Dairy industry must unite to boost futures market liquidity

(Agrimoney) – The dairy industry should unite to boost liquidity in the New Zealand whole milk powder futures market, the Commonwealth Bank of Australia said.

Given the highly volatile spot market in dairy products, producers need access to reliable price hedging, the CBA said.

And the New Zealand Exchange’s whole milk powder contract is best placed to provide a bench mark for price hedging, as long as its booming liquidity is sustained.

“Desire alone though will not create liquidity,” the CBA warned.

NZX offers best hope

The CBA noted the possibility for a highly liquid whole milk powder futures market to be become the benchmark for all dairy prices, with price contracts based on an agreed premium or discount to the whole milk powder price.

Whole milk powder is well suited for that task, as it responds very rapidly to global supply and demand shifts.

“With a well-functioning market, price spreads between whole milk power and other products would become more standardised and trade within established ranges most of the time,” the bank said.

And the NZX whole milk powder futures contract offers the best chance for a liquid milk market.

Volumes soar

The volumes of whole milk powder traded on NZX have risen by 17-fold since 2011, and represents the most popular futures contract in dairy.

New Zealand is the world’s top milk exporter, and exports a very high proportion of its milk.

Also, a large quantity of New Zealand milk production goes to making commodity milk powder, rather than premium and value added products.

This means that New Zealand prices are unusually exposed the global supply and demand dynamics.

‘Natural product to exchange’

The CBA noted that whole milk powder is better placed to act as a benchmark commodity, as global demand growth is being driven in regions where liquid milk is hart to obtain.

And whole milk powder has the widest range of applications for food processors, compared to more specialised products.

“For milk processors and users alike, whole milk powder offers the least need to commit to particular products and so is the natural product for these parties to exchange,” the banks said.

Predicating spot prices

The CBA said that the NZX whole milk powder futures contract was becoming more accurate at predicting spot prices at GlobalDairyTrade auctions.

The auctions are held bi-monthly, and run by New Zealand’s largest co-operative Fonterra.

“The futures market is matching the GDT auctions when it matters,” the banks said.

Price hedging

A more liquid futures market would benefit the industry by making it easy to forward sell milk, the CBA said.

“Processors would have the means to fix the prices for a greater proportion of their throughput ahead of time.”

And consumers, such as food processers, would also benefit from the ability to lock-in the price of powder.

Incremental changes

But the CBA said that despite these successes, the contract was still not liquid enough.

“In our view the industry needs to focus its attention on facilitating the NZX’s whole milk powder futures’ journey to becoming liquid,” the bank said.

The bank called for incremental changes, based on suggestions from around the industry, but flagged the potential to reduce the number of contracts traded, concentrating liquidity.