Article 16 December 2019
Dairy price volatility spiked after 2007 due to a perfect storm of factors including policy shifts, adjustments to new grain demand dynamics, increased investor flow and other impacts. Since 2007 volatility has remained elevated (clearly visible in the FAO’s dairy price index in figure 1) and with increasing uncertainty over macroeconomic conditions and trade flows, market instability is likely to become an endemic part of the dairy world.
The dairy market is cyclical in nature moving from periods of oversupply and lower prices to undersupply and higher values (at times in three year cycles). This is the root of the fundamental precariousness; the dairy market prices are intrinsically very volatile due to the inability for producers to respond to short-term price movements with supply shifts and inelastic demand from the retail and value add industries. Volatility often increases up the supply chain to the product level. In addition, dairy prices are beholden to the fluctuations of grain prices as a major input cost. In 2007 when grain markets rallied due to the increase in demand from biofuel production and China (and investor money flow) this had a direct knock-on impact to the dairy prices.
Prior to 2007, policy structure in the EU and US kept markets buoyant and more stable with minimum producer prices (illustrated in figure 2). Major shifts have occurred in the policy tools used as regions wish to reduce budgetary outlays and minimize artificial impacts in the market supply and demand dynamics. As policy influences such as quotas or minimum prices are adjusted, or abolished, price volatility naturally increases.
This instability is magnified by future policy implications and with trade wars and Brexit threatening to have lasting impacts on the dairy market and trade flows. For example, the unprecedented changes that may occur in the dairy industry in the UK do not offer a clear trajectory, milk prices may increase with further sterling devaluation, or if the UK’s fluid milk surplus is no longer exported to the EU local values could plummet; only uncertainty is assured.
The low values are compensated by ever increasing yield per cow and direct payments to farmers, but certainly it is the low-priced environment, and volatility in margins that is to blame for the consistently shrinking number of dairy farmers in the UK (down nearly 40% since 2006), and the EU (down over 80% since the mid-1980s). Consolidation allows for more efficient and lower cost production, required for competition on the international market, but the falling numbers have yet to stabilize and with future volatility likely it is not possible to say when the reductions in producers will ebb.
The EU dairy market, the largest in the world is emblematic of what has occurred in the past 40 years. The bloc’s weighted average raw milk price is shown in figure 3 as well as the low and high range of all the national values and a measure of volatility, the coefficient of variation. Clearly the volatility since 2007 is like nothing previously seen. As the EU has removed production quotas and reduced minimum prices it is probable such spikes in volatility will continue.
As varied as the global dairy market is there are indexes for most major markets that Stable can offer price protection for; this includes producer prices up the supply chain to the value-added products such as cheese and butter. Price protection contracts can be a relevant tool in this industry as derivative liquidity can be an issue along with high basis risk. With higher volatility in the dairy markets risk management tools are essential to ensure margins and the future. Contact us if you are interested in speaking with our analyst team regarding the global dairy market trends and how Stable can help.
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