ASB senior rural economist Nathan Penny said one of the biggest lessons from the recent dairy downturn was the vulnerability of dairy farmers to massive price swings.
“In contrast to the widely held belief, New Zealand can do something about farmgate milk price volatility,” he said in a paper called Lessons from the Dairy Downturn, part 2.
The season-long milk pricing and payment system sometimes gave farmers signals that were out of whack with market prices.
Therefore, NZ milk supply could and did under- and overshoot relative to market demand, amplifying price volatility.
Penny suggested quarterly payments would help align NZ supply with global market prices more quickly.
It should make forecasting easier for Fonterra and reduce the risk of overpayment, enabling higher monthly advances and shorter retrospective periods.
Penny thought Fonterra could advance 80% of the forecast, rather than starting about 65% as it did now.
A Fonterra spokesman said the existing method of forecast and payment was in the best interest of farmers and reflected the way they operated and planned onfarm.
Stability and certainty in budgets came from forecasting through to the end of a season.
The annual structure was crucial to Fonterra’s ability to operate at scale and as a global co-operative.
Furthermore, it wasn’t optional but a requirement under the Dairy Industry Restructuring Act (DIRA), including quarterly updates.
“The current system also enables us to make adjustments to advance rate schedules to help farmers when cashflow is needed most.
“It ensures farmers’ payments are higher when they most need the capital, typically in the lead-up to the peak of the season and more predictable over the season as a whole.
“All farmers have access to independent price risk management tools such as those hosted on the NZX website, which they can choose to use to help manage volatility of milk prices,” Fonterra said.
MyFarm chief executive and dairy farmer Andrew Watters agreed with Penny’s proposition to enable the right signals in autumn, when farmers had leeway to manipulate production and costs.
“Many times farmers have milked on to take advantage of a high milk price when in fact spot prices have been crashing.
“The extra milk produced then exacerbated the size of next season’s milk price fall.”
Federated Farmers dairy section chairman Andrew Hoggard said there were both pluses and minuses in more frequent milk payment settlements.
The ability of farmers to respond in different ways during the season to changing price signals was limited but he agreed perverse behaviour did show up in autumn.
Fonterra farmers already had ways of locking in milk prices to avoid volatility, former Treasury economist and dairy industry commentator Peter Fraser said.
The complexity of Fonterra’s price-setting, the hypothetical competitor and the system now enshrined in the DIRA was “farmers doing it to themselves”.
Changing the payment periods would not change the price outcome, Fraser argued.
“All that would do is change the risk profile – who is holding the risk and for how long.”
Problems in Australia recently showed Fonterra’s vulnerability as number two processor, obligated to match Murray Goulburn’s milk price.
In NZ, Fonterra was the market leader and if it set the milk price too high all other companies were exposed to what Fraser called vertical foreclosure, a type of anti-competitive market behaviour.
Australian critics of both MG and Fonterra hoped publicity, law suits and regulatory investigations would result in an improved milk payment system, giving farmers more certainty.
But the fundamental differences between the Australian and NZ payment systems came down to supply commitment and share structure, Hoggard said.
“If Australian farmers want the benefits they perceive we get in NZ then they have to pay the price associated with that – buying shares.”
To run the market share value system Fonterra had to have farmgate milk price transparency that reflected global dairy prices.
Those price signals did not get through to Australian dairy farmers until late in the 2016 season, resulting in a clawback that was still generating controversy.
Penny said the Australian problems arose from a deliberately bold price set by MG, whereas his thesis was prompted by Fonterra NZ’s deliberately conservative forecasting and advance system.
“A change to more-frequently settled payments may not do much for larger dairy farmers but it could help small to medium farmers that were close to going out of business in the last downturn.”
Shorter futures contract periods should also enable more farmers to participate because reduced milk price volatility would cut down exposure to margin calls, Penny said.
Dairy industry analyst Geoff Taylor, who devised share and milk price schemes in the past, said Fonterra farmers were offered fixed-price contracts but didn’t take them up enthusiastically.
Yet the Open Country Dairy four-month payment system seemed well received by its farmers.
Using the futures market to fix milk prices was complicated for farmers.
In the United States banks offered farmer-friendly options based on the futures markets but here the reputational damage done by the interest rate swaps appeared to deter banks.
“It seems a contradiction that Fonterra fixes the currency value but doesn’t offer fixed milk prices on behalf of farmers.
“When milk powder prices fall the NZ dollar should fall but Fonterra has hedged, which doesn’t help the milk price for farmers.”
In principle Penny’s proposition was worth supporting, Taylor said.
