NZX Ltd., the operator of New Zealand’s stock exchange, is developing a hedging tool to help dairy farmers protect themselves against volatile milk prices and currency swings.
NZX wants to introduce so-called dairy swaps within the next year, the exchange’s Chief Executive Officer Tim Bennett said in an interview in Wellington. The product will give dairy farmers more price certainty and curb the currency risk they face with NZX’s current futures contract, he said.
The New Zealand dollar has risen 2.5 percent this year, the second best-performing in the Group of 10 currencies, offsetting higher global milk prices. As New Zealand seeks to become Asia’s food basket and boost exports, a third of the economy, younger farmers are expected to borrow heavily to buy properties, making hedging tools more necessary, said Bennett.
“If we want to get young farmers on to the farms, and own those farms, then they will need risk management tools because the lenders will want to reduce the price volatility,” said Bennett. “That’s why this is good for the economy.”
New Zealand’s dairy farmers owe NZ$30.5 billion ($24 billion) on outstanding loans, according to the Reserve Bank of New Zealand’s web site. The average age of the current generation of farmers is almost 60 and many are debt free, meaning there could be significantly more lending in the future as a new generation seeks to buy land, Bennett said.
Auckland-based Fonterra Cooperative Group Ltd., the world’s largest dairy exporter, pays its 10,500 farmer shareholders every month for the milk it receives from them. By using swaps, farmers are effectively buying insurance against falls in that payout caused by swings in commodity prices and currencies.
Hedging tools are designed to give farmers more certainty by allowing them to sell a portion of their product forward at a fixed price. The current futures contract, which has traded 30,000 lots since starting almost two years ago, is linked to the U.S. dollar-based GlobalDairyTrade auction price.
The swaps will ideally be denominated in the local currency and tied to Fonterra’s payout price, Bennett said. While banks have historically been reluctant to offer such swaps, citing a lack of counterparties to match with farmers, that’s changed over the past six months, with rising interest from food groups that want to fix their input costs, according to Bennett.
“If you think about the risk management requirements of the New Zealand dairy farming community, it’s all about trying to buy some fixed price exposure to the payout,” said Bennett.
Whole milk powder prices increased for a third straight time in the latest auction to reach a five-month high, Fonterra said Sept. 5. Powder has risen 18 percent since mid-July as the worst U.S. drought in 56 years curbs supplies and pushes global food prices higher.
Still, Fonterra last month cut the forecast payout to its shareholders for the current season, saying the New Zealand dollar’s strength was more than offsetting higher global prices.
Demand for food commodities including dairy is rising in emerging markets as economic growth lifts incomes and spurs sales of protein-rich meals. World food production will need to expand 70 percent by 2050 as 2 billion people are added to the population, according to the United Nations.
Fonterra said last month it shipped a record 620,000 metric tons of dairy products from May to July after New Zealand milk production rose to an all-time high.
The company, which accounts for about 40 percent of the global trade in dairy products, forecasts milk demand in China will rise 7 percent a year on average by 2020, according to a presentation from CEO Theo Spierings in March.
China’s own supply is estimated to increase about 4 percent a year, creating the opportunity for milk producers to meet the shortfall, he said.