Securing returns: The benefits of milk price hedging

Findex Accounting & Business Advisory

With milk price volatility a persistent challenge for dairy farmers, Findex Associate Partner - Accounting & Business Advisory, Rachel Fraser, emphasises that hedging strategies can safeguard income.

“Farmers already fix their interest rates and feed costs, which are major inputs,” she says. “But the dairy payout is the biggest driver of profitability outside of production, so there’s no reason not to consider hedging against milk price fluctuations. With access to multiple hedging products, careful strategies can provide greater pricing certainty.”

Hedging is not just about fixing the milk price; it can also be like an insurance policy where a premium is paid to protect against low milk price payouts. “You trade a known cost for protection from a potentially larger loss, investing in certainty,” Fraser explains.

Unlike the past, when farmers relied on fixed prices from processors like Fonterra or Open Country Dairy (OCD), today’s options include milk price futures on the Singapore Exchange (SGX) and derivatives like puts, calls, and collars. These provide flexibility to tailor risk management strategies.

Fraser clarifies that hedging isn’t about chasing the highest price but ensuring consistent returns and shielding businesses from severe downturns. The process begins by calculating a farm’s breakeven point, which includes operating costs, interest, loan repayments, drawings, capital expenditure, and a reasonable return.

“We then design strategies based on risk appetite, explaining the attributes, costs, and cash flow impacts of various hedging products.”

Each financial instrument has unique pros and cons, requiring careful combinations for optimal results.

“These aren’t one-size-fits-all products,” Fraser notes. That’s why they are only used as part of a considered, clearly articulated hedging strategy. And we don’t favour individual products, instead integrating multiple tools contextualised with market pricing and individual farm goals,” she explains.

Many strategies are milk price dependent, necessitating appropriate selection of the underlying hedging instruments. “While protecting against lower-than-expected payouts – the reason for hedging - you want to leave room for upside benefit should the payout turn out higher than expected. We also spread risk by averaging in over time, rather than locking in everything at once,” says Fraser.

While hedging can appear complex, expert advice simplifies it. “If milk prices drop dramatically, there’s no need for farmers to find themselves in trouble,” she says. “The tools are out there, and it doesn’t have to be difficult,” Fraser concludes.