Cut dairy risks or suffer, says US expert

Robert Chesler. Photo / Supplied

Volatile dairy prices are here to stay and those who don't get to grips with the risk will be left behind, according to dairy futures expert Robert Chesler.

Chesler is a Chicago-based account executive in the dairy division of commodities advisory and trading firm FCStone.

He was in Auckland last week to talk to potential users of an NZX dairy futures product on a new NZX Derivatives Market.

The market is expected to launch in September, subject to regulatory approval, with a dairy futures product first, which was expected to be followed by equity derivatives.

FCStone worked with everyone from small farmers to large processors and retailers.

"Everyone has a risk, it's a different type of risk but nonetheless they have a risk," Chesler said. "A tremendous amount of people out there in a global perspective either don't know or have just learned that there are tools out there that allow them to mitigate that volatility and lock in prices that are preferable for their business."

Whole milk powder futures would be the first product launched on the new market.

When global dairy prices first spiked people said it was an aberration unlikely to continue, Chesler said.

"Well that was two and a half years ago."

Dairy prices dropped back but did not consolidate and stay there like they would have in the past when government support prices were very high but rather rose again before starting to curve back down, he said.

"So we're fairly confident that the volatility is likely to stay."

FCStone - which has applied to be a general clearing participant for the NZX Derivatives Market - undertakes broad education of sectors and works with companies to help them draw up and execute risk management plans.

"I believe that those who don't use these [risk management] tools will be at a competitive disadvantage in a short period of time, I would suggest five years," Chesler said.

Grain risk management in the US had been around for more than 160 years, while tools for the dairy sector had existed since about 1996, he said.

The European Union had made commitments to reduce intervention levels to the point of being irrelevant and planned to phase out the quota system, he said.

"That will allow the price as well as the supply and demand of the product to fluctuate."

In the US volatility increased as government support prices were lowered in the late 1970s and early 1980s.

"To the point where currently the support prices are not profitable for anybody and so they're a non-factor and volatility is very high.'

There was a natural focus back to New Zealand and what happened here was always part of discussions, whether in Chicago, New York, Germany or Australia.

The geographic location of New Zealand did not matter in the modern world of internet and laptops, while the advent of electronic trading removed any concern there might have been about time zones.

The NZX contracts had a great chance of success, he said.

"I believe that the position of New Zealand dairy products in the global market place means that people look towards New Zealand as a leader in the industry and this is just another way in which New Zealand can stand out in that position."

The futures contracts would be settled in cash, rather than products, using Fonterra's online auction globalDairyTrade to determine price.

The globalDairyTrade settlement mechanism strengthen the NZX position globally because everybody looked at that auction price, Chesler said.

"It's globally minded, it's not a voluntary reporting mechanism, it's based on actual bids and offers that the participants are putting through, its very transparent as far as the final number [is concerned]."

NZX head of markets Fiona Mackenzie said: "We're a small market, we're on the other side of the world and the more international investors and the firms that help them connect to our markets the better it is for our market overall."

DEALING WITH THE DANGERS

* NZX Derivatives Market expected to launch in September with a dairy futures product.
* A futures contract is a tool for managing risks to price and cost in a volatile environment.
* A firm can use a futures contract to effectively lock in a price.
* NZX dairy futures contracts will be settled in cash, rather than physical product.
* Potential users include milk processors, manufacturers, dairy trading firms and futures brokers.