Singh has studied the vulnerability of New Zealand farmers to an increasingly complex and volatile global dairy commodity sector.
She outlined their options to smooth their exposure for her Nuffield Scholarship research report, Accepting price volatility or managing for price stability is a choice.
Singh outlined a tool box of varied instruments or Price Risk Management (PRM) now used by United States and, increasingly, European dairy farmers who are regularly using fixed forward prices and flexible hedging tools.
They enable farmers to push the risk further up the processing chain or onto the futures market.
The tools are relatively new for Europe but Singh sees the need for more to be available here, based as much on social as economic necessity.
“Given the financial stress farmers are under, and particularly within the younger generation of farmers, there should be a choice there for options to help smooth their incomes.”
She maintained using PRM tools would ensure farmers could gain greater control over their businesses’ future profitability as farms became more about business outcomes than just lifestyle choices.
Despite leaps in financial literacy by dairy farmers, in part necessitated by tightening financial conditions, the level of risk management understanding had not kept pace.
Her research highlighted the choppy nature of the market that was now the “new normal” for those younger farmers grappling with growing their asset and managing debt levels.
Over the past eight years Fonterra milk prices had varied by plus or minus 25% within each season and by plus or minus 35% between seasons. Opening and final milk prices varied by an average of $2.50/kg MS.
The most extreme examples were the 2014-15 season when milk prices dropped 60% and in 2009-10 when it leapt 33%.
Singh said price volatility was relatively new for NZ farmers, with prices relatively stable before the global financial crisis in 2008.
That coincided with the reduction of market intervention in Europe and the US making prices more transparent. But it also meant prices were more likely to swing based on market pressures.
She pointed to one Rabobank analyst who had since opined any attempt to predict global dairy prices was now “a pure guess”.
Overall, volatility in whole milk powder price fluctuations was 40% over the past decade compared to 22% in oil and 26% in sugar.
Singh’s research was timely given the recent announcement by NZX it would offer milk price futures and options to reduce volatility.
The only other tool available to farmers had been Fonterra’s guaranteed milk price scheme, discontinued last September, something Singh admitted being disappointed about as a key player in its development.
“For it to return, that will be a decision the co-operative and farmers will have to make.
“Given the financial stress farmers are under, and particularly within the younger generation of farmers, there should be a choice there for options to help smooth their incomes.”
“Having had it though does at least mean the conversation on such instruments was started.”
In the course of her study Singh visited six US states, discussing PRMs with brokers, farmers and processors.
US farmers had benefitted from having a government-sponsored Margin Protection Programme that insured against extremely low prices in the market.
However, 8% of farmers were also opting for forward contracts with their co-operatives to provide pricing certainty.
Key reasons for doing so included high debt levels, lack of liquid reserves and above-average production costs.
Tools popular with farmers included forward fixed pricing contracts similar to Fonterra’s GMP, and minimum cash prices.
Minimum cash price options were another tool that locked in milk prices to a minimum “floor” price but did not lock farmers out of the upsides that might develop through the season.
Farmers found using schemes provided by their processors offered longer-tenure contracts, easier payment terms and simplicity.
Futures and options had also been available for 20 years through the Chicago Mercantile Exchange, with trade volumes steadily increasing for the past five years.
Singh admitted she was surprised during her visit to find out processors had been offering their farmers price-fixing tools for more than a decade.
And while European farmers were newer to PRM tools they were catching up fast with similar tools to their US counterparts.
The exception was futures which were hindered by a lack of a transparent market price for milk.
With the removal of quotas, PRM tools were becoming another competitive option processors could offer their farmer suppliers.
Singh said given NZ’s exposure to overseas markets and a clear market price for milk, it was even more well placed to link to a futures market than European farmers.
But she emphasised there was no “silver bullet” solution in the PRM instruments, recommending forward or futures contracts should be used on a portion, not 100%, of milk and incorporated with other traditional strategies like feed contract pricing.
After the impact of poorly understood swaps, she expected Financial Markets Authority restrictions on instruments would be of higher importance.
• MORE: To learn more about NZX milk price futures and options go to www.farmersweekly.co.nz/milk-price-derivatives and read the special feature in the May issue of Dairy Exporter.
