Europe’s nascent dairy futures market has received a much-needed liquidity boost, as concern over a dip in production following a blazing hot summer drives trading volumes higher.
A total of almost 20,000 tonnes worth of skimmed milk powder, butter and whey were traded on the EEX in September, the highest monthly volume on record. Since skimmed milk powder futures were launched in 2010 in Europe, the industry has been waiting for liquidity on the derivatives market to pick up. But brokers and analysts said that the dairy sector, including the traditionally conservative co-operatives, was now becoming more active as they look for ways to hedge themselves against fluctuating prices. “[The European dairy derivatives market] is still illiquid but we are at a tipping point,” said Kevin Bellamy, global dairy sector analyst at Rabobank, a leading lender to agribusinesses.
“Some of the big co-ops are moving into derivatives more quickly,” he added. With key producing regions hit by record temperatures, concerns about supply had been rising. Brexit, which will have a large impact on the UK and Irish dairy sector, is also driving volatility, as well as a desire to mitigate price risk with derivatives, said analysts. “It’s become more obvious to people that high volatility is not going away,” said John Lancaster, senior analyst at commodity brokers INTL FCStone, adding: “The big processors are using the futures to fix their prices and the big retailers are also participants.”
The impact of dairy price volatility became apparent in the mid-2000s when the EU started to lower its “intervention price” where it provides price support by buying the products at a certain level. In 2015, Brussels abolished the quota system, which had regulated the amount of dairy products produced.
However, unlike the US, where dairy futures contracts are traded on the CME, and New Zealand, which has derivatives on the NZX futures exchange as well as auctions on the Global Dairy Trade platform, low liquidity on the derivatives markets made hedging practically impossible for buyers and sellers in Europe over the past few years. That is changing, and Sascha Siegel, EEX’s head of agriculture, believes the potential to grow is large. For example, EU dairy production is similar in volume terms to that of the region’s wheat. In 2017, the EU produced 154m tonnes of milk and 152m tonnes of wheat.
Nevertheless, the amount traded for EEX butter futures last year was about 3 per cent of overall production while skimmed milk powder was 4 per cent. This compares to 3 times the volume of milling wheat traded on the European futures and options markets in relation to the total EU wheat production, according to INTL FCStone. Compared to the US agricultural derivatives markets, the difference is even more stark.
Milk futures and options volumes are about 70 per cent of physical volumes, 210 per cent for non fat dry milk, which is similar to skimmed milk powder, 70 per cent for butter and 40 per cent for cheese. For wheat futures in Chicago, the ratio is more than 110 times for the combined futures and options volume compared to actual US production, the broker said.