ 8.00
$ 7.00
$ 6.50
$ 6.00
$ 5.50
*113 Possible
Coverage
Choice
Combinations
$ 5.00
$ 4.50
Coverage Percentage
90%
85%
80%
75%
70%
65%
60%
55%
50%
45%
40%
35%
30%
$ 4.00
25%
Coverage Level
$ 7.50
Expectations of MILC Payments
(Using Futures Prices)
START IN MARCH 2009
APRIL
START IN
– JUNE 2012
START IN OCTOBER 2010
START IN MARCH 2013
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
3/1/2001
10/1/2001
5/1/2002
12/1/2002
7/1/2003
2/1/2004
9/1/2004
4/1/2005
11/1/2005
6/1/2006
1/1/2007
8/1/2007
3/1/2008
10/1/2008
5/1/2009
12/1/2009
7/1/2010
2/1/2011
9/1/2011
4/1/2012
11/1/2012
6/1/2013
1/1/2014
Corn Price ($/bu)
Using CME to Forecast NASS Corn
8
6
4
2
0
-2
NASS Corn
CME Corn Settlement
Basis
1/1/2001
9/1/2001
5/1/2002
1/1/2003
9/1/2003
5/1/2004
1/1/2005
9/1/2005
5/1/2006
1/1/2007
9/1/2007
5/1/2008
1/1/2009
9/1/2009
5/1/2010
1/1/2011
9/1/2011
5/1/2012
1/1/2013
9/1/2013
5/1/2014
Coybean Meal Price ($/ton)
Using CME to Forecast AMS SBM
600
500
400
300
200
100
(100)
(200)
AMS SBM
CME Settlement Price
Basis
NASS All-Milk Price
CME CIII
CME CIV
5/1/2014
9/1/2013
1/1/2013
5/1/2012
9/1/2011
1/1/2011
5/1/2010
9/1/2009
1/1/2009
5/1/2008
9/1/2007
1/1/2007
5/1/2006
9/1/2005
1/1/2005
5/1/2004
9/1/2003
1/1/2003
5/1/2002
9/1/2001
1/1/2001
Milk Price ($/cwt)
Using CME to Forecast AMS All-Milk
30
25
20
15
10
5
0
Regression Price Inputs and Outputs
US All Milk Price
• Class III Milk, Class IV Milk, Lagged Prices,
Seasonal Dummy
US Corn Price
• CME Corn, Lagged Prices
US Alfalfa Hay Price
• NASS Corn, AMS Soybean Meal, US All Milk
Price, Lagged Prices
AMS Soybean Meal
• CME Soybean Meal Prices
Deviates in 6th Nearby Soybean
Meal Contract
Are Corn & SBM Prices Correlated?
SBM Price
Increases
Corn Price
Decreases
-5
SBM Price
Decreases
150
100
50
0
-50 0
-100
-150
-200
-250
-300
Corn Price
Increases
5
y = 18.923x - 29.102
R² = 0.167
Deviates in 6th Nearby Corn Contract
Deviates in 6th Nearby Corn
Contract ($/bu)
Are Milk & Corn Prices Correlated?
Feed Price
Increases
Milk Price
Decreases
-10
5
4
3
2
1
0
-1 0
-2
-3 Feed Price
Decreases
-4
Milk Price
Increases
10
20
y = 0.1828x - 0.0013
R² = 0.215
Deviates in 12th Nearby Class III Milk ($/cwt)
Deviates in 6th Nearby Soybean
Meal Contract ($/ton)
Are Milk & SBM Prices Correlated?
Feed Price
Increases
Milk Price
Decreases
-10
150
100
50
0
-50 0
-100
-150
-200
-250 Feed Price
Decreases
-300
Milk Price
Increases
10
y = 7.8004x - 25.965
R² = 0.1825
Deviates in 12th Nearby Class III Milk ($/cwt)
20
Example Probabilities CME Feed
September 15 Corn Price PDF
0.4
0.35
CME futures and
options prices
provide a forecast
of the expected
price and
uncertainty
0.3
f(x)
0.25
0.2
0.15
0.1
0.05
0
1
2
3
4
5
Corn Price
6
7
8
9
Example Probabilities CME Feed
-3
September 15 Corn Price PDF
0.4
7
0.35
6
0.3
September 15 SBM Price PDF
x 10
5
0.25
f(x)
f(x)
4
0.2
3
0.15
2
0.1
1
0.05
0
1
2
3
4
5
Corn Price
6
7
8
9
0
100
200
300
400
500
Soybean Meal Price
Simulate from CME corn and soybean meal price
distributions to get NASS and AMS prices
600
700
Example Probabilities CME Milk
September 15 Class IV Price PDF
0.12
0.1
0.1
0.08
0.08
f(x)
f(x)
September 15 Class III Price PDF
0.12
0.06
0.06
0.04
0.04
0.02
0.02
0
5
10
15
20
25
Class III Price
30
35
0
5
10
15
20
25
Class IV Price
Simulate from CME class III/IV milk price
distributions to get NASS all-milk price
30
35
CME Probabilities Combined
September 15 Corn Price PDF
September 15 Class III Price PDF
0.4
0.12
0.35
0.1
0.3
0.08
f(x)
f(x)
0.25
0.06
0.2
0.15
0.04
0
0.1
Class III
0.02
5
10
15
20
25
Corn
0.05
30
0
35
1
2
3
4
Class III Price
5
6
7
8
9
Corn Price
-3
September 15 Class IV Price PDF
7
0.12
September 15 SBM Price PDF
x 10
6
0.1
5
0.08
f(x)
f(x)
4
0.06
3
0.04
2
Class IV
0.02
0
5
10
15
20
25
Class IV Price
SBM
1
30
35
0
100
200
300
400
500
Soybean Meal Price
600
700
September 2015 MPP-Margin
September 2015 MPP Margin Histogram
400
350
Generate a probability
distribution of MPP-Dairy
Margin (for all coverage
months)
300
Frequency
250
200
150
100
50
0
0
5
10
15
MPP-Margin Price
20
25
MPP-Margin Forecast 9/8/14
Estimated IOFC w/ 50% Interval
17
Mean IOFC
25% Boundary
75% Boundary
16
2015 Forecast
15
$/Cwt
14
13
12
11
10
9
8
$8.00
0
2
4
6
8
10
Month
12
14
16
18
MPP-Margin Forecast 9/8/14
Estimated IOFC w/ 90% Interval
18
16
Mean IOFC
10% Boundary
90% Boundary
2015 Forecast
$/Cwt
14
12
10
$8.00
8
6
0
2
4
6
8
10
Month
12
14
16
18
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
12.00
10.00
$/cwt
8.00
6.00
4.00
2.00
0.00
Jan-15
Jul-15
Jan-16
Jul-16
Jan-17
Jul-17
Current Programs
With MPP
Average MPP decreases $0.91/cwt, margin < $8 most of time
Jan-18
Jul-18
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
12.00
$/100 lbs (45 kg)
10.00
8.00
6.00
4.00
2.00
0.00
Jan-15
Jul-15
Jan-16
Jul-16
Jan-17
Jul-17
Jan-18
Jul-18
Current Programs
With MPP
MPP With Less Participation
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?