To compete with the best, Ireland needs to milk the tools that are available
Bankers will be worried about the wide fluctuations since 2007 in milk prices paid to Irish farmers, with peaks in 2007 and 2011, but a severe slump in 2009.
Milk prices had been stable for 10 years, but that changed in the past decade, and there has been increased volatility in prices of fertiliser and dairy rations, too.
The result was highly volatile incomes for dairy farmers, with the National Farm Survey compiled by Teagasc showing incomes in 2009 substantially lower than for any other year since 1997, and record incomes in 2011.
How is this a problem? In the good years don’t you make up for what you lose in the bad, whether you milk cows, make butter or cheese, or use dairy ingredients in a foodstuff.
Some farmers or traders may be happy to take these risks, but most are not.
A mechanism to guarantee a minimum price level would be welcome to all parties in these transactions, and would guarantee investments in the dairy industry.
On the marketing side, dairy processors are in competition with other food ingredient suppliers. A multinational preparing the recipe for a new product has a choice between a dairy fat and another fat for inclusion. They would not wish to change the recipe (and all their promotional literature) as market prices change, and may prefer the ingredient which suppliers are able to offer a fixed price for a defined period ahead. In that case, vegetable fat suppliers can win out over dairy fat suppliers.
The wide fluctuations in milk prices and consequent risks in recent times (which are likely to increase) were the focus of a seminar in Cork Institute of Technology (CIT), sponsored by Teagasc and ICOS, where there was a very fruitful discussion between experts, co-op board members, and dairy industry management.
Convincing data was provided that, with expected changes in policy, milk prices were likely to continue to fluctuate widely.
All parties in the chain appeared to have an interest in reducing their risk. The good news was that the means to share this risk are being developed.
“Normal” volatility is desirable. It reflects changes in supply, demand and policy, and provides price signals to facilitate efficient reallocation of resources. Extreme volatility is undesirable, with many negative consequences.
Volatile prices are unstable, hard to predict, and may not leave a profit, when they are low.
At CIT, Professor Andrew Novakovic, from Cornell University in the US, spoke about the experience in the US of dairy price volatility. The US had a system of price support similar to the EU’s intervention system, up to 1989, when it was substantially abolished. Milk prices have become much more volatile since 1990, and particularly since 1996, when trade became more open. Since 2000, there has been a trend towards higher US milk prices — but with much greater month-to-month and year-to-year variation.
Prof Novakovic said milk price volatility isn’t new, but was previously more predictable. Input prices are also volatile, and there is no sign that this is likely to change with economic instability and climate issues.
A range of risk management tools are available for US dairy farmers.
The anti-volatility tools on offer to the dairy industry in the US — and in New Zealand — are becoming of increasing interest in Europe, and particularly in Ireland, as EU policy moves further away from price supports and international trade expands.
Hedging (making an investment to offset potential losses or gains) is more popular in the grain business than in milk.
A government-based margin insurance scheme is viewed as too complex. Forward contracting with the milk buyer, where the buyer effectively takes on the risk and protects itself by buying “futures”, is popular, but still accounts for a minority of sales. Two types of contracts are on offer: A fixed price contract and a floor price contract. The latter effectively provides a minimum price, but allows the producer to benefit from the high prices when they occur.
How far are we from these mechanisms in Ireland? Not as far as you might think.
Glanbia already has a fixed price contract over three years with 40% of their farmers, involving 20% of these individual farmers’ milk. This price is adjusted as the price of farm inputs changes.
Dairygold Co-op has a scheme with their suppliers to provide a longer term milk price guarantee (for product going to Danone). Connacht Gold also have a fixed price contract, which was described by IFA sources at CIT as “innovative” . The positive reaction to these initiatives is an indication that the wide fluctuations in milk prices are not acceptable to farmers, and that they welcome change.
The schemes introduced so far imply that the risk is being absorbed by the processor. They can hedge these risks.
Another speaker at the seminar was Liam Fenton, the son of a Limerick dairy farmer (who claims to still milk cows on the family farm), who now heads up the European arm of US risk management company FCStone, based in Dublin. This company has been involved in risk management issues in the US dairy sector for 20 years. He described a product operated by his company in the US, which gives a close approximation to the average milk price over an 11-year period (reducing variation to less than 7c per hundredweight, in a price averaging nearly $14).
The development of tools like this in Europe is slow, partly because there is a lack of trusted data, and partly from suspicion of the new — therefore requiring education of the participants.
With the aid of these tools, processors can make longer term contracts with customers, are protected from the time lag between milk purchase and product sale, and may gain new custom. They allow farmers to sleep better at night.
With the projected growth in milk supply in Ireland, and the risks involved, Ireland should be at the forefront in the use of these tools in Europe.
But is this gambling rather than legitimate business?
Maybe, yes.
The gamble has gone wrong this year for many of the Irish farmers who forward-sold grain before the harvest. Due to severe harvesting difficulties, negotiations are ongoing with grain assemblers and end users to work out a formula to use for the forward-sold grain.
However, if tools such as fixed price contracts become widely available, it could be argued that those who stick with the ups and downs will be the real gamblers.
