NZX head of derivatives Nick Morris says milk price futures and options trading was up 73% in the first quarter of 2021 compared with the same period last year.
The 6641 lots represented just under 40 million kilograms of milksolids spread across three seasons – the current, 2021-22 and 2022-23.
Last year 18,990 lots traded were 114m kg, equivalent to 6% of New Zealand’s annual milk production.
The last traded price in the current season was $7.64/kg and for next season the price is $7.48.
Farmers seeking to sell futures contracts at $7-plus prices may be wondering who wants to buy at these high levels and whether that demand will last.
Head of dairy for Asia for global financial services provider StoneX Financial Jason Bray says farmers selling NZX milk price contracts is only the first step in a longer chain of market participants, including dairy processors, traders, speculators and end users.
“Buyers of milk price futures have very different and sometimes unique investment objectives,” Bray said.
“One could say that farmers have a single objective in forward fixing a portion of their revenue rather than accept a floating exposure until their processors declare the final milk payout.”
Without disclosing client names, Bray says processors would be the natural buyers of milk price futures as the first step in the physical flow.
Their objective is to effectively fix their number one cost – milk – to allow their salesforce to sell commodity products with a known underlying cost base.
“Without some form of hedging the milk price is essentially floating until the end of the season,” he said.
Commodity traders and end-users are also growing users of milk price and other dairy futures.
“A number have negotiated and secured long-term product supply agreements whose final purchase price is determined by a mechanism that references or benchmarks the milk price, again floating,” he said.
“However, once they have booked a sale with their own customers, they will buy milk price futures to underpin their cost of goods sold, stabilising the sales margin.”
Both of these scenarios are examples of how existing and new NZX market participants are using the tools to de-risk their businesses and insulate operations from adverse effects of commodity price volatility.
Bray also says speculators are valued market participants who add liquidity to futures markets.
Generally speaking, they take a directional view of the market after using models, forecasts and assumptions that will determine whether a financial product is undervalued or overvalued and trade accordingly.
Different perceptions of value amongst derivative market participants present opportunities to transact hedge positions that may not have been available with speculative interest.
Bray says two major features of futures markets like the NZX dairy derivatives are price transparency representing the underlying physical market, which tends to be more opaque, and the transfer/exchange of risk by marketplace participants.
Any day of the working week a farmer can view where the futures market participants are anticipating Fonterra’s milk price to be for not only the current, but seasons in advance.
He says dairy derivatives have a long way to grow yet.
In the United States it would be unusual to find a large dairy operation who was not at least aware of commodity derivatives and futures.
In Europe a number of large processors offer forward contracting programs to their milk suppliers as ways of forward fixing milk prices.
Jarden head of derivatives Mike McIntyre says more dairy farmers were adopting risk management of their milk revenue by using futures contracts.
Larger, generally well-resourced farms were the first adopters followed by sophisticated smaller operators.
While banks were not requiring farmers to use futures, budgets prepared with some portion of milk production locked in must be regarded favourably by financiers.
Right now, most activity in milk futures is in the September 2022 contract period, with some interest in the 2023 option.
McIntyre says farmers need not fear a lack of contract buyers at higher prices.
“If I am a multinational chocolate maker and my supermarkets want a supply price for next year, I need to lock in milk powder at US$4000/tonne and get on with making chocolate,” McIntyre said.
“The powder processor in NZ might then lock in milk prices with futures contracts.”
