Price risk management for farmers
Price risk management
for farmers
2
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
3
• Improve cost efficiency
• Adopt best farming practice
• Diversify
• Avoid overstretching
financially
How to mitigate income risk?
4
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.
5
What to do about price/income
risk?
HEDGING
6
Hedging: A risk management strategy used in limiting or offsetting probability of loss from fluctuations in the prices of commodities, currencies, or securities.
7
Why seek to hedge income risk?
To know what is coming and be
able to plan!
8
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?
9
10
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?
11
Source: Dairy Farmers of America
Example
12
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
13
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
14
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
15
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
16
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
17
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
18
Source: Dairy Farmers of America
19
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
20
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