Dairy market volatility: Can we hedge our bets to protect Irish farmers?
Co-operatives and the Irish Dairy Board have been developing strategies to deal with market risk over the past number of years, and some of them already have a fair portion of their milk locked into fixed price schemes that take the worst out of the volatility. As well as ensuring a proportion of processors’ revenues, it is also in their producers’ best interests as it bolsters milk price.
ICOS has been working with institutions such as Cork Institute of Technology, the Department of Agriculture, and risk managers like FC Stone to raise awareness of the worst impacts of volatility and to get farmers to a position where they would consider some sort of insurance against low prices.
However, the difficulty over the last couple of years was that farmers weren’t really ready for some form of structure where they would be losing out on the fantastic prices at the time, just to avoid the possibility of a price drop that might never come. The price drop was always going to come, however.
Milk prices of almost 40c per litre, while welcome for Irish farmers’ cash flow and profitability, were probably too high, especially in the context of low global feed prices. At that price, everyone is an efficient milk producer; and they certainly produced to the maximum possible.
World supply grew by 5% last year, against a demand rise of around 2%. The 3% or so oversupply (albeit temporary) is roughly equivalent in volume terms to another New Zealand popping up on the dairy scene. This is a fleeting phenomenon, although it may take most of 2015 for supply and demand to come back into alignment. In the meantime, dairy buyers will sit back and watch supplying countries and their producers suffer.
What can we do about it? In the short term, unfortunately the answer is ‘not much’. We need to see the current low prices slowly curtailing international supply, and maybe hope for an “event” somewhere else around the world, to help turn off the global milk tap.
In the meantime, there is a huge amount of work being done, led by the IDB and others, to develop tools which could make a dairy futures market work for Ireland. Futures markets allow people on both sides of the market, suppliers and end customers, to hedge their own position on financial markets, effectively to insure against prices moving against them.
A producer ensures his milk income by taking a financial position (or “betting”, if you like) against his own interest. In this case, a farmer “bets” on low milk prices. If the milk prices are low, he wins the bet and his winnings compensate him for his loss on his milk. If the milk price is higher than predicted, he loses on the financial trade but is compensated with the high milk price.
The end result is a guaranteed milk income for the portion of the income which he hedges. This model can work very well, and does so in the US. The net cost to farmers who hedge on these markets seems to run at around 0.5% of sales; at least that’s the case when futures markets are up and running.
The problem we have in Europe is that these markets are only in their infancy. There is a huge amount of work to be done, and perhaps a couple of years of dipping the toe in the water, before Irish co-operatives and their members could consider depending on these tools.
T J Flanagan is dairy policy manager of ICOS, the Irish Co-operative Organisation Society.
