Milk price contract's prospects look good, says US expert

Robert Chesler. Photo / Dean Purcell

NZX's milk price contract due for launch next month stands a good chance of success, despite the failure of most futures contracts, says Chicago-based futures executive Robert Chesler.

Chesler, who is vice-president foods division at financial services advisory company INTL FC Stone, said he believed the contract would struggle to gain traction initially.

"I think it will be a challenging first year or two from a liquidity standpoint - as it should be for a new contract - but I believe there is a need for the contract and as education rolls out I believe users will continue to step in and utilise it," Chesler said.

Chesler was in NZ with FC Stone risk management consultant Charly Chai to speak at NZX seminars on how to use the new contract.

NZX's existing dairy derivatives market - which is closely aligned with the bi-monthly GlobalDairyTrade auctions - has been going for nearly six years.

"There are more futures contracts that are started every year than I could count, and the vast majority of them fail and don't make it past the first or second year," Chesler said.

"We are fast approaching the end of year six [for NZX dairy futures] and volume has grown in almost every year," he said. "That is a sign of a successful market and one that shows signs of longevity."

NZX is developing New Zealand milk price futures and options contracts, intended for launch in May. The contracts are expected to go some way towards filling the gap left behind when Fonterra stopped its popular guaranteed milk price scheme, which allowed farmers to lock in part of their production at a set price, last year. The new milk price contract is in response to growing demand from producers and buyers of milk products wishing to manage risk around price fluctuations. The price of Kiwi dairy farmers' milk is determined largely by quickly changing foreign demand tables.

We are fast approaching the end of year six [for NZX dairy futures] and volume has grown in almost every year. That is a sign of a successful market.

Robert Chesler, FC Stone

With about 96 per cent of NZ milk turned into export product, local dairy farmers have little domestic demand to rely upon for price stabilisation, which is quite different from some of their main global competitors in the European Union and the United States.

FC Stone, whose origins go back to 550 Mid-West grain co-operatives who clubbed together to offset risk, has been a supporter of NZX dairy futures since their inception in 2010.

Despite the current slump in international dairy prices, Chesler said there was optimism for the long-term future, based on increased demand.

"There is, underpinning the next 20 years, an expectation that demand cannot be matched by supply capabilities," he said.

"Based on that, over a long period of time, we should continue to see the base average level of prices increase."

Over the shorter term, Chesler said he expected prices in the second half of this year to be marginally higher than the first half, unless there is an "outlyer" event. He expects prices in 2017 to be "respectably higher" but that it will be a slow grind.

The record highs seen in 2014 were the result of short-term disruption to production capacity, particularly in China, which had to be replaced immediately by foreign product.

"It was not sustainable and demand growth in China was and is flattening," Chesler said.

"It is the long-term growth there and particularly in Southeast Asia and India that underpins the reasons why dairy will be profitable for a long time, but it will also have a lot of peaks and valleys," he said.

"The dairy markets have been volatile for many years and the world seems to have finally accepted that the volatility is not going to [subside] any time soon."

Futures contract

• Will allow farmers to lock in farmgate milk prices.

• Priced in New Zealand dollars per kg of milksolid.

• Aimed at farmers, brokers and banks.