Tackling Volatility in Dairying – A New Approach

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UFU Watch Commodity Watch - Written by Senior Policy Officer Chris Osborne

This week, Commodity Watch starts with a question in relation to milk prices; is there a mechanism whereby you could use high milk prices to cushion the impact of lower prices, whilst still reaping the benefits of the high returns during the good times? 

With higher milk prices continuing to generate an optimistic air in dairying, it may seem an odd time to discuss milk price volatility.  Yet there is probably no better time to highlight this ongoing volatility and share what the UFU have been doing to tackle it. Whilst Northern Ireland base milk prices averaging 27.14ppl for the year-to-date (January to July 2018 inclusive) it was only two years ago, the base milk price for the same period was 17.19ppl for the same period, a difference of 10ppl.  So prolonged was the slump in base milk prices, that the average in 2015 was 19.42ppl and in 2016 it was 19.11ppl, a very clear indication of how volatile dairy markets are.

Yet, milk price volatility remains an unaddressed issue within dairy policy.  Whilst there is a nod of acknowledgement to the sporadic availability of fixed-price contracts from processors, we need to do more to open up “a tool-box” which would be offered to dairy farmers.

There is a new approach to milk pricing called Dairy Vol, which may provide the answer to the opening question of this article.  Dairy Vol. is the brainchild of Tim Cowen and William Neville and is considerably simpler and easier to implement than Derivatives.  The key selling points about DairyVol are that it is simple, intuitive, boosts confidence, transparent, independently verifiable and low risk. 

Dairy Vol. utilises ‘precautionary’ savings, the use of high milk prices to buffer low milk prices. It takes the tops off the highs and bottoms of the lows and therefore delivers a fair long-term milk price.  It is essentially a stabiliser, which does not reply upon complex and expensive financial instruments.

Dairy farmers can lock in a % volume of the milk they produce, providing an element of certainty when milk prices are low and improves cash flow management. Back in 2015/2016, a major problem you will recall was that dairy farmers citing unbearable cash flow pressures whilst prices were in the doldrums.

Central to the workings of DairyVol is its use of a Moving Average.  The DairyVol price is constituted of two parts; the first part will still be based around the “standard pence per litre”, with the second part of the price being a moving average.  Volatility is reduced by including a % of the moving average paid by the processor over a previous 2 year period, calculated monthly. The higher/lower the milk price goes, the greater the DairyVol price is made up of the moving average.  A series of Milk Price Bands are key to the DairyVol calculation.  The midpoint of the bands is a processor 4-year average monthly milk price (calculated annually).  What is crucial is that the structure of the bands are agreed and tailored in discussions between the dairy processor and farmers.

Back in 2016, the UFU brought to Northern Ireland a high profile global panel of dairy industry experts to discuss the topic of milk price volatility.  One of the conclusions was that, largely, we are masters of our destiny.  EU Farm Commissioner Phil Hogan, speaking in Dublin last week reaffirmed that the dairy industry has a “substantial role to play” in adapting to the evolving market situation and price volatility. He called for an “integrated and professional approach between producers and processors” as “farmers cannot be expected to adjust to changing conditions on their own”. Dairy Vol presents one such solution.

As far as next steps are concerned, I will be preparing a worked example, specific to Northern Ireland and this will be published in a subsequent Commodity Watch.