There are a range of dairy hedging strategies available for dairy farmers to manage their milk income risk.
Most farmers understand the fixed milk price option offered by Fonterra. In our experience, however, the milk price futures offered through the NZX can be an excellent risk management tool and one that is not so well understood by the dairy community
To be able to purchase milk futures, you must firstly open an account with an NZX listed broker. You are then able to purchase future contracts at a set price eg the current price at time of writing is $6.62 per kg MS. The milk futures are purchased in bundles of 6,000kgMS eg: to buy 18,000kgMS would require 3 contracts.
At the time of purchase you are required to open a margin account and deposit funds into that account.
The funds required are known as the margin which starts higher and reduces as the season draws to a close and the actual milk price becomes clearer. Typically the margin will start at roughly $1.00 per kg MS. As settlement date of the contract draws nearer the margin reduces and your account is refunded the difference. The margin acts as a guarantee that you will make good on your requirement to pay over excess funds received should you physically receive a milk price higher than what you have contracted.
On a daily basis this account will go up or down depending on what the market does. For example: You purchase 3 contracts at $7.00, the margin is 56cents. So a payment of $10,080 (being 18,000 x .56) will go out of your bank account that night. The next day if the market has decreased to $6.95 an adjustment of $900 (being .05 x 18000) will be repaid into your bank account and is called a mark to market adjustment.
There is an opportunity to take a position when the futures price is high. Fonterra’s current forecast is $6.40 per kg MS. There is currently an opportunity to secure a price at $6.62 using a futures contract.
None of us know what the season will bring but the use of milk futures enable us to lock in a price for a volume of production which will certainly make budgeting a little easier.