A New Market Dynamic
If you ask most any dairy farmer what “counterparty risk” means, they’re likely to look at you with a blank stare. Traditionally, in Pennsylvania, dairy farm families were very fortunate to have multiple options for their milk market. If you lost your milk market because of the dairy downsizing, going out of business or for some other reason, there were usually four or five other markets waiting to pick up the milk.
That’s not the case anymore. Over the past two years, milk production in the region has been ramping up, with both New York and Pennsylvania increasing by 2.3 and 2.1 percent, respectively. At the same time, Class I fluid milk sales, or milk moving into the bottle, have fallen drastically, requiring some fluid processing plants to reduce capacity to meet declining market demand. That results in markets needing less milk from their suppliers, and in some cases, requiring reductions in herd size or even dropping farms.
The risk of being at the short end of the stick when this situation occurs would be considered a Counterparty Risk. It’s defined as the risk to each party of a contract that the counterparty, or other entity involved in the contract, will not live up to its contractual obligations. If you are an independent producer and do not hold any ownership stake in your milk market, this could be a significant risk for your business.
An example of this is when Grassland Dairy in Wisconsin sent a letter this spring to 75 dairy farmers, mostly in Wisconsin, stating that the company would be cutting back on the amount of milk it buys because of new regulations in Canada. As a result, the dairy would no longer accept milk from dozens of those dairies. Fortunately, most of that milk has since found a home. But for a brief time, those farms were scrambling to figure out how they were going to protect their business and their family from the reality of being without a market to sell their milk.
What Can You Do?
Other examples of this have occurred in Pennsylvania more recently, leaving more and more players in the industry concerned about the counterparty risks farms face as we move into the uncharted waters of an oversupplied regional milk market. Recently I attended a Dairy Outlook Session hosted by AgChoice Farm Credit where two of their associates, Mike Schrey, chief lending officer, and Gines Pérez, chief credit officer, shared suggestions on what all dairy farms should be doing to protect themselves against this risk. Here are their suggestions.
- Be a Quality Supplier: When dairy processors are faced with the difficult decision of decreasing their milk supplies, they are going to look for the low hanging fruit. What farms have reoccurring quality problems and aren’t quick to fix the situation? What farms have refused to keep up with current regulations? Who has somatic cell count issues? Which dairies struggle to pass inspections? These are the farms that will be cut first, so make sure your operation isn’t one of them.
- Seek Education and Keep Current on Expectations: Dairy farm managers today are expected to be more than just quality milk producers. They are expected to have best management practices in place for animal care and welfare, environmental stewardship and even just farmstead appearance. Make sure you educate yourself on what is expected of you and that you are meeting and exceeding those expectations.
- Tell Your Story. Processors like to be affiliated with farms that represent their brand well in the local community. Take the time to share your story with your non-farm neighbors and local community members so they better understand your farm’s role in producing quality food and taking good care of your animals and your farm. Host farm tours, volunteer to speak at local community groups, or get involved in the local school educational program. Demonstrating your commitment to the farm and relating it to the products that your milk is used can benefit both the processor and your farm.
- Know Your Buyer. The AgChoice folks had some good questions to consider: What is the financial position and strength of your milk buyer?, Who is their primary customer? Are they dependent on only just a couple of customers or do they have a diverse portfolio that they serve? What is their sales trends – are sales increasing or decreasing? What are they doing to market the products your milk is used in? Make sure you are attending their informational meetings, reading their newsletters and asking questions. Be active in their programs, and remember, your field representative or milk inspector is your local point of contact, so make sure you have a good relationship with that person. Don’t be afraid to ask how you’re doing in meeting their expectations.
Risk is nothing new to dairy farm families. Anyone who has operated a dairy farm and lived to tell about it will tell you that it is one of the risky ventures you can take. However, not all farms are aware of how sensitive they are to counterparty risk. Make sure you take the time to know your own situation and are taking the steps necessary to protect your business and your future against that risk.
If you would like to learn more about managing your risks, you can talk to the center’s Risk Management Program Manager Alan Zepp at 717-346-0849 or firstname.lastname@example.org. He is available to sit down with you and review all of the risks affecting your business and your options to protect yourself against them. Learn more at www.centerfordairyexcellence.org under “Business Tools.”
Editor’s Note: The Center Focus is a column published monthly by Jayne Sebright, executive director of the Center, in the Lancaster Farming Dairy Reporter.