Outline Q&A: What will influence MPP outcomes? Systems - - PDF document

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Impacts of the Margin Protection Program

Chuck Nicholson

Penn State University

21st Annual Workshop for Dairy Economists and Policy Analysts Milwaukee, WI, May 1-2, 2014

Outline

• Q&A: What will influence MPP outcomes?
• Systems thinking analysis of the MPP
• Simulations model analysis:

– Base, “Best” Case and a range of possible

• utcomes

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What Will Influence MPP Outcomes?

Influence on MPP Outcomes Comment

What Will Influence MPP Outcomes?

Influence on MPP Outcomes Comment Milk prices High milk prices (relative to feed) mean limited (no?) MPP impact; Low milk prices mean larger MPP impact

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What Will Influence MPP Outcomes?

Influence on MPP Outcomes Comment Milk prices High milk prices (relative to feed) mean limited (no?) MPP impact; Low milk prices mean larger MPP impact Feed costs Higher feed costs mean lower margins and larger MPP impact; Low feed costs mean limited (no?) MPP impact

What Will Influence MPP Outcomes?

Influence on MPP Outcomes Comment Milk prices High milk prices (relative to feed) mean limited (no?) MPP impact; Low milk prices mean larger MPP impact Feed costs Higher feed costs mean lower margins and larger MPP impact; Low feed costs mean limited (no?) MPP impact Amount of milk protected More milk protected means larger MPP impact; Less milk protected means limited (no?) impact

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What Will Influence MPP Outcomes?

Influence on MPP Outcomes Comment Milk prices High milk prices (relative to feed) mean limited (no?) MPP impact; Low milk prices mean larger MPP impact Feed costs Higher feed costs mean lower margins and larger MPP impact; Low feed costs mean limited (no?) MPP impact Amount of milk protected More milk protected means larger MPP impact; Less milk protected means limited (no?) impact Level of margin protection selected Higher margin protected means larger MPP impact; Lower margin protected means limited (no?) impact

What Will Influence MPP Outcomes?

Influence on MPP Outcomes Comment Milk prices High milk prices (relative to feed) mean limited (no?) MPP impact; Low milk prices mean larger MPP impact Feed costs Higher feed costs mean lower margins and larger MPP impact; Low feed costs mean limited (no?) MPP impact Amount of milk protected More milk protected means larger MPP impact; Less milk protected means limited (no?) impact Level of margin protection selected Higher margin protected means larger MPP impact; Lower margin protected means limited (no?) impact

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What determines…?

Influence on MPP Outcomes What Determines It? Milk prices Milk production, product demand Feed costs Demand for feed, planting decisions, fuel costs, other factors Amount of milk protected Expected payout from MPP? Level of margin protection selected Expected payout from MPP?

What determines…?

Influence on MPP Outcomes What Determines It? Milk prices Milk production, product demand Feed costs Demand for feed, planting decisions, fuel costs, other factors Amount of milk protected Expected payout from MPP? Level of margin protection selected Expected payout from MPP? Milk production Cows and milk per cow

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What determines…?

Influence on MPP Outcomes What Determines It? Milk prices Milk production, product demand Feed costs Demand for feed, planting decisions, fuel costs, other factors Amount of milk protected Expected payout from MPP? Level of margin protection selected Expected payout from MPP? Milk production Cows and milk per cow Cows Profitability (culling rates) Milk per cow Profitability (season, weather)

What determines…?

Influence on MPP Outcomes What Determines It? Milk prices Milk production, product demand Feed costs Demand for feed, planting decisions, fuel costs, other factors Amount of milk protected Expected payout from MPP? Level of margin protection selected Expected payout from MPP? Milk production Cows and milk per cow Cows Profitability (culling rates) Milk per cow Profitability (season, weather) Profitability Milk prices and feed costs (other, too)

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What determines…?

Influence on MPP Outcomes What Determines It? Milk prices Milk production, product demand Feed costs Demand for feed, planting decisions, fuel costs, other factors Amount of milk protected Expected payout from MPP? Level of margin protection selected Expected payout from MPP? Milk production Cows and milk per cow Cows Profitability (culling rates) Milk per cow Profitability (season, weather) Profitability Milk prices and feed costs (other, too)

Milk Production Milk Price Cows Milk Per Cow Profitability <Milk Price>

✔ ✔ ✔ ✔ ✔ ✔

Milk Price Feed Costs Farm Profitability Cows Milk Per Cow Milk Production

• +

+ + + +

• Can create feedback diagram to show the linkages (over time)

This is the “money makes milk” process (or “Less money makes less milk”) What happens with the MPP?

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Milk Price Feed Costs MPP Margin Value Farm Profitability Cows Milk Per Cow Milk Production

• +

+

• +

+ + +

• MPP margin value

depends on milk price and feed costs

Milk Price Feed Costs MPP Margin Value Farm Profitability Cows Milk Per Cow Milk Production

• +

+

• +

+ + + Expected Margin at Sign-Up +

• MPP margin value

influences of expected margins during coming year

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Milk Price Feed Costs MPP Margin Value Proportion of Milk Protected Margin Protected Farm Profitability Cows Milk Per Cow Milk Production

• +

+

• +

+ + + Expected Margin at Sign-Up +

• MPP margin

expectations influence participation decisions

Milk Price Feed Costs MPP Margin Value Proportion of Milk Protected Margin Protected Farm Profitability Cows Milk Per Cow Milk Production

• +

+

• MPP Indemnity

Payments + + + + + + + + Expected Margin at Sign-Up +

• MPP participation and margins

determine payments But payments influence profitability Profitability influences milk production Milk production influences milk prices Milk prices influence MPP margin MPP margin expectations influence participation

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MPP Possibility #1

One possible outcome:

• If the margin never gets below $8, then the

program will never operate

• No impacts of MPP
• Congress is brilliant (#1)

– Program cost taxpayers nothing – “Supported” dairy farmers

MPP Possibility #2

Another possible outcome:

• Margins get below $8 during 2014-2018
• Then, what happens?

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Milk Price Feed Costs MPP Margin Value Proportion of Milk Protected Margin Protected Farm Profitability Cows Milk Per Cow Milk Production

• +

+

• MPP Indemnity

Payments + + + + + + + + Expected Margin at Sign-Up +

• MPP participation and margins

determine payments Payments make farms more profitable than they would have been without MPP More profitability means more milk than would have been without MPP More milk means lower prices than would have been without MPP Margin < $8 MPP margin expectations influence participation Lower milk prices mean lower margin than would have been without MPP

MPP Possibility #2

Another possible outcome:

• Margins get below $8 during 2014-2018
• Program design leads to less adjustment
• f milk supplies in periods of low margins
• Low(er) prices and margins may persist

due to less adjustment

• MPP could reduce average prices and

margins during 2014-2018

• How likely is a margin < $8 in the future?

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History of the MPP Margin, 1997-2013

2 4 6 8 10 12 14 16 1997 1999 2001 2003 2005 2007 2009 2011 2013 $ per cwt Averaged $8.50/cwt since 1997, but only $7.11/cwt since 2008 < $8 the majority of months since 2008.

Margin Will Be Influenced by the MPP

• The past may not be a reliable guide

because the MPP did not exist

– Did not influence what the margin was

• But we would expect that the MPP would

affect margins if the program is active

• Need to account for this in a forward-

looking analysis

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Simulation Model Analysis

• Uses our system dynamics model of the

U.S. supply chain, which includes:

• All main dairy products categories
• All principal dairy policy instruments
• U.S. dairy product trade
• Dynamic response of milk supplies to

profitability

– 4 farm size categories, CA and Rest of U.S.

Simulation Model Analysis

• Compares “Baseline” with previous

policies to outcomes with MPP

• For various possible scenarios

– Milk production – Feed prices

• MPP analysis assumes high level of

participation in MPP due to subsidized premiums

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Simulation Model Analysis

• Assumed that farmers will base decisions
• n expected margins for the next 12

months

• Decision at the beginning of each calendar

year

• Program implemented in January 2015

Simulation Model Analysis

Assumed (simple) participation decision rules:

• If expected margin > $8.00, protect 90%

milk at $4.00

• If expected margin <$4.00, protect 90%

milk at $8.00

• If expected margin between $4.00 and

$8.00, protect 75% milk at $6.50 (a ‘sweet spot’ on the premium schedule)

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Simulated Baseline Values, 2015-2018

0.00 5.00 10.00 15.00 20.00 25.00 $/cwt

All Milk Feed Cost MPP Margin

Feed cost is exogenous, assumed based on 2013-2014 futures prices

The Baseline Indicates

• Low price period projected in 2016
• Low margin period projected in 2016

– This puts us into possibility #2 from above – Margin < $8/cwt – Program could become active (depending on producer decisions)

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Why Consider This Baseline?

• Dynamic model has been evaluated based
• n a common process for dynamic models
• The amplitude and magnitude of price

movements are consistent with those

• bserved during 2000-2014

– Price cycles (Nicholson and Stephenson, 2014) – (If cycles are different going forward, then all bets are off)

Model Versus Actual MPP Margin, 2012-2013

0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00

Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13

Margin, $/cwt MPP Model Model tended to over-predict margin, 26% MAPE during 2012-2013.

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Impacts of MPP Compared to Baseline

• Reduced margin by $0.96/cwt
• Reduced average all milk price by $0.96/

cwt

• Reduced Net Farm Operating Income

(NFOI) for all farms

– Even including indemnity payments

• Much great price stability
• Fewer months with NFOI < 0
• Government expenditures nearly $4 billion

Simulated All-milk Price, 2015-2018

11.00 13.00 15.00 17.00 19.00 21.00 $/cwt

Baseline MPP Average milk price decreases $0.96/cwt, greater price stability

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Simulated MPP Margin, 2015-2018

0.00 2.00 4.00 6.00 8.00 10.00 12.00 $/cwt

Baseline MPP Average MPP decreases $0.96/cwt, margin < $8 most of time

Simulated NFOI, Medium-size Farm (230 Cows), 2015-2018

• 10,000
• 5,000

5,000 10,000 15,000 20,000 $/month

Baseline MPP MPP reduces average NFOI for medium-size farm by about $21,000/year, minimizes months with NFOI < 0 $2,882/month average payment during 2015-2018

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Simulated NFOI, Medium-size Farm, 2015-2018

• 10,000
• 5,000

5,000 10,000 15,000 20,000 $/month

Baseline MPP MPP reduces average NFOI for medium-size farm by about $21,000/year, minimizes months with NFOI < 0 NFOI increased by indemnity payments NFOI lower due to lower milk prices

Simulated Cumulative NFOI, All Farms, 2015-2018

5 10 15 20 $ billion

Baseline MPP MPP reduces cumulative NFOI for all U.S. dairy farms by about $4.9 billion $4.9 billion

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Simulated Indemnity Payments Net of Premiums, 2015-2018

• 100

100 200 300 400 500 $ million

Baseline MPP MPP indemnity payments occur in 2016, large compared to MILC payments

Simulated Cumulative Gov’t Expenditures, 2015-2018

1 2 3 4 5 $ billion

Baseline MPP MPP indemnity payments net of premiums total $3.8 billion (MILC $300 million)

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Irony?

• Government spends $4 billion to lower

farm incomes by $5 billion

• The good news:
• Consumers in the U.S. and countries to

which we export would benefit a great deal

• Much more stable prices

Why Congress Is Brilliant

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Why Congress Is Brilliant

• Without the 90% adjustment to the feed

cost for the margin…

• Cost of the program under our price

projections would have been..

• $30 billion over four years

But Nothing is Certain

• Alternative assumptions would change the

impacts of MPP

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MPP Impacts: an “Empirical Question”

The impacts depend on:

• Assumptions about milk prices and feed

costs

• Assumptions about participation decisions
• The relationships between margins,

participation decisions, indemnity payments, and milk production

Consider a “Best Case” Scenario

• Higher milk prices

– 24-month reduction in MPC used to simulate this – Beginning May 2015

• Lower feed costs

– 25% reduction in our feed cost projection – Beginning May 2015

• Compare a new Baseline to MPP

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Simulated All-milk Price, Best Case, 2015-2018

11.00 13.00 15.00 17.00 19.00 21.00 $/cwt

Baseline Best Case MPP Best Case Baseline MPP MPP has limited impacts on milk prices (+$0.07/cwt on average 2015-2018)

Simulated MPP Margin, Best Case, 2015-2018

0.00 2.00 4.00 6.00 8.00 10.00 12.00 $/cwt

Baseline Best Case MPP Best Case Baseline MPP Lowest margin higher, limited time with < $6.50/cwt

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Simulated NFOI, Medium-size Farm, Best Case, 2015-2018

• 10,000
• 5,000

5,000 10,000 15,000 20,000 $/month

Baseline Best Case MPP Best Case Baseline MPP MPP lowers average NFOI for medium-size farm by about $800/year

Other Best Case Results

• Cumulative NFOI for all farms decreases

$140 million during 2015-2018

– Compared to nearly $5 billion in previous

• Cumulative government expenditures are
• $357 million

– Government earns money from the program

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Stochastic Analysis

• Clearly, milk prices and feed costs matter

for the impact of the program

– More magnitude than direction

• Assessed N=200 scenarios with various

combinations of higher milk prices and higher or lower feed costs

– Look at distribution of outcomes

Distribution of Average All-Milk Prices During 2015-2018

5 10 15 20 25 30 35 40 45 14.50 15.00 15.50 16.00 16.50 17.00 17.50 18.00 18.50 19.00 19.50

Number of simulations

Average Milk Price Range, $/cwt

Baseline MPP

Based on N=200 simulations

MPP narrows price distribution Average -$0.33/cwt

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Distribution of Average MPP Margin, 2015-2018

20 40 60 80 100 120 140 160 180 200 5.50 6.00 6.50 7.00 7.50 8.00 8.50 9.00

Number of simulations

Average MPP Margin, 2015-2018, $/cwt

Baseline MPP

Based on N=200 simulations

MPP makes margin more variable, shifts distribution Average -$0.65/cwt

Distribution of Average Annual NFOI, Medium-size Farm

10 20 30 40 50 60 70 80 90 50,000 60,000 70,000 80,000 90,000

Number of simulations

Average Annual NFOI, Medium-size Farm, 2015-2018, $/year

Baseline MPP

Based on N=200 simulations

MPP shifts distribution

• f NFOI

Average -$13,000/year

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Distribution of Months with NFOI<0, Medium-size Farm

10 20 30 40 50 60 70 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Number of simulations

Months with NFOI<0, Medium-size Farm, 2015-2018, $/year

Baseline MPP

Based on N=200 simulations

MPP shifts distribution

• f months with NFOI < 0

Average 6 fewer months

Distribution of Cumulative NFOI, All Farms, 2015-2018

10 20 30 40 50 60 70 80 90 100 14 15 16 17 18 19 20 21 22 23 24

Number of simulations

Cumulative NFOI for All Farms, 2015-2018, $ billion

Baseline MPP

Based on N=200 simulations

MPP shifts cumulative NFOI distribution Average -$3.3 billion

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Distribution of Cumulative Gov’t Expenditure, 2015-2018

20 40 60 80 100 120 140 160 180 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0

Number of simulations

Cumulative Government Expenditure, 2015-2018, $ billion

Baseline MPP

Based on N=200 simulations

MPP shifts expenditures distribution Average +2.2 billion

Conclusions

During 2015 to 2018, MPP is likely to:

• Reduce milk prices and margins compared

to current programs

• Reduce average NFOI incomes compared

to current programs

– Offsetting effect of more milk production on milk prices, despite payments

• Make prices less variable compared to

current programs

• Be more costly than current programs

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Conclusions

The magnitude of these effects is uncertain, and will depend on many factors, including:

• General trajectory of milk and feed prices

– Influenced by many factors

• Degree of participation by dairy producers

– Likely more varied than assumed in our analysis

The “Nicholson Paradox”

• “Every action to improve the situation will

end up making it worse”

– Attributed to Novakovic and Stephenson