With today's volatile milk and feed markets, having a line of credit specifically devoted to managing your hedging account is a prudent and useful business tool more dairy farmers should consider.
"A key benefit of having a hedge revolving line of credit (RLOC) is that margin calls and marketing expenses do not deplete cash reserves or fill up operating loans," says Greg Steele , vice president, dairy team, for AgStar Financial Services, based in Baldwin, Wis. "This in turn helps maintain the operation's working capital position, which may give the dairy producer more reason to manage risk."
With a RLOC, you and your broker can tap this line of credit when margin calls are made. Settlement back to the account is done when the futures contract expires.
"A hedge line balance should move up and down as hedge notes are placed and removed and as margin calls are made," explains Lori Tiegen, a dairy lending specialist with AgStar. "Typically, your lender will require monthly statements from your broker to verify positions and allow for monthly reconciliation of your transactions. This will also ensure your hedge line is being repaid correctly."
There are a few best practices when establishing a RLOC:
- First, know what your break-even milk price is so you fully understand your costs.
- "Using a [milk/feed] margin approach is generally the best approach when hedging milk production," says Steele. "Non-feed costs are generally stable on a dairy operation, however, feed can and does f luctuate. In order to reduce these f luctuations generally feed should be priced at the same interval that milk prices are. For example, if milk is marketed for January through June, then purchased feed costs should also be priced for this same time period."
- Finally, develop a written marketing plan with your broker. He or she can help you devise specific strategies to meet your risk management needs. It may involve futures, options or other tools to meet you objectives.