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Development of the Irish Dairy Milk Price Index

Contents

1) The impact of market volatility on farming.

2) The impact of market volatility on Dairy companies.

3) Development of the Irish dairy milk price index to create a milk futures market to mitigate price volatility?

o Roadmap.

o Operation of framework.

o Particular strengths of framework.

4) Conclusion.

A Farming Perspective – What volatility exists in Dairy Farming today?

Learning – A high level of volatility exists in dairy farming and the tools which exist today to manage

this volatility must be developed further to protect the full development of the industry.

Sources: (1) Milk Price is as per the KPMG league.

(2) Milk Production cost is as per the

Teagasc 2009 – 2014 Profit Monitor Data.

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What are the consequences of high Volatility?

For the Farmers. 1. High uncertainty in personal income. 2. Uncertainty on liquidity to repay bank debt. 3. Reduced capacity to secure bank debt to expand. 4. Lower confidence to expand and grow the industry. 5. A high risk in their business models. 6. Inadequate tools to manage milk price discovery.

A Dairy Company’s Perspective – What volatility exists in the dairy Industry today?

Learning – The dairy markets became very volatile post 2006, and today very few tools exists to

manage the inherent risk associated with this volatility.

• Assumption - I am using cheese pricing to illustrate the general dairy commodity volatility.

What are the consequences for Dairy Companies?

1. Reduced Profitability of Dairy Industry. Our customers are researching options to replace dairy products in their recipes, to

avoid price volatility, and such product substitution will reduce the overall profitability of the industry.

Lower profits for industry as companies dip into their margins to provide greater support for farmers in periods of weak markets.

2. The Irish Dairy Industry will not achieve its full potential. Our inability to pay a sustainable milk price ongoing leads to unhappy milk suppliers

limiting the development of the industry to its full potential. Reduced capacity to raise funds to reinvest to add scale, grow brand value and

develop more added value type products. [Both equity & Debt] Higher investment in working capital to provide financial support for “cash poor” milk

suppliers, is reducing funds available for company development.

3. A competitive disadvantage in world Markets. An inability to include price consistency in our product proposition for customers to

reduce their exposure to the current volatility in the dairy industry.

4. Greater inherent risk in Dairy business. Volatility >20% in markets increase the challenge to plan and deliver a strategy. Lower return on investment. High balance sheet risks. - (High stocks with no guaranteed prices.) A greater risk of not meeting bank covenants on existing and new debt.

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What is the Milk Price Index plan to create a milk futures market to mitigate price volatility?

• Stakeholders – (Work ongoing since May 2014).

– Arrabawn, Aurivo, Dairygold, Kerry, North Cork,, Tipperary, Carbery, Ornua, FC Stone.

• Plan

How has the milk price futures in the US reduced volatility

in the US Dairy Industry?

Learning – This is very useful evidence to illustrate the reduced volatility of the futures market over

the physical market.

Price volatility is significantly

reduced but average pricing

has not increased.

What are the possible benefits for the dairy Industry?

• Farmers – A possible scenario for farmers if futures reduced volatility by 50%.

• Food Manufacturing Companies

– A possible scenario if futures reduced volatility by 50%.

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How do we envisage the Eurex Milk Price futures index will operate?

• The Milk Price Index will be managed by an independent financial institution. [Currently FC Stone are filling this role].

• The Milk price index will be calculated and updated monthly.

• The historical index prices and futures index prices will be listed on the Eurex, as illustrated below using the CME in the US, as an example.

• 1 • 1 • 1 • 1

How do we envisage the Eurex Milk Price futures index will operate? (Continued)

• All Irish dairy farmers or dairy farmers throughout Europe can access offers for future milk price contracts and choose to sell their milk if they deem the price acceptable.

• The cost of trading milk futures will range between 0.15 c/l and 0.30cpl.

• The Irish coops will coordinate the trades in the futures markets for milk producers and manage the requirements of the financial exchange. [In long-term maybe individual farmers can manage these trades themselves.]

• The existing physical trades of the dairy companies will continue. The only change is that the contract price will now be supported by a financial trade to deliver a fixed contract price.

What are Four strengths of the Milk Price index?

• High Liquidity. – High selling interest by farmers resulting from the index quoted

in a unit of measurement which farmers can engage with. – Market research conducted by FC Stone on dairy buyers in

Europe suggests that buying interest will be high.

• Accurate index. – There will be high correlation between physical trade and index

price. – The index will not be subject to accelerated peaks and troughs

as it is not a spot index.

• Availability. – The index will be widely available to all milk producers, milk

processors, and food processors in Europe through the Eurex.

• Currency. – There is no currency exposure as index will be in euro’s.

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Conclusion

• Quote from Keynes extracted from The General Theory…………”Economics is a science of thinking in terms of models joined in the art of choosing models which are relevant to the contemporary world. It is compelled to be this, because, unlike the typical natural sciences, the material to which it is applied is, in too many respects, not homogenous through time.” (CW, XIV: 296)

• Taking direction from this insight the model required to progress the Irish dairy industry must be developed to manage a changing environment, and the change I am referring to today is increased volatility. There is a need to act and there is a need to develop a new solution.