NZX plans to offer milk price futures, options to reduce volatility

Some 95 percent of New Zealand's production is sold overseas, making the country's farmers more exposed to global prices than larger countries such as the US. Photo / Mark Mitchell

NZX, the financial markets operator, is developing a new market offering New Zealand dairy farmers a way to lessen the risk of volatile milk prices.

The Wellington-based company plans to start a futures and options market for milk on its trading platform, allowing farmers, processors and others linked to the local dairy industry a way to fix the future price of milk to reduce uncertainty.

The milk contracts will add to the NZX's existing futures contracts for whole milk powder, skim milk powder, anhydrous milk fat and butter, and its whole milk powder options.

Global dairy prices have become increasingly volatile over recent years as government subsidies and schemes propping up prices have reduced, allowing prices for more products to be set by the market.

For farmers, that's meant huge swings in prices, with the country's dominant milk processor Fonterra Cooperative Group paying a record $8.40 per kilogram of milk solids in the 2013/14 season but just $3.90/kgMS in the current 2015/16 season.

"Dairy has opened up in terms of its trade and it has transitioned into a global commodity and is now experiencing similar levels of volatility as other commodities," said Kathryn Jaggard, head of derivatives at NZX. "The development of these contracts is really in response to demand from dairy farmers and is a consequence of that continued volatility."

Auckland-based Fonterra, the world's largest dairy exporter, trialled its own fixed-price scheme, known as the 'guaranteed milk price' the past few years, allowing farmers to lock in some of their milk supply at a fixed price.

However it canned the scheme last year, disappointing farmers such as state-owned Landcorp, the country's largest corporate farmer, which benefited from being able to plan its future operations knowing what the price for its production would be.

"There have been some flirtations with fixed price schemes which were helpful to some farmers but obviously now we're in a place where there's a distinct lack of risk management tools available and that continuing volatility has just come to a head that it's certainly unsustainable for many dairy farmers," Jaggard said.

Some 95 percent of New Zealand's production is sold overseas, making the country's farmers more exposed to global prices than larger countries such as the US with big domestic markets, and farmers in other markets also benefit from government support and a wider range of risk management tools, NZX says.

Larger dairy farmers are expected to be among the first to take up the scheme but NZX says the new market could also be used by processors to enable them to offer a fixed price contract to farmers, or by banks to launch a swaps contract.

For NZX the addition of futures and options contracts for milk builds on its launch of its global dairy derivatives market in October 2010 and is part of its aim to become the global hub for trading tied to New Zealand's biggest export commodity.

"It's important as an exchange and as a derivatives market for us to continue developing our products where there is demand," Jaggard said.

"This is really an NZ Inc thing as well, obviously our agricultural markets are incredibly important and the development of risk management tools are a big part of the sustainability of those markets moving forward."

The new contracts futures and options contracts are expected to launch in May.