This information is to provide some context to how farm business owners should approach the decision-making processes in relation to price risk management tools. Adopting any milk price risk management tool requires considerable research, planning, analysis and monitoring and farmers are encouraged to seek experienced professional advice to support their decision-making processes.
What is Milk Price Risk?
Milk Price Risk is the uncertainty of the price a farmer will be paid for their milk in the future. The risk is the combination of the chance of an unfavourable change in milk price and the impact it could have on a farmer’s business and welfare.
What is Milk Price Risk Management?
There is no ‘one solution’ or ‘silver bullet’ to solving or removing price risk exposure for a NZ dairy business. Each farm business’s circumstances are unique and require the farmer to assess the effectiveness of different options and ensure they align with their needs. These needs will be influenced by factors such as efficiency of production, ability to manage farm costs, debt levels, risk appetite and level of understanding of their business financials.
Many parts of the world already utilise sophisticated milk price risk management tools and more options are becoming available in the New Zealand market (e.g. Fixed Based Milk Price, NZX Milk Price Futures and Options Contracts).
Where milk price risk management tools fit within overall business management
Being profitable and financially resilient is fundamental to sustainable dairy farming in New Zealand. Farms that are more resilient are:
- Technically efficient (e.g. achieving pasture and herd potential sustainably)
- Financially efficient (generate more profit per unit of output, manage expenditure, achieve higher Return on Asset)
- Cash liquid (generate more discretionary cash)
- Manage debt servicing (have sufficient cashflow to cover interest and principle obligations)
A farmer’s decisions are a balancing act of these components and, planned, managed and executed well, will create a buffer against the volatility of things outside influence including price volatility.
A few important points about milk price management tools:
- They are designed to remove the peaks and troughs of milk price i.e. it soothes out milk price throughout the season and from season to season.
- They are not designed to receive a higher or better milk price and should not be viewed as ‘something to make money from’
- There is a cost to using these tools (refer to the provider for full details)
- Anyone can use these tools, but they are particularly useful for business owners whose businesses cannot afford a sharp drop in milk price for one to two seasons or prefer less volatility in milk price.
- These tools can be accessed through dairy companies directly (e.g. Fonterra’s Fixed Base Milk Price) or through a risk adviser or broker.
It is important that before a farm business adopts a milk price risk management tool they do their homework and understand why they should manage their price risk before they look at which solution to go with.
Many farmers already have strategies in place and do not require any change, but no two farms are the same and not every year is the same.
The following steps will assist in developing a milk price risk management plan for your business.
Have a plan – what do I want from my business in the future?
Be clear on what you want your business to achieve for you, your family and those involved. Developing some form of business plan first with set goals, actions and strategies will provide clarity and assist with future decision making. Visit the planning section.
Review your business – how much does milk price risk affect me?
- Break even milk price (BEMP) is an essential business indicator of success that highlights the ability of your business to cope with volatile milk prices. To work out your own breakeven milk price, use the Break-Even Milk Price calculator.
- Regular budgeting and monitoring of financials, including testing sensitivity scenarios will help make for greater informed, relevant and timely decisions. Visit our budgeting section.
- Review your financial and physical performance and focus on factors within your control, which influence business resilience and profitability through DairyBase.
Become more informed
- Understand how the milk price is calculated and what drives it.
- Talk to experts and professionals for advice and information on both operational risk management strategies inside the farm gate and milk price tools.
- Document the decisions made and the reason for them, this will help later when reviewing decisions.
Managing Price Risk – what are my options?
Businesses have the option to either accept price volatility or manage price risk for stability.
This can be done by:
- Doing nothing and accepting the risk. This is a valid management solution for farmers with low breakeven costs, low debt or access to other strategies such as other income streams and flexible liquid assets.
- Utilise alternative milk price risk management tools. Milk Price Risk Management tools can provide potential solutions to gain certainty around milk price for a period. It is important to be aware of the implications as these tools are not designed to maximise profits or smooth cashflow but to protect margin (difference between what you are paid and how much it costs to produce).
Review and Reassess – did my decisions work for my business?
It is important to continually review and evaluate the decisions made around milk price risk management. Ensure the plan still aligns with the overall business plan and comfort level. Readjust if necessary.
Always remember that Milk Price Risk management tools are not about maximising profits but stabilising them.
If you are looking to find out more about Milk Price Risk Management contact
- Your Dairy Company Representative
- NZX Market Education
Resilience, to ‘Bounce Without Breaking’, in New Zealand Dairy Farm Businesses
Prof Nicola Shadbolt, Dr Femi Olubode-Awosola, Bvundzai Rutsito (OneFarm, IFM, Poland, 2013)
Accepting Price Volatility or Managing for Price Stability is a Choice
Satwant Kaur Singh, Nuffield New Zealand Farming Scholarship, 2015