Analysis: Dairy farm income stability tools

An 89-page report titled: ‘An evaluation of suitable tools to manage price/income volatility at dairy farm level in Ireland’ was launched by Teagasc last month.

The report is the work of Teagasc economists Jason Loughrey; Trevor Donnellan; and Fiona Thorne; as well as Thia Hennessy from University College Cork; and Declan O’Connor from Cork Institute of Technology.

It acknowledges that, although some price volatility is desirable to convey signals of market developments to producers, extreme volatility – as the Irish dairy industry has experienced in recent years – negatively impacts the development of the agri-food sector.

The report claims that volatility impacts the sector by curtailing investment, research and development as well as disrupting normal trade patterns.

A survey of Irish dairy farmers revealed that farmers believe market risk and volatility in prices is the greatest risk facing their farms.

The report focuses on five income support tools which are:
  • CAP support payment;
  • Forward contracts for milk;
  • The income averaging scheme;
  • 5-5-5 income stability tool;
  • Dairy Margin Insurance.

CAP support payment

The Common Agricultural Policy (CAP) is currently recognised as a useful buffer against dairy-market price volatility. However, the recent communication on the future of the CAP suggests that there may be a reduced budget available for the traditional Pillar I farm payments.

Furthermore, as dairy farmers increase milk production, the relative share of direct payments to overall farm income declines, rendering the CAP as a buffer to be less effective.

Forward contracts for milk

According to data from 2016, it appears that Irish dairy farmers would have been better off by over 1c/L if they had opted to forward contract 20% of their milk produced.

The report outlines that farmers must be aware that the overall objective of fixed milk price schemes is to reduce income volatility rather than to ‘beat the market’.

According to the report: ‘Forward contracting of milk is useful because milk price received will likely over and underperform the spot price from year-to-year.

The income averaging scheme

The report suggests that this scheme is of somewhat ‘limited usefulness’.

It suggests this because participating farms are vulnerable in a situation where farm income in a particular year falls well below the preceding four years.

As well as this, eligibility rules relating to off-farm employment of the spouse are restrictive and mean that many dairy farms are automatically excluded from participation.

5-5-5 Income stability tool

The 5-5-5 tool involves implementing a five year income averaging system, with a 5% deferral of annual milk receipts and a five year allowance for the funds set aside to be drawn down.

It is suggested in the report that the proposed 5-5-5 tool has the potential to significantly reduce the volatility of after-tax household disposable income and support farm investment, without greatly affecting the overall tax contribution.

If managed the right way, the proposed tool looks promising but, the report also outlined that farmers should seek advice from a financial professional before implementing any of the tools.

The report also outlined that a combination of the 5-5-5 tool and other risk management tools, such as forward contracting, can provide adequate protection for farmers in helping to manage income volatility risks.

Dairy Margin Insurance

This option is not currently available in Ireland and, according to the researchers, will not be available for the foreseeable future.

It was outlined in the report that, judging from US experience, this system has been relatively unsuccessful to date as a result of a low-level of farmer uptake.

It was also noted that insurance such as this could be costly in Ireland.

According to the research, public support to cover at least a part of the farmer’s premium payment would also be needed to attract the private insurance industry to back this system; therefore, the research found it would not be as feasible as some of the other tools.