Let's manage dairy price risk
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The sudden and huge drop in the farm gate milk price in recent months is a stark reminder that price volatility is now a permanent feature of EU dairy markets.
This drop, coupled with the fact that input costs have not dropped to the same degree as the milk price, has led to a margin squeeze and serious cashflow problems on some farms.
Ireland is arguably the most exposed country in the EU to the effects of dairy price variability. Last winter we experienced the highest milk prices in the EU, while in recent months we have found ourselves at the opposite end of any milk price comparison.
We export more than 90% of all milk processed and are largely at the mercy of commodity prices, which are very volatile. Small changes in supply or demand for dairy commodities have a large impact on prices. These changes are frequent and often unpredictable and transmit to milk prices rapidly.
For some farmers, the high returns of last year will balance out the current low returns and they will now adjust their plans accordingly. However, others are far more exposed to this type of income volatility.
These include farmers who have invested heavily in expansion or some new entrants for example. For this latter group risk management tools are highly desirable. These tools must be voluntary as not all will use or require them at any one point in time. However, as time progresses their circumstances may change and at that point, they too may then desire these tools.
The reality is that Irish dairy farmers currently have access to a very limited selection of risk-management tools. The EU Commission will point to the Basic Payment Scheme and a Crisis Reserve as their response to volatile farm incomes while placing any additional responsibility on national governments, who in turn have largely delegated responsibility to industry.
The result is we do not have margin insurance, as available to US dairy farmers, or other risk management tools such as “rainy day” deposit schemes to manage the risk associated with price volatility. Income averaging may work for some but can add to cashflow problems if not used optimally and with discipline.
The Irish industry, and milk processors in particular, have responded to this need for risk management options by launching tools such as fixed-price forward milk contracts and milk flex.
The fixed-price forward milk contracts were developed partly in response to meeting the desire of some of their customers wishing to manage their risk. Dairy price volatility is a challenge for the entire dairy supply chain and customers prefer to trade with suppliers who facilitate their risk management and offer stable prices.
As a result, processors were able to offer back to back contracts which managed risk for both its suppliers and customers.
For many years, this tool successfully helped a cohort of farmers to manage their risk. During this period input prices were relatively staple and their margin reasonably predictable.
However, the war in Ukraine, amongst other factors, led to unprecedented and unforeseen high input prices which eliminated any margin farmers may have envisaged when they entered their fixed price contract. Indeed, the margin turned negative for some.
This has led to a very negative view of these contracts and the debate around these tools has become polarized and at times inaccurate. Some critics now argue that these contracts are not fit for purpose and should be abandoned. However, these critics have not proposed any alternative tools.
This has done a major disservice to some farmers who need risk management tools. Meanwhile farmers in the US in particular (a growing competitive force for exports) are availing of a suite of risk management tools. This helps to explain their output growth in recent years and their reluctance to cut production now.
Fixed milk price contracts can be designed to better share risk or provide better income security. For example, Kerry Group has added input cost adjusters to its more recent offerings.
These are contracts, and with both parties' agreement can be redesigned for future use. For example, by using bands it may be possible to better share the risk in times of extreme prices. Likewise, the development of dairy derivatives such as options may also be worth considering in this context.
So greater discussion and education are required so that these tools, and any alternatives, are evaluated in a fair manner. Representatives of all parts of the supply chain need to have input into this discussion and this requires leadership.
The current price volatility and the recent experience of forward supply contracts mean that a relevant stakeholder group of the industry should be convened as a matter of urgency to examine issues and recommend solutions.
With the milk processing sector again under almost 100% co-operative control, an industry wide response is more feasible as priorities should now align across the sector.
This stakeholder group will be aware that income volatility is only one of the many risks faced by dairy farmers. Policy and regulatory risks are ever present as recently seen with the removal of derogation for some farmers and the ever more stringent nitrates directives.
This year’s weather is a stark reminder of the risks posed by climate change while working in an environment where illness and injury are a constant worry. Add in financial and market risks and it difficult to think of a sector which is more exposed to risk than dairy farming.
Therefore, all stakeholders in the Irish dairy supply chain should now be focused on how we find solutions that protect a cohort of vulnerable farmers and the industry they fuel from one risk that can be managed.
However, any developments in this area must be cognizant of the need to seriously reform the current milk pricing mechanism which is no longer fit for purpose and serves neither processor nor farmer. Please let a full and frank discussion begin.
