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Is a Hedge Loan a Good Idea for Your Operation?

Lori Fetzer
Educational Opportunities: 
Dairy, Young, Beginning Farmers, Women in Ag
Home > Education & Events > May 2016 > Is a Hedge Loan a Good Idea for Your Operation?

Dairy producers who want to raise their game in the area of risk management may want to consider making a request to their lender for a hedge loan. A hedge line of credit is a loan used to finance hedging transactions which will generally be in the form of futures or options contracts.  It’s critical that the financing for these transactions be based upon a “true hedge” whereby the dairy farmer is taking futures positions on milk yet to be produced and maintaining that position until the sale of the hedged milk occurs, at which time the financing is repaid.

Speculative transactions are not eligible to be funded by a hedge revolving line of credit, or RLOC.  By agreeing to an RLOC Hedging Loan, your lender has established a commitment to fund margin requests associated with agreed upon milk contracts, recognizing that margin requirements are offset by corresponding gain in the value of the contract.

A key reason for developing a hedging program for your operation is to manage market volatility.   If you are exploring the option of a hedge loan and want to learn more about whether or not it’s right for you, your lender is a great resource. There are a few best practices to keep in mind when discussing the need for a hedge loan with your lender.
  1. The first is the development of a written marking plan and knowing your break-even analysis. This will give your lender confidence that you understand your costs and you have developed a policy that will lead to a successful hedging program. 
  2. Utilizing the services of a reliable marketing consultant who can provide advice and help develop hedging strategies specifically for your dairy operation is a highly recommended practice. 
  3. Using a margin approach is generally the best approach when hedging milk production.  Non feed costs are typically quite stable on a dairy operation, however, feed can and does fluctuate. In order to reduce these fluctuations generally feed should be priced at the same interval that milk prices are. For example, if milk is marketed for the Jan – June then purchased feed costs should also be priced for this same time period. This will generally allow a producer to capture a true profit margin.
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A great benefit of having a hedge RLOC is that margin calls and marketing expenses do not deplete cash reserves or fill up operating loans. This in turn helps maintain the operation’s working capital position, which may give the dairy producer more reason to manage risk. In summary; develop a marketing plan, know your break-even cost, hire a qualified advisor and use a margin management approach to reduce the risk and manage price volatility in your dairy operation.
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