Sharp farmgate price swings are a big problem, but how can farmers cope? Charlie Taverner asks what tools each sector has to cope with volatility.
Challenges: Growers have full exposure to world markets, due to pull-back of EU protection in 1990s. Also facing pressure from fertiliser and agrochemical markets.
- Sell crop forward – Fixes price ahead
- Managed pools – Merchant or co-op markets on growers’ behalf
- Tracker contracts – Follows market over time period and takes average price
- Feed plus contracts – Gives grower a certain premium for hitting quality target
- Min/max contracts – Gives grower upper and lower limit to price
- End-user deals – Links producer with final buyer, guaranteeing agreed spec and price for a specific quantity
- Futures trading – Through a broker, grower buys and sells contracts on the exchange to protect against price changes
- Options contracts – Lets grower using futures benefit from upward or downward movements, for a premium.
What the expert says: NFU chief arable adviser Guy Gagen says there is a diverse set of products to help arable farmers manage risk.
“They can exist largely because there is a futures market that gives you up to three years out a very clear indication of what the price will be,” he says.
“That is the best information from those operating in the market. It won’t be that ex-farm price when we get there, but it is the best view out there.”
Risks down the road: Any grain sale or contract that references futures markets could soon carry extra costs due to new EU rules. The Markets in Financial Instruments Directive, which comes into force in January 2017, could make farmers ask authorities for permission before each trade. The NFU is lobbying against it.
Challenges: Farmers are quickly having to learn how to cope with severe volatility, which seems to work in two- to three-year cycles. The removal of EU milk quotas this April has only added pressure. Very few risk management tools are in place.
- Retailer-aligned contracts – Fixes a cost-of-production covering price for several months, though these cover less than 20% of UK milk
- Formula contracts – Tracks costs and basket of commodities, but limited volumes available to Dairy Crest, Muller Wiseman and some smaller suppliers
- A and B contracts – Pays farmers one rate for a proportion of their milk and a more variable rate for any extra. If used well, with the more stable and long-term “A” price, can help farmers manage risk
- Forward-buying feed, fuel and fertiliser – Lets farmers lock-in some of their variable costs
- AMPE futures – Work by trader INTL FCStone and Milkprices.com lets farmers see where milk prices could be heading in months ahead.
What the expert says: Kite Consulting managing partner John Allen says the dairy sector has stepped out into a new, volatile world but does not have the support mechanisms to cope.
He says milk processors are likely to start engaging more in futures markets and offering farmers tools – such as fixed-price, longer-term deals – to manage volatility.
“These tools will be used more by processors and probably by the large dairy operators who will be business-minded and able to understand the risk,” he says. “The good thing about futures markets is you do not trade at the expense of the other farmers but at the expense of the speculator.”
Risks down the road: With dairy prices in a deep trough, tools will need to be developed fast to help farmers prepare for the next cycle. Farm leaders and politicians want a futures market like the one in arable, which could be used for price discovery. But this will only work if traders are interested.
Beef and sheep
Challenges: UK lamb prices are locked into a yearly cycle due to seasonal supply, while currency fluctuations also have a big effect, with one-third of British sheepmeat exported. For beef, the past two years saw a major crash after prices hit an all-time high following the horsemeat scandal, and another sharp plunge in spring 2015.
- Supermarket supply groups – Some producers are offered contracts guaranteeing a premium above the market rate for a fixed period
- Contract-rearing and finishing in beef – Run through businesses such as Blade, offering farmers a premium over base price for following a programme and meeting weight and specification
- Forward-buying feed – Lets farmers fix part of their cost of production.
What the expert says: SAC Consulting beef and sheep team leader Gavin Hill says livestock farmers tend to be price-takers and cost-takers.
He says the industry continually talks about contracts, but few abattoirs and supermarkets offer them.
“Farmers need consistency. There needs to be some guarantee, some sort of assurance that the prices won’t move too much,” he says. “That allows farm businesses to budget more accurately.
“To set up contracts both parties have to be content with it and this takes time.”
Risks down the road: Farm leaders have warned about falling beef producer numbers, as profitability forces farmers out of the sector and threatens the industry’s critical mass. In sheep, currency will remain a key factor as the UK cements itself as the biggest European sheepmeat producer and exporter.
Challenges: Volatility is not new for pig producers. The unsubsidised sector faces a triple threat from the feed market, the pig market and exposure to imports, as the UK is not self-sufficient.
- Tools available
- Finished pig contracts – Containing cost-of-production element
- Agreed final price – 50% final price contract
- Weaners sold on contract – Part-fixed, part-sliding
- Forward-buying feed – Producers can lock-in the biggest element of their cost of production.
What the expert says: Independent consultant Peter Crichton says pigs are the most volatile of the livestock sectors, as stock cannot be held back on farm if they are ready.
He says the current price downturn has meant fewer fixed-price or cost-covering contracts are being offered by processors and retailers.
“We can try to iron out the ups and downs but we are faced with a cyclical market because of the short nature of the production cycle,” Mr Crichton says.
“At the moment the only thing you can lock into is feed; supermarkets are buying hand to mouth.”
Risks down the road: Supermarket support for British pork has kept some imports at bay so far. The ongoing retail price war might start biting into the UK’s premium if supermarkets need to claw back more margin.