Some farmers with up to 90% of milk tied into fixed-price contracts

"On the basis of what we know now, it was unwise to become so heavily exposed by fixing a milk price while not having some security around inputs."

Successive Governments have "neglected" to protect Irish family farms from the worst extremes of income volatility, according to the Irish Co-Operative Organisation Society (ICOS).

Representatives of ICOS attended a recent Oireachtas meeting, at which they called for the introduction of an income stabilisation measure in policy to enable dairy farmers to use periods when market returns are higher to create a modest rainy-day fund to support them when market returns are weaker, or cost of production increases greatly.

In the past 12 months, ICOS said, returns for dairy products and ingredients have increased significantly and co-ops have, in turn, increased the farmgate milk price by over 40% year-on-year.

“However, the milk processor/co-op does not benefit from the rise in product prices for contracted volumes of milk under back-to-back or fixed contracts and cannot pass the return back to farmers with volumes of milk locked-in to fixed contracts,” ICOS said in its recent submission to the Oireachtas joint committee on agriculture, food and the marine.

Dairygold’s John O’Gorman, who is also the ICOS dairy committee chairman, told the meeting that co-ops “fully understand and empathise” with suppliers who have a high percentage of their annual milk supply in fixed milk price contracts.

“We are in an unprecedented situation in terms of the significant input price inflation which has taken place,” Mr O’Gorman said.

We must acknowledge that the events in recent months have been unprecedented, caused initially by Covid and supply chain disruptions and so forth, and exacerbated by the unfortunate war in Ukraine.”

Mr O’Gorman said that ICOS only in recent times came to understand that there are milk suppliers who “have significantly more than 20% to 30%” of their milk supply tied into contracts.

“We have some member co-ops who have milk suppliers far in excess of that range and some milk suppliers approaching maybe 90% of their milk tied into milk supply contracts,” he continued.

“On the basis of what we know now I suppose, it was unwise to become so heavily exposed by fixing a milk price while not having some security around inputs.” He added that the options to remedy the situation for these farmers are “limited, I’m afraid”.

“They involve appealing to the buyers, in other words, our customers, as fixed milk price contract holders are back-to-back contracts whereby a volume of milk is matched to a volume of product. We understand these conversations have taken place with only very limited success,” Mr O’Gorman said.

“From our position, the integrity of the contract is very important in principle, and we have to protect our reputation as a reputable trading partner. The only other option is for the wider milk pool to carry the cost.

“It should be pointed out that co-ops also are losing significantly in this as the cost of processing milk has increased massively, and the processing margin has also been eroded due to the high costs around energy and so forth. Co-ops, however, have been as creative as possible to help farmers.”

Banks responsible, in part

ICOS said in its submission that fixed milk price contracts were welcomed by all stakeholders, and “promoted very strongly by financial institutions because they enabled greater security in relation to lending, thus facilitating greater access to finance for farmers, especially new entrants taking on large levels of debt”.

ICOS has called on the Oireachtas joint committee to engage, as part of its review of these contracts, with the main banks to “establish what assistance can be provided to farmers overly-exposed to the substantial rise in the cost of production”.

“The banks must bear significant responsibility as they are in part accountable for encouraging certain suppliers to go down this route of tying in large volumes of milk into fixed-price contracts to minimise or de-risk the farm investment,” Mr O’Gorman told the committee.

He said that there need to be new options built into the fixed milk price scheme to deal with the risk of inflation, “such as a financial transaction through the futures markets for feed, fertiliser and energy”.

“This would allow farmers to lock in their input costs as well as their output prices, thereby securing a margin. We have a very good example of this in the US,” he added.

ICOS CEO TJ Flanagan told the committee that “there’s a difference in the number of people who have fixed-price contracts and the people who have problems with their contracts”.

“There could be 2,000 that have all sorts of volumes tied up, but in terms of those who have 'problem volumes', it is certainly less than 1,000,” Mr Flanagan said. “The total volume of milk in fixed-price contracts is certainly well under a billion litres. 

"Our understanding from talking to people is it’s somewhere between 450 and 700 million litres. While everyone who has one is saying ‘I’d be better off if I didn’t’, the vast majority is in smaller contracts, moderate proportions of their milk.”

"A new market dynamic”

Fixed milk price contracts are voluntary, for durations typically of up to three years but some as long as five years, ICOS noted in its submission to the Oireachtas. These are agreed contracts, which cannot be renegotiated, the organisation said.

The purpose of these contracts is to provide milk suppliers with the opportunity to de-risk a portion of their milk supply. However, as inflation has soared those who signed up have been left behind.

ICOS said that individual co-ops are “taking mitigation measures depending on the level of exposure across their catchment area and are assessing the matter on an individual supplier level”.

Earlier iterations of fixed milk price contracts contained an inflation adjustment mechanism but following feedback from milk suppliers, it was removed.

ICOS said it “strongly believes” there is still a place for these contracts as part of an overall suite of volatility supports tool, but that “it is obvious we are operating in a new market dynamic”.

“ICOS believes it is worth evaluating the benefits of introducing a cap and collar mechanism into future versions of fixed milk price contracts,” it said in its submission. “However, we recognise that such proposals will not resolve the matter for farmers with significant volumes of milk in contracts.”

ICOS appealed to the Oireachtas committee to prioritise the establishment of an income stabilisation measure to manage volatility, along the lines of the ICOS 555 proposal, which would allow farmers to defer a small proportion of their income in a good year and draw it down in a bad one.

“If we had more options, farmers could deploy a range of measures to reduce volatility than just to rely on one single measure, the fixed milk price scheme, which was all that was available to them and was introduced by co-ops in good faith and has served the industry well until recent unprecedented events,” Mr O’Gorman told the meeting.

In its submission to the Oireachtas, ICOS said that successive Governments “have failed to act and neglected” to support Irish farms from the “worst extremes” of income volatility.

The ICOS representatives said they will continue to advocate for the delivery of an income stabilisation measure “in line with the commitment in the programme for government to consider further taxation measures to manage evolving issues such as market volatility and the similar recommendation contained in the Food Vision 2030 report”.