Doug Block, a dairy farmer for 45 years, says he grew up in an era when the price of corn feed for cows fluctuated by just 6¢ a bushel. The U.S. didn’t ship much cheese and butter overseas, and the government often bought cheese to buoy the market when prices sagged. Those days are gone. Block’s business depends on pasture conditions in New Zealand, Europe’s inventories, and China’s milk consumption. He also has to deal with wild swings in the market after the U.S. government scaled back support over the last decade.
So in the past decade or so, Block and others in the dairy business have increasingly been doing what corn farmers have done since at least the late 1800s. They’re hedging with futures, essentially locking in a price down the road. “More and more dairy farmers will participate, because it’s a needed form of risk management,” Block says. And it’s become a booming business: Outstanding futures and options contracts for butter as well as nonfat dry milk reached a record in April, according to CME Group.
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. U.S. farmers are producing record amounts of milk even as Americans drink less of it. 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 way to manage that is to use hedging,” says Kevin Ellis, chief executive officer of Cayuga Milk Ingredients, a processor based in Auburn, N.Y., that sells cream and dairy powders for domestic use and export. The CME initiated dairy derivatives in 1996 with contracts for milk used to make cheese. Futures for other products followed over the years, including nonfat dry milk, butter, and cheese. Still, there are fewer than 250,000 futures and options contracts on the market for all dairy products. That’s small compared with corn, at about 1.7 million for futures alone. And trading in dairy remains relatively less, well, liquid, making it hard for speculators to get large transactions done, says Ari Officer, a Chicago-based trader and partner at a firm called Tres Leches.
But the market is growing globally. New Zealand’s exchange began offering whole milk powder futures contracts in 2010 and butter futures in 2014. Euronext’s dairy market started after the European Union abolished its milk quota system in the spring of 2015. Proprietary trading firms are stepping into dairy futures and options, increasing the number of speculators participating in the market, says Kurzawski. Volume traded on exchanges will equal total milk production by 2025 as more farmers, processors, and speculators jump into the market, according to data from brokerage Rice Dairy LLC. That compares with about 23 percent today.
Although futures can offer farmers some predictability, smaller operations are struggling to keep afloat. Low milk prices have accelerated industry consolidation. Dairies with at least 8,000 cows, once a rarity, are more common because the riskier environment favors operations with economies of scale, says Marshall Hansen, senior vice president for agribusiness finance at Farm Credit Services of America. And those big players are increasingly sophisticated about financial markets. Land O’Lakes Inc., the largest U.S. dairy cooperative, has been steadily increasing its hedging activity, says Beth Ford, a chief operating officer.
Such growth recently prompted Rabobank, the largest agricultural lender, to start its own risk-management desk for dairy. Demand for help with hedging is coming in particular from mega-dairies with thousands of cows. “We’ve got growing supplies and more demand. The highs are getting higher and the lows are getting lower, and costs of production aren’t going down,” says Ryan Yonkman, a broker at Rice Dairy who works with farmer clients. “Every year, we get new customers, and it’s for those reasons.” Milking cows, it turns out, is no work for the fainthearted.
By: Shruti Singh and Lydia Mulvany