Price risk management

for farmers

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Farming is risky! • Weather • Animal/plant health

• Financial

• Assets (fire, theft…)

• Personal/family member health/injury

• Third party accident on your farm

• Risk of extreme volatility • Of milk price

• Of input cost

• Therefore, of income

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• Improve cost efficiency

• Adopt best farming practice

• Diversify

• Avoid overstretching

financially

How to mitigate income risk?

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As the last link in the chain,

what farmers can do to

manage extreme volatility is

limited in the absence of

specific risk management

instruments.

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What to do about price/income

risk?

HEDGING

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Hedging: A risk management strategy used in limiting or offsetting probability of loss from fluctuations in the prices of commodities, currencies, or securities.

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Why seek to hedge income risk?

To know what is coming and be

able to plan!

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Why seek to hedge income risk? • Extreme income volatility has undesirable consequences on

farms

• Cashflow planning

• Investment

• It also has undesirable consequences at

processing/marketing level

• Investment

• Substitution

• R&D

• Risk management measures count in farmers’ favour when

applying for credit applications from farmers

• Hedging gives you greater visibility and certainty to help you

plan

• Can you afford to take the risk?

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Cost of hedging risk?

• You’re spared the troughs, but you forego the peaks

• International studies suggest you lose out compared to taking

the market price on the day – but not by much

• This is the cost of certainty/predictability for a period

• You have to decide: is it worth it to you?

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Source: Dairy Farmers of America

Example

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A few examples of risk

management mechanisms US Margin Protection Programme for Dairy Producers

• US Govt run insurance scheme Fixed price/margin contracts

• Glanbia, Morrison (UK retailer) for liquid milk supplies (new)

Fonterra Guaranteed Milk Price

• A new fixed price scheme only available this year

Pricing options offered by Dairy Farmers of America

• US co-op scheme

Tax based schemes • New Zealand and Australia

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US Margin Protection Program • New government run scheme (Agricultural Act 2014)

• Dairy farmers (established or new) can opt to lock in margin

over feed costs for 25% to 90% of reference production

• They can choose their mini margin level between US$4/cwt

and US$8/cwt (6 to 14 €cents/litre)

• Default/mini is US$4 for 90% of production, for free except

admin fee (called catastrophic cover level!)

• Cost: $100 flat admin fee, plus payment of premium pro-

rata to cover chosen, also varies per period and per

production level (see next slide)

• Benefit: payment of difference between actual margin over feed costs and covered margin

• Scheme very recent, so no clarity yet as to how well received by farmers

• More info at http://www.futurefordairy.com/program-

details

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Premia for MPP-Dairy, exclusive of $ 100 administrative fee (in €cents per litre)

Tier 1 - 2014 to 2015 Tier 1 - 2016 to 2018 Tier 2

US$/cwt €cents/litre CPH over 4 m lbs (1.7m litres)in €c/l

$4.00 7.09 0 0 0

$4.50 7.98 0.000001 0.000002 0.000004

$5.00 8.86 0.000003 0.000004 0.000007

$5.50 9.75 0.000005 0.000007 0.000018

$6.00 10.63 0.000007 0.000010 0.000027

$6.50 11.52 0.000012 0.000016 0.000051

$7.00 12.41 0.000029 0.000038 0.000147

$7.50 13.29 0.000040 0.000053 0.000183

$8.00 14.18 0.000084 0.000084 0.000241

Example of cost: covering US$ 7/cwt (12.41c/l) for 2014/15 for producer with Covered Production History of 1.5m l = € 4333.33

Margin coverage level threshold

CPH 4m lbs or less (1.7m litres) in €c/l

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Fixed price/margin contracts

• Glanbia

• Fixed price + partial cost indexation. Based on sharing risk between customer, Glanbia and farmer. 4 x 3

year contracts thus far, approx 15% of GIIL milk bought

through this. Well received by farmers

(oversubscribed)

• Morrison (UK retailer) for liquid milk suppliers.

• Still in development (only mooted this month)

• Plan to pay farmers a 3-month price based on rolling average of index butter and milk powder prices

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Fonterra Guaranteed Milk Price • Introduced Summer 2014, after successful pilot of 328 farmers for

13/14 season

• Pilot: NZ$7/kg MS(approx 30€c/l) 15m kg MS, oversubscribed so

every farmer had to be scaled back to 40% of application.

• Proposed 14/15 scheme: 60m kg/MS in 2 tranches – 40m kg in June

with 12 months GMP, 20m kg in December, with 6 month GMP.

June tranche only attracted 26m kg MS.

• June tranche price options: farmer can choose percentage of

estimated milk production and “bid” for a fixed price of $6.60,

$6.70, $6.80, $6.90, or $7 –$7 was the opening 14/15 forecast price.

• If oversubscribed, mechanism to adjust individual bids, not

dissimilar to Milk Quota Exchange mechanism! Hence not all

farmers will get any or all milk covered.

• June: all farmers got $7.

• Scheme based on link with customers who are offered an array of

risk management options.

• More info on www.fonterra.com

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Dairy Farmers of America

options offered to farmers

• Pricing options based on product mix quotes from USDA

(Class III (cheese) and Class IV (powders/butter) milk price

quotes)

• Pricing options based on monthly cheese USDA quotes

(apparently most relevant to California producers) • Pricing options based on “Target Blends” – including more

products to offset the volatility of the Class III and Class IV

commodities

• Options including feed cost riders (corn, soya or a mix (milk

feed))

• Co-op offers simple options to farmers based on above, and farmers choose to avail of one option or another, or to take

the going price on the day.

• More info at http://www.dfariskmanagement.com/pricing-

products

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Source: Dairy Farmers of America

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Tax-based schemes • Available to farmers, fishermen and foresters in New

Zealand (Income Equalisation Scheme)

• Farmers put away funds in special tax-exempt savings accounts in good years

• Bring funds back into business within 5 years to be taxed

as income in poorer years

• Similar scheme available to Australian farmers (Farm

Management Deposit Scheme) • Basis for IFA proposal for a similar scheme – but not

retained in the Agri-Tax review

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Conclusions • Farmers more likely hedgers than speculators: they simply

cannot afford the risk

• Price volatility of milk and feed cannot be avoided, only managed

• CAP and EU dairy policy post 15 have a part to play • Irish industry must come forward with innovative

hedging/contract options

• Any mechanism must be • Voluntary for the farmer

• Must not interfere with the “real” market price • Government must review tax-based solutions

• EU must provide supportive policy environment