Dairy Farmers’ Price Risk Management Solutions Offer Benefit To End Users, Too
by Edward Gallagher, president, DFA Risk Management
Volume 138, No.16 Friday, October 11, 2013
Substantial price volatility is now part of the dairy industry’s business culture. Over time, a phase down of dairy price supports, reduced trade barriers, a globalized dairy industry, “just-in-time” inventory management and federal ethanol policies have contributed to this growing volatility.
“Working with a dairy cooperative or milk plant, an end user can enter into a hedge that establishes a dairy ingredient purchase price and ultimately pass this price through to a dairy farmer supplying the cooperative or milk plant. This type of hedge leads to a more sustainable dairy industry as the end user clearly defines the input cost.”
The end result is a lack of price predictability, challenges with meeting budget and unwelcome impacts on operating statements.
All of this has driven a change in end-user business practices when it comes to dairy price volatility. Five years ago, a buyer managing price risk looked for an extremely good deal. The goal was often locking in a price at the bottom of the market — or least a better price than the previous year.
If that was not possible, an un-hedged dairy budget absorbed most, if not all, of the impact of rising prices. In some cases, it also meant foregoing the opportunity for a profitable margin and accepting less than budgeted results. Buyers were, in essence, speculators.
Increasingly, today buyers recognize the impact of rising prices in their budgets and operating statements. They recognize the importance of hedging and realize that 50 percent of the time, a hedged-price position will likely be higher than the eventual “spot” market price.
However, combining a marketing strategy to hedge input prices (e.g., energy, interest rates and other commodity ingredients), contributes to “locking-in” the cost of goods sold, providing the ability to take a strategic position on the product’s sale price. This allows the opportunity to manage a profitable margin and the ability to better maintain profitability.
Dairy farmers face all of these issues, as well.
To manage in this climate of increasing volatility, more dairy farmers are embracing risk management solutions to manage this volatility and establish a profitable and sustainable business.
Recent experience has shown that farmers are eager to lock in a milk price, while hedging their input risk. As sellers of milk, dairy farmers’ economic interests are harmed if milk prices decline below their costs of production.
They frequently lock into feed
prices (which contribute 50 to 75 percent of their production costs), diesel prices, interest rates and other cost factors.
As volatility has increased in dairy markets, dairy farmers also are taking milk price hedge positions in tandem with input price hedges in an effort to manage a profitable margin.
There is a unique opportunity to manage dairy price risk on both ends of the production chain. Working with a dairy cooperative or milk plant, an end user can enter into a hedge that establishes a dairy ingredient purchase price and ultimately pass this price through to a dairy farmer supplying the cooperative or milk plant.
This type of hedge leads to a more sustainable dairy industry as the end user clearly defines the input cost, while giving dairy farmers a known milk price against which they can manage input costs.
For businesses facing growing and uncertain global markets, hedging milk and input prices can lead to:
• increased price certainty
• better price predictability
• opportunities to manage a consistently profitable margin
• better likelihood of meeting budget targets
At the end of the day, this mutually advantageous approach allows both end users and dairy farmers to achieve success.
Edward Gallagher is president of DFA Risk Management (www.dfariskmanagement.com), which creates customized risk management tools for dairy producers and end users, including pass-through contracts that assist DFA dairy producer members and customers in protecting against the adverse impacts of volatility.