Kraft split – but what happens to the cheese?

It’s a surprise move from US giant Kraft splitting the cash cow of the American Grocery brands from the high growth ‘snack’ brands targeted the later at developing markets, (including Europe).  Clearly the split makes sense from an investment view point, and its easy to see that there are investors who want “steady dividends” generated from US grocery cash cows, and those who want rapid capital growth, which might be raised from emerging market ‘snack’ sales. And, shouldn’t the investor make the decision of what type of return he, or she, wants, rather than management deciding on the level of ‘risk’ to shareholder funds once the money has been invested?

However, what about all of the advantages of size? Does this split mean, (just as consolidation is rife elsewhere in the food and drink sector) that Kraft have discovered that there are no ‘economies of scale’ in the food sector after all, and are we about to see lots of demergers unravelling all of the mergers to date?

And where will cheese fit in? Kraft cheeses have been a staple in the market both inside and outside the USA, and Cheese could be ‘snack’ or a ‘grocery’……

By all accounts, Kraft have “taken their eye off the cheese ball” recently, with sales of Kraft processed cheeses suffering some heavy declines in the North American market  over the past few years. Price increases needed to cover raw material costs will not have helped that, and there may be more to come.

The exception in terms of performance is ‘Philadelphia’ which is a rising star and doing well both inside and outside the states and has recently launched in the big cheese market of France. The plan is for ‘Philadelphia’ to be part of the American grocery business and it is not clear if
this will mean that it will reduce its presence elsewhere in the world. If so it will certainly create space in the Fresh Cheese market for others……

India – the biggest gets bigger

First published in Dairy Innovation Magazine

The growth of the Indian economy is impressive by any measure. The
9% GDP growth achieved in 2010
(currently forcast at above 8.5% for 2011), is predicted by Finance Minister Dr. Pranab Mukherjee, to
rise to 10% shortly this will place it ahead of China as the worlds fastest
growing economy with a retail market growing at 25% annually.

Of the BRIC countries, in the world of Food and Beverage, India is
likely to offer the greatest potential for
growth over the next 20 years.
According to UN projections the adult population in India will increase
by a 240 millions over the next two decades, compared with 20 m in Brazil. The
adult population of Russia, by contrast, will decline sharply by almost 20 m
and China’s will peak in 2015 and then gradually decline. By 2030, India is
forecast to overtaken China as the world’s most populous country. In addition
the rate of urbanisation in India is predicted by the UN to be maintained at
above 2.4% until 2030 with China’s rate of urbanisation falling to 1.2% in the
same period. At the same time, the OECD estimate that, over the next 30 years
that, using the World Banks definition, the ‘middle classes’ in India will
expand, from below 10% of the population currently, to over 90%. As a result
The food and beverage sector is already seeing dramatic impacts Coke cola, for
example, reported a 22% increase in sales across India in the second quarter
2010. The Asian Bottled Water Association report that he Indian bottled water
market is currently growing at 60% per year.

 

India is worlds biggest producer of milk with annual production of
111.11 m tonnes which in 2009/10 contributed around 8% of the country’s GDP.
The current growth in dairy production of 3.19%, surprisingly continued through
the drought of 2009, but is according to the India Dairy Association, still around
3% lower than the growth in demand forcing up prices and sucking in imports. In
the past two years, milk prices have risen from Rs 17 a litre to Rs 27 a litre.
While the percentage growth of products is not as high as in such
countries as Brazil and China the size of the market makes the total volume
growth bigger.  However, despite the
growth in demand India in the past a big importer of milk and dairy products.

 

The aim, and the need, in the coming decades is clearly to expand
production to meet the increased need of the urbanised middle classes.  Growing and intensification of the dairy
sector may be problematic. Much of the current production, around 55%, is
buffalo milk (India produces over 90% of the worlds supply from Buffalos), and
the majority of milk is produced in the informal sector by small holders and
landless labourers who are grouped into village co-operatives at village level
(in 2007 the NSSO in India reported that 69% of milk was produced on farmers of
less than 2Ha). The market itself is also complex. To provide
them a steady market and a reasonable price for the milk produced, about 13.90 million farmers are brought under
the ambit of 133349 village level cooperative societies.

 

Operation Flood,  a programme
initiated by National Dairy Development Board in 1970, was the previous major
initiative to develop India’s Dairy Industry from stagnation to success and
operated until 1998. Indeed, Operation Flood led to the growth of dairy
industry in India, and helped India become the world’s largest milk producer.

To build on
the success of Operation Flood, and to take the dairy cooperative movement
further, the Government of India, through the National Dairy Development
Board(NDDB) has now approved a new National Dairy plan, “Perspective 2010”.

Perspective 2010 is a plan, to be funded by a soft lone from the
World Bank,  which will have an outlay of
more than Rs. 17,300 crore ($3,650 million) to achieve a target of 180 million
tonnes of milk production annually by 2021-22 across the 14 key dairying states.
Milk production is expected to grow at 4% giving an annual incremental output
of 5 million tonnes in the next 15 years. The NDDP plan
envisages that the project will do everything from increasing cattle and
buffalo productivity, to expanding coverage of milk producers, procurement and
processing through four ‘thrust’ areas, ‘Quality Assurance’, ‘Productivity
Enhancement’, ‘Institution Building’ and providing a ‘National Information
Network’. By the end of the operation 65% of the milk should pass
through the formal sector compared to 30% now. To cope with the additional processing in the
formal sector the plan will expand milk processing capacity by an
additional 60 million kg per day, expand drying capacity by an additional 1200
metric tonnes per day, and refurbish existing processing capacity with an
outlay estimated at about US $ 2300 million.

In the first phase ‘Perspective 2010’ will focus on the six key
dairying states; Gujarat, Punjab, Karnataka, Uttar Pradesh, Bihar, and
Maharashtra.  Currently these states are
amending their co-operative law to meet the demands of the project. The NDDB
has set up a new organisation, “NDDB Dairy Services” with its headquarters in
New Delhi to implement the plan. The new body is headed by the impressive figure
of Ms Sangeeta Talwar as Managing Director, previously of Tata Tea and Nestle,
and famed for spearheading the celebrated
‘Jaago Re’ campaign which was aimed  at
developing young peoples views on issues like voting and corruption, she
will be responsible for all aspects of Perspective 2010’s role out and the
formation of implementation bodies within the states.

Although India is striving to maintain its self sufficiency the
continued population growth, urbanisation and growth of the middle classes
leads to the conclusion that India will become a major target for exporters in
future years and that it must become an attractive target for inward investment
developing the formal milk sector and serving the newly well off population.

Global Dairy Top 10

First published in Dairy Innovation Magazine

The dairy world continues to cautiously get back to normal after the price shocks of 2008/9, it is interesting to note that the collective turnover of the Top 10 dairy companies in the world shrank by $13.5Bn between 2008 and 2009 an average of 10.5%, and that many of them have taken great care to strengthen their balance sheets as they recover from recession.

In the near future, it seems highly likely that the process of globalisation will continue and again start to gain momentum. Dairy remains one of the fastest growing food sectors around the globe and there is a big gap to fill between the average consumption of dairy products in developing markets of 51Kg per year and the average of 268kg per year consumed in developed markets. As the trend in these markets for consumers to be more urban, wealthy and middle class, continues there is a growing acceptance of the nutrition and health benefits of dairy which coupled with a developing palate for western diets continues to drive increases in demand.

As indicated by this years Top 20 list published in July by Rabobank,  with notable exceptions it is multi national companies from developed markets who, through joint ventures and acquisitions, are benefiting from the growth in developing markets bringing their technical ability to quickly adapt to the changing desires and providing food safety reassurance to new these consumers.

The Top 10 ranking has changed little from 2009 but there are some notable changes in those challenging to be in the list with Asian companies creeping up the list as the Asian markets continue to dominate world growth.

The increase in international trade which increasingly  fills the gap as demand outstrips supply in developing countries together with the ebbs and flows of supply and demand for products and inputs continues to lead to increased market volatility which in turn continues to encourage further consolidation another trend which is set to continue.

Nestle (Dairy Turnover 2009 – 25.9BN USD)
Expanding based on Health and Nutrition in developing markets

Nestle  continues to be the biggest dairy company in the world. During 2010 the reins of the dairy SBU (Strategic Business Unit) passed from the assured hands of Tom Coley, who had run the business since 2002,  to Thierry Philardeau previously a senior player in Nestles water business . As the worlds biggest food company Nestle sets major trends in the way that the market is seen, Paul Bulcke (CEO) this year reaffirmed the companies commitment to nutrition and health as their key marketing thread. This has been particularly impactful in developing markets where the companies ‘Creating Shared Value’ initiative is seeking to provide improved nutrition to people in developing markets at affordable prices. Nestles focus on developing new markets is reflected in the recent announcement  of an investment of $100m in co-operating with Fonterra in the building of a dairy plant in Chile.

Danone (Dairy Turnover 2009 – 14.8BN USD)
Biggest Fresh Milk milk supplier expanding though acquisition in Russia and CIS

At number two in the overall dairy ranking Danone continues to be the biggest supplier of fresh dairy products around the world. Danone has also had a change in management during the year with Jordi Constans being named as Head of fresh dairy products. As an organisation in 2010 Danone have increased their focused on Health and Nutrition in which dairy plays a major part despite continued difficulties in getting claims regarding its probiotic products recognised by the European authorities. In addition, after a previous association with Wimm Bill Dann, owning an 18% stake which they quickly divested this year Danone have now acquired Unimilk, making Russia and the CIS their biggest market.

Lactalis (Dairy Turnover 2009 – 12.7BN USD)
French Dairy company aiming to be worlds leading cheese company through acquisition

Although French, Lactalis now does most of its business (56%) outside France. This year the company has continued a steady international growth. The purchase of Spanish company Puleva Foods buy out is the latest in a string of acquisitions for Lactalis, including the Italian cheese company Galbani, U.S. company Rondele, Lubborn creamery and Spanish company Forlasa Alimentación. Lactalis has had a long term acquisition strategy aimed at making it the worlds leading cheese company, however more recently they have shown an interest in the French Yoghurt maker Yoplait.

Friesland Campina (Dairy Turnover 2009 – 11.2BN USD)
Dutch giant co-operative continues to consolidate assets after merger

Friesland Campina have continued with the significant reorganisation of the business since the merger of the two major Dutch co-operatives continuing with the planned closure of 6 sites and the merger of R&D facilities at Wageningen. Despite the focus on re-organisation the company posted strong growth for the first half of the year mainly due to strong performance in its Asian and African markets which grew by 15.9% rather than Europe where growth was disappointing. Cee’s t’Hart the CEO in setting out the companies strategy until 2020 envisages growth in dairy-based beverages, branded cheeses and infant and toddler nutrition ingredients as it plans to target previously unexplored markets in the Middle East, North Africa and South East Europe.

Fonterra (Dairy Turnover 2009 – 10.2BN USD)
Revised capital structure and reduction of debt put co-op in strong position

Fonterra have had a successful year making the second biggest payout to farmers in its existence. The Board have also been able to persuade members to adopt a new capital structure allowing share trading between farmers requiring the co-op to have less capital on hand to manage this, and during the year have significantly reduced their gearing through further farmer investment. This will allow Fonterra to invest further in infrastructure to support its global business for example the $100m joint investment with Nestle in Chile. However, while becoming one of the most competitive global players, Fonterra complain that they still have to supply domestic competitors some of whom are foreign owned, with milk from their producers under the Dairy Industry Restructuring Act

Dean (Dairy Turnover 2009 – 9.7BN USD)
Increasingly difficult trading conditions impact biggest US player

While maintaining its position as the biggest US dairy company Dean, which owns Horizon, Alta Dena, Garelick, McArthur and other dairy brands nationwide, is struggling with a shift toward private-label milk consumption, excess capacity in the industry and price cuts it made to appease consumers and retailers. Both Fitch and S&P the two big credit rating agencies have downgraded Dean’s credit rating recently and the company has seen third quarter profits drop by three quarters. The companies Fresh Dairy Direct-Morningstar businesses have been particularly hit as supermarkets have sought to reduce prices throughout the current recession. Interestingly the company’s soya beverage subsidiary Whitewave which successfully acquired Belgian company Alpro last year bucked this trend continues to generate respectable profits.

Arla Foods (Dairy Turnover 2009 – 8.7BN USD)
Danish co-op saves its money to strengthens investment in developing markets

Arla’s key approach to recovering from the recession and market turmoil has been to save money and build its balance sheet strength. By it’s own admission the company has paid a lower milk price than many of its members would have liked. However the company is now well positioned and starting to make investments in key markets such as the Netherlands, Sweden, South America and the UK, announcing a £150m dairy in Aylesbury and investment at the UK Westbury powder plant. Such investments are designed to maintain their position as a world player.  The prudent approach to finance together with the companies strong branding linking them ‘Closer to Nature’ has been very positive throughout the year. The company has also changed the basis by which Swedish milk prices are paid to try to overcome their lack of competitiveness caused by currency changes to maintain one of its key home markets. However to remain in the global league, at some point Arla may have to address its capital structure in a similar way to Fonterra to provide the level of investment required.

DFA (Dairy Turnover 2009 – 8.1BN USD)
US co-op morns loss of leader while looking at the future market

Dairy Farmers of America, Inc. overcame the sad news in December 2010 that its Chairman, and industry titan Tom Camerlo had lost his fight with cancer with Randy Mooney, previously Vice Chair elected as Chair.  The company retains about 30 processing sites after the sale of its National Dairy Holdings business to Mexican company Lala during 2009. In 2010 DFA have expanded into the growing Hispanic cheese market with the purchase of Houston based Castro Cheese. DFA which is responsible for the purchase of about one third of all milk in the US and is a major supplier to Dean Foods has spent much of the year in 2010 recovering from the very difficult year experienced by members in 2009 when market volatility led to poor prices. As a result of this DFA have a major interest and involvement in the ’Foundation for the Future’ proposals from National Milk Producers Federation to change the basis for the market of raw milk in the US.

Kraft (Dairy Turnover 2009 – 6.8BN USD)
US food giant recovers from difficult time with cheese

Kraft is the biggest U.S. manufacturer and marketer of food products, second to Nestle around the globe. It grew out of a wholesale cheese delivery business established in Chicago in 1903 and growing rapidly by supplying American forces in both World Wars. Kraft have focused on the controversial takeover of UK chocolate maker Cadburys recently moving the holding company of the business to Switzerland to avoid paying UK tax. US Cheese revenues, representing 6% of Kraft’s total turnover were down by 10,1% in 2010 leading to more than an 18.1 drop in operating margin from US cheese indicating the difficulties which the market has been through over the last couple of years. However, the US cheese market is showing signs of recovery, and the re-packaging of its Philadelphia brand may lead to an improvement in Kraft’s performance in this area next year.

Unilever(Dairy Turnover 2009 – 6.4BN USD)
Anglo-Dutch conglomerate continues to indulge itself with ice cream

The Anglo-Dutch giant Unilever while being one of the biggest dairy companies in the world by merit of its Ice Cream businesses sometimes has an uncomfortable relationship with the rest of the sector with its approach to such issues as trans fatty acid labelling and claims made about its yellow fat products. Unilever compete aggressively with Nestle in the $59Bn global ice cream markets with brands such as Ben and Jerry and Magnum, investing in R&D to provide healthier options for indulgence. Together Unilever and Nestle control over one third of the global market for Ice cream. With the ice cream market in countries such as India expanding at around 20% per year Unilever are well placed to take advantage of this key indulgence market.

Russian reverberations – Lip-smakin’-thirst-quenching –MILK!!

(Article written for Dairy Innovation Magazine – Issue 35 February 2011).

In what was to many a surprise move, PepsiCo announced in December that they had agreed to pay $3.8Bn to buy a controlling stake in Wimm Bill Dann, Russia’s biggest dairy company. Insiders report that they plan to complete the purchase of the whole company for a huge $5.4Bn by mid year 2011. It makes Russia Pepsico’s biggest international market, and makes them the biggest food and drink company in Russia. The deal, which is notable as it is the biggest deal ever in the Russian market outside the energy sector, was made possible by the sale of its 18% share in Wimm Bill Dann, earlier in 2010, by French dairy giant DANONE. Interestingly, the price which DANONE sold its stake for valued the company at slightly over $2.5Bn (under half the value which PepsiCo have now put on it). All this leads you to believe that Pepsico really wanted this big step to happen! Wimm Bill Dann, who’s turnover in 2009/10 was $2.4Bn has been expanding rapidly in recent years and is undoubtedly a success story, and the Russian economy has expanded at over 7% per year in the last decade, but why would PepsiCo want to buy a Russian dairy company so much?
Many commentators have focused on the juice market. Certainly, using Wimm Bill Dann’s juice business allows PepsiCo to continue its age old duel with Coca-Cola by becoming the leader in Russian juice. Combining its previous Lebedyanski juice sales with Wimm Bill Dann’s will give Pepsico a 42% market share compared to Coke, with its Multon and Nidan subsidiaries, having about 35% of the market. But this is clearly not the whole story.
The change in dynamics in Pepsico’s Russian business seems to reflect a change across its thinking globally. Prior to the move Pepsico’s turnover in Russia relied on its beverage and soda products (41% of turnover) and juice (27%) with a small footprint in snacks. Now 47% will come from dairy. PepsiCo CEO, Indra Nooyi, says “dairy has huge untapped potential to bridge snacks and beverages. We see the emerging opportunities to ‘snackify’ beverages and ‘drinkify’ snacks as the next frontiers in food and beverage convenience”. She also talks about health and nutrition as a key priority with sustainable growth including the need for “healthy consumers” reflecting their mission statement “Performance with purpose”. Pepsico, the second biggest food and drinks company in the world, appear to take their responsibility to human sustainability very seriously, Jaya Kuman who heads up their recently formed Global Nutrition Platform has set out an impressive plan to expand their “Good for you” nutrition business, including fruit and veg, whole grains, functional nutrition and low fat dairy, from $10Bn to $30Bn by 2020. He also has plans to reduce the amount of salt, added sugars and certain fats by 25% by the end of the plan. Nor is it only in developed markets that Nutrition features, Mehmood Khan, the companies R&D chief, talks about the opportunities for hygienically and nutritionally enhanced dairy as an opportunity of improving nutrition in developing markets.
Of course, this is not Pepsico’s first foray into dairy. In 2009 the company entered into a joint venture with Almarai, the Saudi Arabian dairy concern, forming “International Dairy and Juice Ltd.” in which Pepsico have a 52% share to Almarai’s 48%. Part of the agreement is that the company will not trade in the countries of the Gulf Co-operation Council which form Almarai’s home markets, but has already acquired subsidiaries in Jordan (Teeba) and Egypt (Begti). Together with Wimm-Bill-Dann the company now has an excellent chance to expand its dairy and juice operations across the Middle East and Asian regions.
PepsiCo may find the dairy sector in Russia altogether more challenging. Competition is increasing across both traditional dairy categories and new value added ones. DANONE’s purchase of Unimilk means that Russia is now its biggest market and they too are looking to establish their health adn nutrition credentials. Regional companies are continuously improving the quality of their products and packaging and seeking to expand their coverage of the market. Innovation is proving vital in this rapidly developing market of 142m consumers with increasing disposable incomes. Wimm-Bill-Dann themselves have a programme to increase turnover by $650m by 2015 and launched 70 new sku’s in 2010 alone including a new cheese ‘Granfor’ and shortly a new product aimed at reducing blood pressure.
The Russian market itself has been turbulent over the past year with the Chief Executive of the Federal Anti-Monopoly service (FAS) Teymuraz Kharitonashvili, accusing dairy companies of “price gouging” due to the claimed gap between the price received by producers, of 11.5 roubles, compared to the price paid by retailers of 32 roubles (about $1). (A 70:30 split in favour of the processor). Head of Russian Dairy Union, Vladimir Labinov, argues that the case has been overstated and that the value along the supply chain goes 40% to farmers, 28% to processors, and 32% retailers. But there have been reports last year of retailers such as Seventh Continent a retail chain tearing up their contract with Danone/Unimilk due to unacceptable price hikes. There have even been threats of government intervention using their ability to fine companies 1.5% of revenue for unacceptable price increases. Competition for raw material is also likely to be an issue with the cost and availability of fodder being affected by last years drought in Russia reducing production in Russia by 1.5% from 2009.
PepsiCo’s move into Russia signals a highly strategic move for the company which will undoubtedly change the way we think about the dairy sector in future. The fact that they have moved in the way they have demonstrates the important contribution of dairy to world nutrition in coming years. It also demonstrates that dairy remains one of the most exciting industries around the world not just for traditional dairy companies but the food and drink sector as a whole.

Could Gordon Gecko trade milk?

“Could Gordon Gecko trade milk?” That was the question when I chaired the Dairy Pricing Risk Management Seminar which Zenith International held in conjunction with our good friends at FC stone this week. Would his macho approach be enough when over the past 20 years volatility in dairy prices has :

• Been over 33% more than equities.
• Grown by an average of 400% (comparing the first decade to the second).
• Been second only to Wheat in commodity products.

That’s  what’s driving the exchanges to develop products with three of the top four exchanges around the world now offering dairy futures contracts (CME, Eurex and NYSE Euronext). This week the launch of the NZX dairy futures market see www.nzxfutures.com with early trading accomplished.  There are also a number of Over the Counter bi-lateral deals to be made.

The attendance was excellent with a wide range of companies from across Europe attending. The aim of the day was to provide a practical guide to companies wanting to start developing a risk management system, and some were clearly moving in that direction.  What I thought was really excellent, as well as the “How to” guides from the traders was the three presentations from companies who are already doing the risk management ‘thing’ (Fonterra, Glanbia and Schreiber), who gave an excellent and honest view of the drivers, prospects and pitfalls of starting to hedge.

The key stages in building a company strategy emerging from these sessions were:

• Identify what the risk really is in business terms?
• Decide on the appetite for risk?
• Have a governance structure – avoid rouge traders!
• Identify the tools
• Educate the staff involved
• Decide on clear objectives
• Execute the plan – and don’t be tempted to speculate along the way!

The key advice from the three companies was:

• Start early
  If managing volatility is coming then getting at least a foot on the learning curve early is sensible to give time to develop a system for you.
• Be cautious
  Start small and build up over time
• View as insurance not income generation
  This is not about making money this is about locking in expected profit and avoiding the effect of volatility. It is easy to start speculating don’t do it!

Its still early days for these systems, and everyone should at least consider using the markets. Only in this way will there be enough liquidity to make the market usable and to get the effect we need in dampening excessive volatility. So “Who should get into the market first?”, everyone should.  It was clear from those clustered around the brokers at the end of the seminar that more will enter the market over the coming months, but progress should be viewed over the medium term of two to three years as continued market deregulation occurs and these new markets come into their own.

Speakers at the Zenith International / FC Stone Seminar on ‘Risk Management for European Dairy Pricing’ this week in Amsterdam.

We have global agreement – ‘there is a problem!’

It seems like an echo around the globe……from USA, to Europe to Oceania. As Dr Charles Nicholson from California Polytechnic State University said this week to the US Dairy Industry Advisory Committee (DIAC), the US equivalent of the High Level Dairy Group in Europe, on the subject of market volatility, “there is and issue, there is a problem”. At the same time the European Council of Agricultural Ministers was signing up to the recommendations of the European High Level Dairy group which contained recommendations to nurture means of coping with market volatility. Meanwhile Paul Campbell, Strategy Manager from New Zealand processor Fonterra, argued in a speech to a groups of UK farmers this week that “there would be increasing volatility though the next five years”. 

With world production set to increase by over 20% in the next ten years, driven by increases in production in India, China and South America (and probably Africa), compounded by the effects of climate change, population growth, urbanisation, market liberalisation and shifts in trade balance, frankly, it would be a miracle if volatility were not to increase.

So what should be done about it. Most economists would suggest that if markets are left to their own devises they will develop mechanisms to cope. For example the launch of another futures market by NYSE LIFFE for Skimmed Milk Powder on October  18. I have also been frequently amazed just how price responsive farmers around the globe can be if the price is right.

In fact the trouble with high level groups and committees of Ministers and their administrators is that they have to be seen to act. In the US three measures are being considered; the Costas/Sanders Act; a marginal milk pricing programme; and a Foundation for the Future programme, which would seek to manage increased production across the industry. In recent weeks in Europe we have seen, in particular the French and the Germans fighting a rearguard action to question the abolition of quotas and ensure guarantee of farm incomes. While all of these policies are no doubt driven by worthy socio-economic arguments and political reality until these is some certainty of how the market will operate it is difficult for companies to develop commercial strategies to mitigate risk.

The attendance at the seminar I am chairing this week in Amsterdam for Zenith International which has engaged considerable interest from the commercial sector across Europe is evidence that the commercial sector is dealing with the issue. The real risk, as highlighted by Dr Charles Nicholson is that government intervention in one part of the supply chain will leave produce surplus stocks which overhang the market and make the process of managing risk more rather than less complex. Lets hope the politicians develop solutions which support the current commercial efforts rather than undermine them.

Why take the risk with dairy?

Since 1997 the Chicago Mercantile Exchange (CME) has been operating a market in butter and skim milk powder futures – trade has been steady but by no means overwhelming. In 2010, fanned by the fire of multiple analysts reports predicting continued and increased volatility and the roller coaster market ride of the last two years, the number of markets and financial tools for managing risk in dairy products has rapidly expanded. (Eurex in Frankfort launched their futures markets in butter and SMP in May; the NZX in New Zealand will launch a WMP futures market from October, CME also launched alternative tools earlier in the year).

And is anybody using these markets…..? It appears not!

So given the recent experience and the predictions for the future, the likely impact of, for example; rising input prices; uncertainty of demand caused by the current economic situation; the La Niña weather phenomenon currently affecting the Pacific region; and, other future, as yet unknown, supply and demand shocks caused by climate change or other reasons; why do companies “take the risk with dairy”?

Talking to companies at last weeks European Dairy Association, World Dairy Forum a number of answers seem to emerge.

• Time and cost to implement – Futures and Options can be complex to trade in, and require resources, capital and experience to use successfully. Particularly in Europe there has been a lot of theory talked about risk management but practice is thin on the ground. At a time when most resources are stretched, few companies are making the commitment required.
• Uncertainty over government response – The European Commission responded to the huge market fluctuations experienced over 2008/9  by changing the dairy market rules; re-introducing export refunds; changing intervention arrangement; and, providing substantial aid packages. While there were understandable political and social reasons for intervening the moves will have impacted the outcome of any futures trades over the period. Pre-guessing such moves, of course, makes operating a successful risk management process more difficult.
• Risk along the supply chain – Degree of exposure to risk varies along the supply chain, however in many of dairy supply chains it is possible in the short term to manage risk by adjusting the price of raw material purchase. i.e. pay the farmers less. This is possible due to the relative inelasticity of supply. Farmers access to complex financial instruments like dairy futures is as yet limited.
• Exchange rate fluctuations – Until recently it has only being possible to use futures with the added risk of currency fluctuations. In places like the UK and Australia this is still the case. Managing this additional risk acts as a further barrier to companies getting involved.

So will the Futures markets die off through neglect?

My guess is, probably not…… The establishment of the new markets will make the facilities more available to companies around the globe and liquidity in these markets will increase over time. All signs point to a continued trend towards de-regulating markets, albeit with the political will to protect producers in the process and the long term consolidated supply base making supply much more responsive to market situations. All this points to a need for commercial players to become more experienced at managing commercial risk, as happens in many other free markets.

In their 2009 report “Price Volatility in the EU Dairy Industry: Causes,Consequences and Coping Mechanisms” prepared for the EDA,Dr Michael Keane  and Dr Declan O Connor PhD concluded:

“As the EU dairy sector is now emerging into a more free market situation, it is likely with appropriate support that a successful futures market can evolve for dairying also. This would be of considerable benefit to industry participants in facilitating enhanced risk management at a time of increased price volatility. However a successful futures market for dairy commodities is likely to require considerable nurturing and support in its initial stages, both from institutional authorities and from the industry itself”.

I myself am going to play my own small part in the nurturing process by chairing a seminar on “Risk Management for European dairy pricing – benefits and challenges” which will be held on the 12 October at the Renaissance Hotel in Amsterdam. For more information on this, and other events being hosted by Zenith International please visit: www.zenithinternational.com/events/event_details.asp?id=105