Could futures contracts solve the problem of milk price volatility?

Dairy industry leaders this week debated the pros and cons of using futures contracts to solve the problem of milk price volatility at the International Dairy Federation’s World Dairy Summit.

Some claimed it gave farmers more warning of upcoming price changes, while others warned against locking in to a long-term contract.

Muller has been one of the first major processors in the British Isles to offer a futures contract. Producers who sign up to its ‘Direct Futures’ programme are able to tie down up to a quarter of their annual milk supply up to 12 months into a fixed-price contract linked to the UK Milk Futures Equivalent (UKMFE).

But speakers at the World Dairy Summit had mixed views over whether futures contracts were the answer to volatility.

What is futures trading and could it manage milk price volatility?

Futures milk contracts give farmers a forecast of how milk prices will change over the next 12 months. They can then decide whether or not to lock in.

In the first phase of the contract, Muller will offer 35 million litres for a fixed 12-month period. This milk volume will be traded in monthly allocations and will be linked to trading with its ingredients customers.

Farmers can lock in a monthly price and a fixed volume up to 12 months ahead.

Muller ensures a guaranteed supply volume for that period and its ingredients customers have certainty of product supply – allowing all parties to plan more effectively.

Benefits

Sascha Siegel from the European Energy Exchange (EEX) explained some of the advantages of futures contracts in addressing price risk in the EU dairy sector.

He said: “We believe this is an instrument which is needed, because the futures markets have been able to guarantee price programmes – like Muller is doing in the UK for its farmers.

“Of course, this typically works well if you have a good output correlation between butter and SMP (Skim Milk Powder).

“When I started in the industry, not coming from the agricultural world, I was pretty amazed at how risk management had worked over many years.

“At the end of the day, the price risk management meant taking on the price whatever happened – as somebody coming from a commodities world, this is very difficult to imagine – but I could see that for too long the farmer was left with a problem once volatility kicked in.

Very often prices have a sense of ‘do or die’ and farmers say, ‘Yes we love the highs, but we hate the lows’. The reality of it is that if you cannot survive the lows, then you have to do something differently.

“We need better price signals for the dairy industry. We need better price signals of what’s happening now and we need better indicators of what will happen in the future.”

Limitations

However, Gerard Calbrix – from the Association of French Dairy Processors – said there were limitations in how futures contracts could mitigate price risk in the EU.

He said: “The difference between the purchasing price of the input and the selling price of the output determines the margin of the economic operator.

“He sets a price which is set in his contract. During this period he still has a price risk; because if the price of his input increases on the market he will have a problem and that will squeeze his margins.

So the benefit of this tool on the futures market is to lock the price of his inputs at the same time as he locks his price with the customer, so that his margins are safe for the duration of the contract.

“He also has a risk that the SMP price increases while he is locked in at the contract price, so it’s clear that traders are using a lot of these to protect themselves from price increases too.”