Peterson, Donald

Shane, Richard

English

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South Dakota State UniversityOpen PRAIRIE: Open Public Research Access InstitutionalRepository and Information ExchangeEconomics Commentator Department of Economics2-10-1993Milk Futures May Be Coming Soon; WinterWheat SituationDonald PetersonSouth Dakota State UniversityRichard ShaneSouth Dakota State University, richard.shane@sdstate.eduFollow this and additional works at: http://openprairie.sdstate.edu/econ_commPart of the Agricultural and Resource Economics Commons, and the Regional EconomicsCommonsThis Newsletter is brought to you for free and open access by the Department of Economics at Open PRAIRIE: Open Public Research AccessInstitutional Repository and Information Exchange. It has been accepted for inclusion in Economics Commentator by an authorized administrator ofOpen PRAIRIE: Open Public Research Access Institutional Repository and Information Exchange. For more information, please contactmichael.biondo@sdstate.edu.Recommended CitationPeterson, Donald and Shane, Richard, "Milk Futures May Be Coming Soon; Winter Wheat Situation" (1993). Economics Commentator.Paper 285.http://openprairie.sdstate.edu/econ_comm/285ECONOMICSCOMMENTATORMILK FUTURES MAY BE COMING SOONbyDon PetersonExtension Economist/Marketing and ManagementNew marketing alternatives soon maybe available for milk producers. TheCoffee, Sugar and Cocoa Exchange (CSCE) inNew York City is considering offeringfutures contracts in nonfat dry milk andCheddar cheese. Years ago, when butterwas a primary product of the dairyindustry, the Chicago Mercantile Exchangetraded butter futures. With theinitiation of government price supportsfor dairy products in the late 1940s andthe rise of substitute spreads, thetrading volume in butter futures fell andthe butter contracts were discontinued.The farm bills of 1985 and 1990 cutthe support price of milk to $10.10, adecrease of nearly $3 per hundred weight(cwt.). A .number of factors, includingthe lower support price, the dairy buyout,the drought of 1988, and last year's coolwet summer, have caused milk prices toshow a volatility similar to that of porkbellies according to the CSCE.Consequently, some dairy companies anddairy product users have been looking forways to reduce their price risk withoutnecessarily reducing profits. If it isnot possible to reduce price risk, higheraverage profits will be necessary so thatprocessors can survive the low returnperiods. This will likely mean lowerprices to milk producers or higher pricesto consumers or both.One alternative is to institute afutures market where the risk of priceswings is shifted to those who are willingand able to assume such risks in hope ofmaking a profit. The use of futuresprovides 3 useful functions to theindustries which use them; (1.) it allowsproducers and buyers to avoid speculation(Continued on p.2)SOUTH DAKOTA STATE UNIVERSITYNo. 316 February 10, 1993WINTER WHEAT SITUATIONbyRichard ShaneExtension Economist/Grain Marketing SpecialistUSDA has estimated winter wheatseedings for 1993 at 51.5 million acres,one per cent above 1992. Prior to therelease of the seedings report on January12, grain traders had expected an acreagefigure of around 53.5 million acres. So,the report definitely helped to strengthenthe deferred wheat futures prices.The trade had expected an increasefrom last years 51.06 million acrespredominantly because the set aside ratefor wheat program participation wasdecreased from five percent to zeropercent. The immediate question is "howaccurate is this report?" The "WinterWheat Seedings" report has been veryaccurate historically. The estimatedacreage has been within one percent ofactual acreage most years or within onehalf million acres of the 51.5 millionacre estimate for 1993.A state by state analysis helps toexplain why the acreage increase wasn't aslarge as expected. Ohio, Indiana and Iowaall planted less than 90 percent of lastyear's acreage due to very wet conditionsat planting time. This would have beenbullish for soft red winter (SRW) wheatprices which are reflected on the ChicagoBoard of Trade, but a 200,000 acreincrease in Illinois plantings lessenedthe impact on price.Hard red winter (HRW) wheat plantingswere 100 to 103 percent of 1992 except inKansas, which is the largest wheatproducing state in the nation. Kansasacreage is down two percent or 200,000acres. Texas acreage was increased a likeamount. Overall HRW wheat acreage isexpected to increase. This market, factor(Shane ... Continued on p.2)Page 2by passing the price risk on to willingspeculators, (2) it provides a veryefficient price discovery mechanism,helping the market to quickly find theequilibrium price given the current marketinformation available, and (3) it provideslong range price signals to producers andusers so they can adjust their productionor purchase plans accordingly.The New york Coffee, Sugar and CocoaExchange approved nonfat dry milk andCheddar cheese contracts on January 13 andpresented its proposals to the CommodityFutures Trading Commission (CFTC) forapproval. A decision by the CFTC usuallytakes 3 to 4 months. Thus, if theproposal is approved, trading could beginby early summer.The cheese contract specificationsare 40,000 pounds of Grade A cheddarcheese in 40 pound blocks, 4 to 30 daysold with standard moisture content andpriced at Green Bay, Wisconsin. Thenonfat dry milk contract specifies 44,000pounds of Grade A powdered milk with 1.25%milk fat, 4% moisture, low heat, in 40pound bags and priced FOB the West Coast.Delivery months for both contracts will beFebruary, May, July, September andNovember.The size of the contract will make itdifficult for most dairy farmers in theMidwest to directly hedge their milkproduction. It takes about 370,000 poundsof raw milk to produce 44,000 pounds ofnonfat dry milk. Likewise, 40,000 poundsof cheese takes about 400,000 pounds ofmilk. Thus, one should have a herd of atleast 225 cows each producing 20,000pounds of milk per year to produce one drymilk contract per month. However, even ifa dairy is too small to directly hedge itsmilk, the futures contracts still offersome marketing advantages. The futurescontracts will make it possible for milkcooperatives to offer cash forwardcontracts to milk producers, allowing themto lock in a known price. Futurescontracts also will provide long rangeprice signals for future production plans.Probably the main reason for thelarge contract size is that it is thecheese producers and milk buyers, not theproducers who are promoting theintroduction of milk futures. Currently,cheese makers have no way of protectingthe value of their inventory, and at timeshave suffered severe financial loss due tofalling cheese prices. The major promoteris the candy industry which uses milk inthe production of milk chocolate and othercandies. While the candy industry is notas concerned about the value ofinventories, it is troubled by changes inmilk prices because these changes affectproduction costs. Adjusting candy pricesby small amounts is extremely difficultbecause of the way candy is marketed. Byprotecting input cost fluctuations, itwill be able to operate with lower profitmargins and increase the volume of candysold.There is apparently enough milksuppliers and users to provide asufficient nvunber of hedgers to make afutures market work. The concern iswhether there will be enough speculators.Speculators are needed to provideliquidity to the market. That is,speculators serve as immediate sellers orbuyers for hedgers who want to buy orsell. Speculators need price volatilityto get and keep their interest in hopes ofmaking a profit on price moves.Currently, the CSCE believes there isenough volatility. However, an increasein government price support for milk couldremove that volatility and kill the milkfutures market.Some dairy cooperatives, which havehad experience using futures as a riskmanagement tool in other commodities, seea milk products futures market as a way toimprove their prices to farmers whilereducing risk. Others, who do notunderstand the use or function of futures,do not like the idea and will not likelyuse them. They will remain at the mercyof the cash market and likely willcontinue to advocate governmentprotection. However, with the largegovernment deficit and the desire to keeptaxes from going higher, increasedgovernment price support seems politicallyunacceptable. It is going to beinteresting to see how well thesecontracts work out, if initiated.******************************************(Shane ... continued from p.l)showed up as a negative price move inthe Kansas City Board of Trade wheat/ Page 3futures market.Given the locations of the acreagereductions and the smaller than expectedincreases, it is unlikely that springwheat will be planted on these acres.Corn belt SRW wheat acreage not planted towheat will most likely be planted tosoybeans or corn and Kansas HRW acreagewill most likely be planted to sorghum orsome other feed grain. All this leads oneto believe that the "Winter WheatSeedings" estimate will be accurate.Hard red spring (HRS) wheat acreagewas up from 14 million acres in 1991 to17.8 million acres in 1992. Anotherincrease in HRS wheat acreage is notexpected. Even if it were to change byfive percent, the increase in acreagewould be less than one million acres.Therefore, total wheat acreage for 1993could be the same as 1992 at 72.3 millionacres. With an increase in HRS and Durumacres, total wheat acres could reach 73.8million.Harvested wheat acreage averaged 83.6percent of plantings from 1985-91 and was86.3 percent in 1992. Most likely 84percent of 1993 plantings will beharvested or about 62.8 million acres.Wheat yields averaged 35.6 bushelsper acre from 1985 to 1991 and 39.4bushels per acre in 1992. At this time,an estimate for 1993 wheat yield is 37bushels per acre. Combined with 62.8million harvested acres, this yield leadsto expected production of 2.32 billionbushels compared to 2.46 billion bushelsin 1992.Beginning stocks of wheat in the U.S.are very reasonable according to the USDAestimate of 486 million bushels. Thisfigure is not statistically different fromthe stocks on hand at the beginning of the1992 marketing year. Stocks plusproduction should make a total U.S. supplyof around 2.86 billion bushels as long as1992-93 exports remain around 1350 millionbushels. This supply is 126 millionbushels less than in 1992.Price potential for the 1993marketing year is $3.10 to $3.45 perbushel, national average. This is 5 centshigher to 10 cents lower than 1992. Thelevel of demand will determine which endof this price range is achieved. Thebiggest demand problems are continuedexports to the Former Soviet Union (FSU)and Most Favored Nation (MFN) status forChina. The market is currentlydiscounting deferred futures due to theselarge "if's" in the demand picture.South Dakota harvest time pricescould easily drop to $2.50 to $2.60 perbushel. The producer who is interested inmaking pre-harvest wheat sales shouldconsider opportunities at $2.90 to $3.00per bushel to sell the first increment forharvest delivery. Cash forward contractsand hedging currently offer prices nearthis level. Buying a put offers a minimumprice of 15 to 20 cents per bushel lessthan the cash forward contract or hedgedue to the cost of the option premium.Participation in the governmentprogram will be high this year. The zeroset aside and $5.25 per bushel advanceddeficiency payment is attractive to mostproducers. The expected total deficiencypayment is $1.05 per bushel and isindicative of a national average wheatprice for the first five months of themarketing year of $2.95 per bushel.Fundamental market factors currentlysupport a higher price than this, butdownside risk is considerable if China andthe FSU do not continue to import wheat.U.S. Uheat Si^sply and DemandUSOA SDSU 1993 Estimates1992 Drought Normal Buicer(million acres)Planted 72.3 72.0 73.0 73.8Harvested 62.4 60.5 62.8 63.4(ixjshels)Yield 39.4 32.0 37.0 40.0(million bushels)Beginning Stocks 472 486 486 486Production 2,459 1,936 2,324 2,536Imports 55 65 50 WSupply 2,986 2,487 2,860 3,062Food 830 830 850 875Seed 95 95 100 100Feed 225 125 200 250Exports 1.350 1.050 1.275 1.3(K)Demand 2,500 2,100 2,425 2,525Ending Stocks 486 387 435 537Expected Price 3.20-3.40 3.40-3.70 3.10-3.45 2.90-3.20SOUTH DAKOTA STATE UNIVERSITYEconomics DepartmentBox 504ABrookings, SD 57007Address Correction RequestedECONOMICSCOMMENTATOREDITOR: Don Peterson, Agricultural EconomistECONOMICS DEPARTMENTSouth Dakou State UniversityBox 504ABrookings. SD 57007Phone: (605) 688 - 4141400 copies of this puolicaticn were produced at a costof less Chan S100.r'**v

Milk Futures May Be Coming Soon; Winter Wheat Situation

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Milk Futures May Be Coming Soon; Winter Wheat Situation

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