Price volatility demands new approach to buying inputs

Volatile commodity markets are putting farm businesses that rely on “spot” purchasing of inputs vulnerable to unnecessary financial risk, writes Roland Wunderle, livestock products manager for AtlasFram Group.

Global markets have been in such a state of flux during the last two years that the financial landscape for farm inputs buying has changed beyond recognition. Prices of everything from feed and fertilisers to fuel and electricity now change so significantly, and on such a regular basis, that determining the optimum time to commit has become increasingly difficult.

Even the most ‘clued-up’ producers find it difficult to keep pace with developments and with inputs purchasing now so critical to overall profitability it is time to adopt a new approach to this area of business.

Increasing volatility

grain

 Grain saw an exponential rise in demand thanks to demand from developing countries such as India and China.

Historically, prices of “soft” commodities have been influenced by four fundamentals; supply, demand, weather and exchange rates, and although subject to short-term ‘spikes’ they have quickly returned to average levels.

Three years ago, markets began to change character and in 2007 we started to emerge from a long period in which prices had been in the doldrums and farmers throughout the world were reluctant to grow crops from which they could not see a return.

In the UK, the situation was compounded as sterling declined from almost US$2.2 towards its long-term average of US$1.8, oil prices broke from US$20-30 per barrel to over US$150 and shipping rates rocketed as world trade increased.

Globally, a key driver of prices was spiralling demand from developing countries, such as India and China, where rapidly-expanding economies increased disposable incomes and encouraged the pursuit of a westernised diet incorporating more meat, which created an exponential rise in demand for grain. Inevitably, soft commodity prices began to rise, slowly at first, but then rapidly as City funds, speculators and “non-core” investors plunged into this hitherto-neglected sector.

The speed of change took everyone by surprise, even experts such as the United States Department of Agriculture, and the immediate impact was felt hardest by producers who purchased all their requirements on spot markets. Conversely, those who had booked their requirements forward, before prices began to rise, gained significantly at that time and with hindsight more should have been purchased in this way.

Reducing risk

Purchasing feed and feed ingredients are the most significant costs on most livestock farms, but historically there’s never been enough of a financial saving to persuade the majority of farmers to contract ahead.

From 2002 to 2006, for example, soya traded at £140-£180/tonne and throughout 2005/2006 compound feeds were £100-£110/t. While some producers are aware of the risks of purchasing everything “spot” and regularly use forward contracts to lock into known input costs, the shift towards long-term contracts in the UK has been relatively slow.

However, risk minimisation will become an essential part of farming profitably in the future and financial institutions who service working capital requirements will place increasing importance on budgeting and risk management. Consequently, producers will have to adopt a new approach in terms of budgeting input costs and output prices.

Most dairy farmers have access to cost-of-production information from their nutritionist, but often don’t use it effectively to calculate fair prices for inputs. Others have unfair expectations over the level to which their supplier can influence prices, but in reality global commodity markets are so enormous that no one purchaser, even a large national purchasing group, can have a meaningful impact.

Commodity markets usually move in long-term cycles which are made up of a series of smaller up-and-down movements. Timing purchases to coincide with these movements, in line with the overall trend, can have a significant bearing. However, you need to be in close touch with the market, have realistic expectations in terms of what you are prepared to pay, set target prices at which you are willing to commit and, if they are reached, place your orders.

Timing is everything and the important thing is to have a grasp of the “big picture” rather than focusing on minor details which have little real impact. Farmers are notoriously independent-minded and most enjoy the challenge of phoning around for the ‘best price on the day’, but ironically they are rarely in a position to judge what that is.

Getting a good deal

While many perceive that squeezing a few pence per tonne more out of a supplier means that they have “done a good deal”, in reality using solid market information to time purchases when prices are favourable, compared with pre-budgeted figures, is much more effective. However, many farmers have difficulty making such decisions because they usually lack time and access to sufficient information to judge the market correctly.

cows feed

 Feed is the largest input AtlasFram Dairy Group sources for its livestock members.
Membership of a professional, independent buying group which has sufficient scale to employ high-calibre staff, enables you to purchase everything through one office where all farms benefit from the same pricing structure.

All our members are different in terms of their purchasing requirements, volumes and buying patterns, but share a common objective, namely to source inputs as competitively as possible. That is the “glue” that binds them and through cooperation everyone gains.

The increasing importance of inputs purchasing to the “bottom line” is reflected in the growth of the AtlasFram Dairy Group, which was formed in 1999. This has expanded rapidly and encompasses herds of all sizes, including some of the UK’s largest.

Feed is the largest single input we source for livestock members, the majority of whom work closely with independent nutritionists, enabling them to separate advice from product and putting them in a much more powerful position in terms of purchasing all inputs. AtlasFram sources more than 70,000 tonnes of animal feed annually, which is tendered for on a regional basis, offers forward contracts for compounds, straights and blends, together with standard and bespoke minerals.

In addition, we purchase £2m of animal health products annually which can save members approximately 10% on the average cost of £70-80 per cow. This includes items such as fly control and worming products, dairy chemicals and breeding supplies.

There is no perfect way of dealing with raw materials volatility, but given the unpredictability of commodity markets, with prices trading in far-wider ranges, at much higher levels and at a time when we don’t yet know where they will stabilise, budgeting based on known input costs and output prices is the safe, sensible option.