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 mechanismsUS Margin Protection Programme for Dairy Producers

• US Govt run insurance schemeFixed 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 2US$/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 thresholdCPH 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