Something to moo home about
Why futures for milk and butter are making a comeback
By SN
THE dairy sector has been one of the industries hardest hit by the current trade embargoes between Russia and the European Union. Faced with a glut of cheese, European producers responded by turning milk not into cheddar or brie, but into less perishable skimmed-milk powder, prompting its wholesale price to drop by a third. Such price volatility can be damaging to all parts of the industry. Both farmers and food manufacturers, such as Nestlé and Danone, rely on a steady price to plan future production. In response, Euronext, a pan-European exchange, launched on April 14th several dairy derivatives aimed at those in the sector who want to hedge against such volatility, and at speculators who want to take on such risks.
In short, a derivative is a contract to buy or sell an underlying asset, index or security at a pre-agreed price in the future. For a farmer or food manufacturer, a derivative can form an insurance policy against future events such as bad weather or interest-rate rises. For a speculator, it can be a lucrative way of betting on whether prices will go up or down.
The very first agricultural derivatives can be traced back to ancient Mesopotamia. There, King Hammurabi’s legal code allowed for farmers to sell their goods at a pre-agreed price, for a future delivery date. The modern equivalent originated in Chicago, which is still home to the world’s largest futures exchange. Located right near the heart of the Midwest’s grain bowl and cattle country, it was the natural place for farmers and merchants to come together and negotiate contracts to insulate against price fluctuations brought by crop gluts and shortages.
Such markets withered in Europe after the second world war, when the Common Agricultural Policy's many farm quotas and food subsidies reduced much of the price volatility. But Euronext's latest move is attempting to relaunch derivatives for butter, skimmed-milk powder and whey-powder prices.
This is not the first time an exchange has tried to reintroduce dairy derivatives since they died out in Europe. Critics wonder whether there will be still much demand for them at all. But there is one important difference this time, argues Nicholas Kennedy, Euronext’s head of business development for commodities. On March 31st, the EU abolished its milk quotas. This means that the policy's artificial support to prices whenever they start to become volatile will no longer exist. He thinks it will alter the dairy market in a similar way that the lifting of price support for wheat did for that market in the 1990s. Euronext’s experience with wheat derivatives—where it took many years for volumes to pick up—suggests that a big dairy-derivatives market will not be created overnight. But let there be no doubt, adds Mr Kennedy, this will eventually create a “revolution in European dairy.”