May 9, 2018

Dairy Farmers Curb Volatility With Futures Markets

 |  By: Anna-Lisa Laca

The dairy industry has been subject to volatile markets for generations. The old saying the dairy business will lift you up two years and down three rings true still today. However, the swings have become deeper and faster than they were for past generations. To cope, many farmers are using futures markets to hedge their bets and take some risk off the table.

Corn farmers have been using futures markets to stabilize prices for decades but the practice has become popular for dairy farmers more recently. A Bloomberg Business story outlines why hedging milk is becoming a common practice.

“Risks and volatility continue to mount for all farmers, especially in the dairy industry,” according to Dave Kurzawski, a senior broker at INTL FCStone in Chicago, quoted in the story. “Many farmers faced losses during the first quarter, and while milk futures prices have been rising recently, that doesn’t necessarily indicate profit this year given that feed and labor costs are also increasing,” Kurzawski says. “And prices are constantly shifting.”

The CME initiated a market for dairy derivatives in 1996, starting with Class III milk. Today there are futures markets for milk, cheese, nonfat dry milk and butter. But despite their growth in popularity, there are fewer than 250,000 futures and options contracts on the market for all dairy products. That’s compared to 1.7 million corn futures contracts on the market today.

“I now feel the money is better used to contract direct on the futures market,” says David Pyle, a dairy farmer from Pennsylvania. “Although we contract directly through our co-op and not with a broker, we learn and adapt as we have gotten more comfortable for what works for us.”

Still, the majority of farmers surveyed in a 2016 Milk Intelligence survey said they don’t use marketing to protect milk income. More than 57% said they don’t use milk hedging. Only 28% of the surveyed farmers who are hedging milk reported hedging 50% of their milk or more. Most analysts recommend hedging 50% of a farm’s milk production either through a broker or directly through the producer’s co-op.

Controlling feed costs through hedging is more common. More than 65% of the farmers surveyed said they hedge at least 25% of their feed. While some farmers complain hedging doesn’t make them any money, Michael Sumners, a dairy farmer from Tennessee, reminds producers the No. 1 goal of risk management isn’t income. “Risk management keeps you from losing money,” he says. “It is not a revenue source.”