Ireland could create EU model for dairy risk management

Ireland is ideally placed to develop Europe’s first dairy sector futures and options index, creating a model for EU-wide adoption, agri-food industry leaders have claimed.

Ireland could create EU model for dairy risk management

Speaking at the IFA-hosted ‘Making Risk Management Work for Farmers’ seminar in Co Laois, representatives of Ornua, ICOS, Department of Agriculture and financial brokerage FCStone agreed that an index would be vital platform upon which to build an Irish commodity price hedging industry.

Seminar attendees heard how US farmers manage price volatility by taking fixed prices for 20% or more of their annual milk output.

Either individually or via their co-ops, the US farmers take “Class II milk future quotes”, fixed prices for future milk output set by the Chicago Mercantile Exchange.

“The Irish dairy sector must decide for itself how much appetite there is for risk management mechanisms,” said Brendan Gleeson, assistant secretary Department of Agriculture.

“These are commercial decisions which the industry has to decide for itself. Establishing an index to have a properly functioning futures market would be an important first step.”

IFA dairy chairman, Sean O’Leary, said Irish farmers had gained some experience of hedging in recent years.

He cited fixed price contracts offered by Glanbia and subsequently other co-ops, aided by Ornua, contracts which allow some farmers to receive in excess of 30c/l for some of their milk.

“These contracts helped farmers understand the concept of hedging — foregoing the highest prices, but avoiding the lowest,” said Mr O’Leary.

“But fixed price contracts are difficult to deliver depending on market prices. They must not be the only option available from industry: Other forms of hedging or margin insurance instruments need to be developed, by industry and in conjunction with government and the EU.”

The conference began with analysis by ex-UCC economist Michael Keane of market changes which meant that volatility would remain a long-term factor for the dairy sector.

John Lancaster, a senior analyst with broker FC Stone, delivered a similar reading of future volatility in input costs including feed, fertiliser and energy.

Charlie Hyland, senior risk manager with FC Stone, said: “With a futures market, you might decide to lock in, say, 10% of your milk output at a fixed price. You can sit here today and know what price you can lock in for your March 2017 milk.

“It is a fixed price contract with which you have the ability to insure against risk. In the US, many more farmers are now doing this. Some farmers are hedging for themselves, others are doing it through their co-ops. In my view, if you have no contract, then you have no control.”

Mr Hyland said co-ops needed to pass on the risks for their fixed price contracts, which is where brokers like FC Stone come in.

Quizzed by an attendee on the cost of providing this insurance, Mr Hyland translated this into an effective cost of 0.05c per litre for milk. The costs for hedging on inputs followed a similar model.

Mr Hyland noted that anyone who hedged their milk at the outset of the Russian import ban could have locked in at 31cpl for future milk. The farmer would have seen a gain of 8-9c/l, with the hedging prices having slid downwards ever since.

However, all of the invited experts repeatedly noted that hedging was not a question of “beating the market”. Instead, the mind-set required for hedging is to focus on the ability it gives to forward plan a business.

Wisconsin dairy farmer Joe Thome explained how 18 years of price hedging have helped him build his family farm from 400 cattle to 1,300 cattle, with huge increases in cattle weights and significantly improved profits.

His farm, Redtail Ridge Dairy in Wisconsin, has 16 well-paid workers, many of them with him for 10 years or more.

“It is not about beating the market, it is about stability in your business,” said Mr Thome.

“John F Kennedy said you are a fool if you think you are going to sell at the top price all of the time. When I’m ahead on price, it’s great. In times when I’m losing by hedging, some people tell me I’m a fool to be doing it. Over time, it has worked out even for me.”

FC Stone’s study of 10-year figures for milk price hedging in US markets showed virtual parity on the effective incomes of farmers who took the hedging route and those who did not.

“If there is an appetite for this, you should have the processors, the distributors and the farmers come together and make it happen,” said Mr Thome. “All I can say is that it worked for me.”

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