Singh is part of Fonterra’s commodity risk and trading team and had worked on the now-axed guaranteed milk price scheme.
She was awarded a Nuffield scholarship for 2015 and has just completed her report, but points out her views are definitely her own rather than the co-operative’s.
Her study tour took her to the United States and Europe – both significant dairy producers and NZ’s main rivals in global markets.
There she found farmers had a wide range of price risk management tools offered by dairy companies, banks, derivatives markets such as futures markets, dairy co-operatives and governments.
In contrast NZ dairy farmers have few, if any, tools available to them to manage price risk, yet they are more exposed to global dairy prices than farmers in the US or Europe where, along with the wide range of those tools at their disposal, they also have large domestic markets.
“We are like a little boat in a big ocean with no safety equipment. In that same ocean there are big ships creating waves of volatility with their (fluctuating) supply and demand. They have all the latest safety equipment yet they don’t even need it all,” Singh said.
Singh quoted International Farm Comparison Network managing director Torsten Hemme when he said, “Risk itself is not really the problem but not knowing your risk profile and not having a risk management strategy can become a problem.”
It’s why she’s sent out a call to action.
More tools need to be developed and they need to be accessible to all farmers, not just larger-scale farmers.
Farmers needed a choice and range of tools, she said.
The industry needed more education on how to manage risk and it needed support tools so farmers could understand how best to use price risk management options, she said.
Relevant and tailored market information was also needed to help farmers make decisions on which tools to use and what they should be doing with them.
Singh said risks existed to both the revenue and expenditure sides of farming businesses.
Milk price risk has become significant in light of recent global commodity volatility and while NZ is not alone in being exposed to that, Kiwi farmers are the most exposed because 95% of their product is sold on the global market.
But they’re also exposed to risks associated with other forms of income such as stock sales.
Singh found the US was leading the way when it came to price risk management.
Farmers there had both sector and government-backed support schemes such as the government-backed margin protection programme where producers can elect to pay a fee to protect their margin. The fee, like an insurance premium, varies with the level of margin cover they want.
A minimum-maximum forward contract has the potential to smooth out milk price volatility by setting a maximum and minimum milk price, limiting the upside opportunity and downside risk.
US dairy farmers can access a forward pricing programme that essentially sets a forward contracted price.
Financial price risk management tools are also offered and managed by dairy companies including dairy co-operatives.
Dairy Farmers of America (DFA) offers its farmers a fixed price contract similar to Fonterra’s former guaranteed milk price scheme, protecting farmers from downside risk.
DFA also offers a collar-type milk pricing system where both a maximum and minimum milk price are set, limiting the upside opportunity and downside risk.
If the market price sits between those points the market price is paid, otherwise either the maximum or minimum are paid.
Farmers could also access a minimum price contract, Singh said.
In that case farmers paid a fee to have access to a milk price that also included a floor price.
But price risk management can even extend to covering the loss of upside benefit if the farmer has used a maximum or collar-type contract. Upside riders and capped upside riders allow the farmer to pay a fee to achieve that.
Singh said dairy companies and co-operatives offered a big range of tools because one tool wasn’t necessarily going to work for everyone as farmers all had different risk profiles.
Of DFA’s 14,000 suppliers about 1000 accessed its price risk management tools.
Fonterra’s guaranteed milk price drew strong criticism from some shareholders on the grounds they perceived it to be anti-co-operative.
But Singh found no such criticism from dairy farmers in US co-ops.
Futures markets are well established in the US and allow farmers to hedge their milk price by selling and buying futures contracts.
Futures for a range of classes of milk are traded on the Chicago Mercantile Exchange and Chicago Board of Trade (CME) with farmers, dairy companies and buyers of milk using futures as a way to manage milk price volatility.
Singh said the main challenges to futures markets, as perceived by farmers, were basis risk and margin calls and account management.
Basis risk relates to the price difference between what the farmer is trying to hedge and the price of the futures product being used in the hedge.
For instance in the US a farmer might sell Class III milk futures to protect against price changes for their milk but they’re paid a milk price that’s set by their own processor.
The difference between the Class III milk price and the price their processor pays is known as the basis.
Margin calls and margin account management can create problems for farmers using futures.
Brokers who manage the hedge require a margin account to be set up as an insurance against defaulting on any loss.
An initial margin is the initial deposit the broker requires. Each day the futures contract is evaluated by the broker with the profit or loss settled each day out of the margin account.
If the market is moving against the farmer’s position and the margin account balance falls below a set value the broker can require the farmer to deposit additional funds to that account, thereby making a margin call.
Banks might not fund these margin calls, creating risk or further financial pressure on farmers.
Singh said a range of online tools also existed for farmers to do complex cashflow budgeting and produce profit and loss statements based on “what-if” scenarios.
They allowed them to stress-test different situations and calculate their profit margins based on various milk and input costs.
That way they could quickly see the effect of locking in a feed price or milk price.
European farmers didn’t have as many advanced tools as US dairy farmers but what they had was well ahead of what was available in NZ.
European farmers were new to price volatility but since the lifting of production quotas more processors had begun offering fixed forward contracts, Singh said.
Futures markets also exist.
Co-operatives and processors can have support schemes whereby they put money away and pay some of it out in a low payout season to support farmers.
Government support also still exists in the form of the single farm payment and intervention for butter and skim milk powder markets.
In NZ the milk price has fluctuated significantly between and within seasons.
On top of that, the increasing level of farm debt and rising costs meant farmers were struggling to farm through volatility.
Her advice to farmers was to have a price risk management plan.
“Understand the milk price and its drivers. Know your finances and what price risk means to you and the impact to your business.”
There was no single solution, and a combination of practices that suited the individual and the farm business were needed, she said.
Doing nothing wasn’t really an option.
“If you don’t manage risk, you are assuming it,” she said.
