Locking in a price for milk

COLUMBUS, Wis. – Fifth-generation dairy farmers, Brady and Brett Weiland, have plans to purchase the family farm from their parents someday. To ensure this dream becomes a reality, the brothers do not leave their profits to chance. Locking in milk prices through forward contracting is a strategy they use to help guarantee the farm’s profitability from one year to the next.

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“Protecting the balance sheet is the No. 1 reason why we contract our milk,” Brady said. “It’s a good feeling to know that next year at this time we’re going to be able to pay the bank, ourselves and our employees, and we’re still going to be in operation. A couple guys in their 20s who are trying to buy the business from Mom and Dad can’t afford to go backward.”
The Weilands milk 1,150 cows between two dairies near Columbus with their parents, Roger and Tammy, and Brett’s wife, Emiley. The family farms 500 acres and buys the rest of their feed from neighbors. Unwilling to be at the mercy of the market for 100% of their milk check, the Weilands have prices for 75% of their milk locked in with forward contracts for all of 2023.
“Our family has been contracting milk for as long as I can remember,” Brett said. “All of us work together with our advisory team on setting a plan ahead of time. We watch margins closely. We know what we’re going to get paid for milk and what we’re paying for feed and do what we can to try and protect that margin.”
A form of risk management, milk contracting fixes a future price for Class III milk by locking in the milk price for a set volume and particular time period. For example, if a farmer locks in a price of $19 for the month of May, and the Class III milk price drops to $13, the forward contract is going to compensate the farmer $6. However, if the Class III price exceeds $19, the farmer has to pay the difference.
“When you lock in a milk price, you give up all the upside and, in turn, prevent a lot of the downside,” Marin Bozic said. “It’s a big shortcoming in the sense you’re removing all that upside potentially. Cheese prices can get wild and rise quickly on strong demand.”
Bozic is an assistant professor in the department of applied economics at the University of Minnesota-Twin Cities. He is also one of eight faculty members of the National Program for Dairy Markets and Policy. Bozic said 5% to 10% of the total U.S. milk volume is contracted currently.
Milk futures are traded daily on the Chicago Mercantile Exchange. A minimum contract size with the CME is 200,000 pounds. In most cases, farmers can contract milk through their cooperative, or they can contract independently through a broker. Cooperatives offer smaller contract sizes in 25,000-pound increments – a more attractive option for smaller farms.
“Last year when milk prices were $22 to $24 and north of that, there was a lot of contracting being done,” said Matt Tranel, broker/agent with Ever.Ag. “Significantly higher prices than that had not been seen in the past.”
Tranel said his clients are typically heavier on coverage in the first half of the year with the average customer contracting 50% to 75% of their milk. In the second half of the year, he said coverage averages 30% to 50%. According to Tranel, a lot of contract purchasing is done in the months of August, September, October and early November to prepare for upcoming consumer demand during the holidays.
“Farmers might not cover as much, but they try to get the most aggressive to layer in for following quarters because demand for dairy tends to drop after Christmas,” Tranel said. “I see data about spending habits come in off the scanners and get a sense of when the consumer is stepping back or reducing some of their purchases. This can be an indication as to when you should push your client to contract their milk.”
Bongards, a milk cooperative in Chanhassen, Minnesota, works with a brokerage firm in Chicago to help its patrons contract milk. Of Bongards’ 300 patrons, milk procurement and field service manager Tom Beringer said 7.5% contract their milk, and that number has held steady for years.
“We have producers who don’t contract at all, some who contract all the time, and some that are in and out,” Beringer said.
Patrons call the broker directly to lock in prices.
“They might say, ‘I want two June contracts at $21,’” Beringer said. “The broker sends us the confirmation, and we put it in our milk payroll system. If June comes and the price settles at $20, they’ll get a dollar added to their contract. If the price settles at $22, we take a dollar off their milk check.”
Farmers contracting their milk pay a fee of 10 cents per hundredweight to Bongards. Bongards facilitates the margin calls for the farmer which comes out of Bongards’ accounts. A margin call is a request from the broker to deposit additional funds into the margin account.
 A margin account contains the money a farmer needs to pay when the contract price falls short of the market price. If dealing directly with a broker, the farmer is responsible for putting their own money into the margin account.  
When contracting their milk, the Weilands work with both their cooperative and a broker.
“We used to go directly through a broker, and now we’re going through our milk processor,” Brady said.  “The broker works with our processor; he’s the middleman. We used to do a margin account, but now it all comes in on our milk check.”
When Brett calls the broker, he states if he wants to set up the contract through the processor or through the Weilands’ margin account.
“The processor has to pay day-to-day margin calls, whereas we don’t have to pay it until our milk check comes, and they take it off our check,” Brett said. “The processor essentially carries the loan for us when the milk price ends up higher than our contracted price.”
Brady agreed.
“When we book it through our processor, the premiums we pay are more than if we did it through our margin account, but we like to use our capital for other opportunities rather than having it tied up in hedging loans,” he said.
The amount of milk they contract changes with the marketplace, and when milk prices are high, the Weilands typically contract 75% of their milk. Leaving the upside open on 25% gives them the opportunity to make more money depending on where the market goes.
“We talk to a lot of consultants and try to understand where the market may or may not be headed, and then we take all that into account while looking at the projected margin to form our own opinion,” Brady said. “You’re never going to hit it perfect. It’s kind of a gamble just like everything else we do as farmers.”
The Weilands milk is split into multiple contracts, and each 200,000-pound contract could be locked in at a different price. Prices can change by the second, Brady said.
“I don’t like to go for that big homerun shot,” Brett said. “As long as the price is above our operating costs, I like to layer it in piece by piece, doing 10% to 25% each month so it averages out and takes away some of the risk. We layer in over the course of many months, doing a couple contracts here and there as long as we’re happy with where margins are at.”
The Weilands watch the markets daily and study price history for the last five to 15 years to determine historic averages.
“Right now, the milk price is higher than previous years, and we’ve been well above that the last year or so,” Brett said. “We believe there’s more risk of a falling market than of milk going to $25.”
The Weilands also engage in other forms of risk management, including Dairy Revenue Protection, options and the Dairy Margin Coverage program. The Weilands’ combination of strategies helps them achieve a level of risk management they feel comfortable with.
“If we’re looking at good prices, we like to contract as much milk as we can,” Brett said. “Right now, we have the option to lock in and sell milk at a good price. We want to take advantage of that because we know at some point prices won’t be as high. If we were on the other end at $16 or $17 milk, we might be doing more puts and calls.”
The Weilands like to look into the future when contracting milk, and good prices prompt the family to reach further out.
“When you can lock in milk over $19, that’s pretty unusual,” Brett said.
The Weilands have targets in place for 2024 as they begin to layer in contracting for quarter one. Currently, 10% of their milk is locked in for January of next year. This year, the Weilands are focused on $20 milk or higher. Their focus for 2024 is slightly lower at $19.25.
“I’d like to sell January through June of next year for that price,” Brett said.
Bozic said it is prudent to hedge far out rather than the next available quarter. He recommends contracting milk nine to 12 months in advance.
“Producers should now be looking into the fourth quarter of 2023 and the first quarter of 2024 and later,” Bozic said. “We need to be proactive.”
Tranel said a farm can contract up to two years forward on the CME.
“How far out people go depends on the market we’re in,” he said. “Right now, we have farms touching both third quarter and fourth quarter of this year, and a couple are touching first quarter of 2024. Many times, people go six months out. It’s a matter of producer preference. When looking way out, bids and offers can be very far away from each other.”
Deciding how much to contract depends on a farmer’s risk preference.
“Some producers regularly hedge everything, while others are more opportunistic,” Bozic said. “When they believe the markets are going to drop, they hedge more. The higher the leverage, the higher the hedge ratio should be. I advise producers to layer it in. Start by hedging 10% of your milk, then a month later, maybe another 10%, etc. If prices rally, you have an opportunity to put in a higher floor.”
Bozic recommends farmers compare prices to their cost of production.
“If the price you can lock is higher than your cost of production, then pull the trigger,” he said. “Also, look at historical patterns. Is the price higher than three-quarters of the prices we’ve had for that time of year for the last 10 years?”
Brady said his family makes decisions carefully and likes to think about things ahead of time.
“We want to be as objective as possible; we’re not deciding based on emotion,” he said. … “We like to have a plan for every scenario so we know how to react.”
Factoring in their use of DMC, the Weilands have a total of 80%-85% of their milk currently covered, which is similar to last year. They also used a small amount of DRP this year for first quarter.
“We keep an eye on options, but we haven’t been doing much of that lately,” Brett said. “We look at what we can do with spread options. We watch if the milk price drops a fair amount, then we might do some options to open up the top side again for fairly cheap.”
When prices are in the middle and it is hard to speculate whether they will go up or down, the Weilands try to contract 50% of their milk and also use DRP, leaving the upside open without falling behind their operating cost.
“In that situation, we’re guaranteeing half of our milk and sliding in a floor for the other half,” Brett said. “We still have the opportunity to play the market and get the upside on 50%, but we’re also 100% covered on the downside.”
When contracting milk, the potential to leave money on the table is real, but it is a risk the Weilands are willing to take.
“We want to do everything we can to protect even if that means taking some off the top in an exceptional year,” Brett said. “You’re never going to hit the peak of the market. There is always going to be some you missed out on, but you try to average out. The goal is to try to make every year profitable and not go backward.”
The Weilands are committed to staying the course and sticking to their plan.
“In 2022, we left quite a bit of money on the table, but we’re already starting to see that money come back on the milk check in the last couple months,” Brady said. “In 2020, when COVID hit and milk dropped to $11, things looked rosy because we had DRP and 1.5 protection factor along with 40% of our milk covered through forward contracts.”
At Weiland Dairy, locking in the price of milk goes hand in hand with locking in the price of inputs.
“Inputs are a big part of it,” Brett said. “We wouldn’t lock in 75% of our milk if we didn’t have 75% of our inputs covered. You don’t want to lock in milk and get bit because inputs go up real high. We want protection on both sides.”
The Weilands have feed prices locked in for the entirety of 2023. They do a lot of physical contracts with their milk, locking in one price for six or 12 months.
“We have dry corn bought through November of this year, and soybean meal is locked in too,” Brady said. “Like milk, we layer in on feed also.”
Dedicated to riding the ups and downs of the market, the Weilands use forward contracting to continually push their farm successfully into the future.
“At the end of the day, you have to do what’s right for your business,” Brett said. “Know your numbers and ensure you can be in business another year from now.”