Milk price – Looking forward to a brighter future?

At last milk price seems to be on the move, and in the right direction. Significant increases in spot milk herald a turning point but in this new post-quota, post-Brexit world there are so many other factors that will contribute to a significant increase in the price of contracted milk.

The spot market represents the value of surplus milk in the UK and fluctuates in direct response to supply and demand.

Effect of Brexit

The increases we have experienced over the last few weeks have been influenced by a shortage but also heavily influenced by BREXIT. The fall in the strength of sterling against the euro has added somewhere in the region of 2.5-3ppl on imported milk.

This has obviously made imported milk less attractive to UK processors and driven them to fight a little more aggressively for milk closer to home. As a consequence their raw material costs have unavoidably increased.

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Processors are faced with a dilemma; increase farm gate prices to stimulate production and buy from a continuing high spot price and European milk market or keep the farm gate price low to keep their average raw material cost down?

In reality they do not need to stimulate the market to produce more milk, the high spot price is already doing that for them. Increase trade in milking cows is evidence of this. Many producers and commentators are postulating a turn around.

In the current situation the processors have another ace up their sleeve. The milk they are buying from direct suppliers can be traded at a healthy differential on the spot market creating cash which goes straight to the bottom line.

Why produce more cheese and other dairy products when there are large world stocks? Do not get me wrong I am not criticising them for doing this, it is just business after all.

It is not certain if the current buyout spot price market is going to turn the market around for all. Remember it is a consequence of a local UK phenomenon; processors still have to sell their produce on a world market.

The GDT

The GDT market is probably one of the best barometers of the world dairy market. The GDT market has, at best been flat to slightly positive since the middle of the first quarter. Historically, from its lowest point the GDT needs around 26 weeks or 13 auctions of positive result to turn from low milk price to a high milk price.

This week’s decisive increase was a welcome sight; up 6% for all commodities traded.

And then there is the issue of a pan European milk pool which is designed to pay a level milk price across Europe to all its members regardless of country and exchange rates. At present our spot milk price is well above that of the milk price on the continent but this means nothing if you are selling into a cooperative with a European milk pool.

Remember the recent supermarket issue regarding a bonus paid to suppliers being distributed throughout Europe? What effect does the currency exchange rate have on this arrangement? If the price is set in euros then I would imagine that UK farmers would be at a disadvantage.

The other issue we have is that a lot of milk and milk products are tied into forward contracts. This will be holding price rises back for some producers on certain contracts. This is an unwelcome caveat in light of the apparent rise in the spot markets and the optimism this has created.

However, it is because of the high spot price and forward selling agreements that they are unwilling to raise the milk price as obviously this will raise the average price they are paying for their raw material and put pressure on their margins.

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Selling milk on the spot is probably one of the best places to be in a rising market, and rightly so. These producers have been some of the dairy men hardest hit by the current milk price crisis and undoubtedly deserve a milk price rise; as do we all.

Then there are those producers that have been on AB pricing arrangements. Hopefully now things should turn in their favour and the B price should exceed the A price. It will be interesting to see if these arrangements are being honoured and the sort of B prices being paid.

In reality does our dairy supply chain really work? The whole dairy industry from primary producer and raw material suppliers through to retailers, in most cases, lack an understanding or choose not to understand the requirements of everyone in the supply chain. In the language of the Theory of Constraints (TOC) they lack an understanding of each other’s UDE’s or undesirable effects.

Aligned contracts are of course an exception but even these do not go far enough as they do not include the feed suppliers. Yes they are aligned to feed prices but do they care if the arable farmer is losing money? Probably not! Using the theory of constraints methodology previously championed by the physicist turned business analyst Eliyau Goldratt I have constructed numerous reality trees in order to identify core problems within the industry.

Regardless of production systems in the current economic situation, milk price is the core issue. That’s no great revelation, however begin to drill further down and the core issue is directly related to the milk buyers inability to recognise the true value of a strong profitable supply chain. However, having said that it is important that the industry works to raise its customer’s perception of their value.

Value to the buyer is anything that addresses its own UDE’s. For example supply pattern, quality, methods of production etc. Sounds familiar? Sounds simplistic but there may possibly be other UDE’s we are not aware of but we can help our milk buyers and even the consumer to address.

Quite simply the goal must be a supply chain that does not have to bring its primary producers to its knees in order to balance supply and demand and pay a sustainable price.

The upward trend in the UK raw materials markets is likely to cancel out some of the current improvements in milk price currently being experienced. The decline in the value of the pound against the dollar has reduced the UK’s buying power by at least 20%. Remember, all commodities are traded in US dollars and as a result feed prices will rise by the same amount.

On a positive note the pain we have endured during the last two years has made us more efficient and focused on cutting costs. As a result most dairy farmers now have production costs at an unprecedented low.

Finally the EU comes out with a support package to support EU farmers, or at least a way of cutting production to stimulate the market. It is reported that this will include a payment for reducing production. Farmers will be paid around 12ppl for any litres produced under last year’s production. Talk about closing the stable door after the horse has bolted!

Conclusion

To conclude on a positive note, milk price is now heading in the right direction. It will take time to reach a level that will allow the majority of producers to begin generating profits and repaying the debt they have accumulated over the past months.

There are plenty of signs indicating that the dairy commodity markets are also poised for an upturn. This will undoubtedly increase the confidence the processors have in the markets giving them the confidence to raise milk prices to direct suppliers. As processors come to the end of forward contracts the price can only go one way. Maybe it is time that the primary producer used forward selling to iron out the inevitable future volatility.

Dr Huw McConochie

Head of Dairy Technical Services

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