Dairy farming and the futures market full report
The only way to preserve a future-proof dairy farming is through margin retention. Without a margin, no sustainable future is possible. A dairy farmer will always have to be aware of this. One way to maintain margin is the use of the futures market for feed and dairy (products). In my research into these futures markets, a number of points emerged that are essential and worth sharing.
The futures market for the agricultural sector has existed worldwide for centuries. Its use has also been praised for years, as well as despised. The reason for this is that there are always winners and losers on the futures market. The futures market has been set up to absorb price fluctuations for both seller and buyer. The futures market provides insight and information about the price expectations about the specific product for the delivery at a previously agreed place and time. The extent to which a contract can change ownership is called liquidity. The dairy futures market was very limited at the start of my research (2015). In the meantime, liquidity is broader and can be described as sufficient for contracts up to a maximum of six months. This is still limited compared to the futures market of the Chicago Board of Trade (CBOT). The EEX in Leipzig has announced in 2017 that it will come up with a futures contract for raw milk. To date, it has still not been introduced. European dairy farmers can now cover their milk price risk on the futures market. For this purpose, these dairy farmers can purchase futures contracts from milk powder and butter. These products are currently being offered on the European futures market. Depending on the milk processor, the right number of futures can be purchased which must correlate with the paid milk price. This correct correlation between the paid milk price and the futures ensures a good 'hedge'. As there are no futures for raw milk, there is a cross-hedge. The higher the correlation between the paid milk price and the futures, the lower the basic risk. The ratio between the number of milk powder and butter contracts can vary per period. A good adviser is therefore necessary. And even then a mismatch can arise between the contracts and the liquid milk (basic risk). By using futures for both the input (feed) side and the output (milk) side, the target margin can be determined. By only recording the input or the output on the futures market, a mismatch or squeeze can occur. The desired margin can therefore disappear. By choosing a fixed strategy and following it consistently, the optimal (desired) risk management is created.
As previously indicated, the futures market is under development. Dutch dairy farmers still make relatively little use of futures and options. The reason for this is often that there is insufficient knowledge of it, but it is also not supported by chain partners. In this way, I would also like to call on the financial institutions (banks) and other chain parties (feed suppliers and milk processors) to provide more support to the dairy farmers. They can facilitate dairy farmers by means of money, market access, knowledge, etc. All of this for a common purpose, preservation and, where possible, expansion of the margin for dairy farming.
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