Global dairy futures market on the way

Photo / Brett Phibbs

An NZX global dairy futures market aimed at helping companies tackle volatile prices is expected to be launched in the middle of this year.

Kathryn Jaggard, derivatives manager for NZX, said the futures contracts would be on globally traded products, with whole milk powder the first dairy product to be launched, subject to regulatory approval from the Securities Commission.

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

Futures contracts could be used by organisations, including processors, manufacturers and dairy trading firms.

"Don't expect farmers to be heavily involved in this in the early stages," Jaggard said. "We expect that farmers will take a wait-and-see approach but there is an opportunity for farmers to use the product.

"I think it's awfully helpful for a farmer every day to see, 18 months out, what's the view or the market sentiment around demand for whole milk powder, where the majority of my payout comes from."

Whole milk powder futures would be followed by skimmed milk and anhydrous milk fat as part of a broader derivatives market that would include electricity.

Companies could use futures contracts to lock in prices ahead of time, Jaggard said.

"Essentially, a futures market is not about trying to beat the market; it's about trying to take the volatility out of the market and make it more predictable," she said.

Dairy commodity prices had become volatile after many years of stability, Jaggard said.

"If I'm a large manufacturer, to be able to lock in or create certainty over the price of my purchases means that I can much better plan ahead for my business," she said.

Bruce Turner, Fonterra director of commodity risk and trading, said the dairy co-operative would use the NZX futures market.

"We think it is essential that Fonterra's quite active in using that, firstly to manage our own price risk and secondly it's important, to the extent that we can, that we help this thing be successful," Turner said.

Volatility in dairy commodities was here to stay, he said.

The Chicago Mercantile Exchange said it would launch an international skimmed milk powder futures contract in the middle of May, while NYSE Euronext was looking at contracts, which would be predominantly aimed at organisations with European dairy price exposure for skimmed milk powder, butter and whey, Turner said.

Meanwhile, derivatives exchange Eurex last week said it would launch futures for butter and skimmed milk powder on May 31, which Turner said would be based on European prices.

However, the NZX futures contract would be the first available for whole milk powder, he said.

"There's no reason why this shouldn't be successful," he said. "Whole milk powder is a very good risk management tool for New Zealand. It's not only applicable to New Zealand farmers, via the co-operative and the producers, but it's also kind of interesting for a whole range of other investment vehicles."

Landcorp chief executive Chris Kelly said if the futures contracts could provide a degree of stability and take out some uncertainty, then the corporate farming company would look at them quite seriously.

Minimising the risk

* A futures contract is a tool for managing risks to price and cost in a volatile environment.

* NZX dairy futures contracts will be settled in cash, rather than physical product.

* All contracts, whether buying or selling, will be made with the NZX clearing house.

* Potential users include milk processors, manufacturers, dairy trading firms, futures brokers.

* NZX expects to launch whole milk powder futures mid-year, subject to regulatory approval.

How a contract works

* A company, for example, buys a futures contract at $2500 a tonne due for settlement in two years' time.

* The final settlement price, determined by real market prices, has increased to $3000 a tonne and the company makes a cash gain of $500 on the contract.

* The tonne of product the company physically needs to buy to run its business costs about $3000 and so, taking the cash gain into account, a $2500 price has been successfully locked in.

* If the company had taken the risk and not used a futures contract the actual required tonne would have cost it more than $2500 a tonne.

* Similarly, if the physical market price had fallen and the company had not used a futures contract then they could have bought the product for less than $2500.

* The risk of price volatility has been managed at a level with which the company is comfortable.