INVESTOR EDUCATION – NZX to launch NZ milk price futures
and options contracts
The NZX has received formal approval from the Financial Markets Authority (NZFMA) and the Reserve Bank
of New Zealand (RBNZ) for its proposed milk price futures and options contracts. The products are expect
to launch in May 2016 and are designed to mitigate the financial risks associated with a variable milk prices
for both producers and purchasers of milk products. It is seen as an important step to assisting the
commodity price risk in New Zealand’s key agricultural sector.
Farmgate Milk Price Futures and Options
New Zealand is the world’s largest exporter of dairy commodities, representing
approximately one third of international dairy trade each year. Global dairy prices have
become increasingly volatile over recent years as the industry battles with supply and
demand imbalances which has seen prices fluctuate from their record high payout of
$8.40 per kilogram of milk solids in the 2013/14 to just $3.90/kgMS in the current
To address this volatility, the NZX plans to start a futures and options market for milk
on its trading platform, allowing farmers, processors and others linked to the local dairy
industry as a way to fix the future price of milk to reduce uncertainty.
Globally, about 378 billion litres of milk is processed each year into a variety of
products. Dairy trade is worth an estimated US$140 billion annually. The export market
is dominated by milk powder, with approximately 2 million tonnes of Whole Milk
Powder (WMP) traded annually.
Currently, around 95% of New Zealand’s dairy production is sold overseas, making NZ’s
farmers more exposed to global prices compared with larger countries such as the US,
who have large domestic markets that farmers can sell their produce on.
The introduction of these risk management tools are seen as a major positive for the
industry as they give both producers and suppliers more options and opportunities to
reduce their earnings volatility. The NZX’s Dairy Futures and Options are designed to
manage risk and smooth out volatility and are intended to create price certainty,
transparency and a forward view of market sentiment.
By trading on the futures and options market, dairy participants create price certainty,
a fundamental competitive advantage in a volatile market. Hedging ensures certainty
for both buyers and the farmer over prices paid for liquid milk, as well as certainty over
forward sales prices. It also means purchasers can secure supply and manage their own
price risk, providing certainty over future purchase prices.
Price certainty is achieved by entering equal and opposite positions in the physical and
futures markets. Any loss in the physical market will be offset by a profit in the futures
market and vice versa (physical and futures market prices tend to move together i.e.
mirror each other). The purpose is not to make a profit or avoid a loss in either market,
but to lock in price ahead of time.
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For NZX the addition of futures and options contracts for milk builds on its launch of its
global dairy derivatives market in October 2010 and is part of its aim to become the
global hub for trading tied to New Zealand’s biggest export commodity.
However unlike the current contracts the NZX offers, the milk price futures values are
tied to the Farmgate Milk Price which is more directly relevant for farmers compared
with individual dairy products (WMP, SMP, AMP etc).
What are futures?
A futures contract is an agreement to buy or sell a commodity or asset at a date in the
future, and at a price agreed today.
When futures contracts mature, they can be settled by buyers and sellers either
exchanging the commodity or asset, or by settling in cash whereby the contracting
parties pay or receive a loss or gain (calculated by reference to the settlement price).
In the case of NZ milk price futures, the buyers and sellers will settle by exchanging
cash, calculated by reference to Fonterra’s announced Farmgate Milk Price.
Cash settlement of a futures contract means participants don’t have to implement
complicated delivery mechanisms or risk having to make, or take, delivery of a product
when trading in the futures market. Cash settlement is particularly preferable for dairy
commodities where food safety criteria, and the actual delivery process, are complex
and not globally standardised.
What is an option?
Options contracts provide the purchaser with the right, but not the obligation, to buy
or sell a particular asset or commodity at a pre-determined price, on an agreed date in
A dairy farmer may use an options contract to protect against the milk price falling but
retain the benefit of potentially higher milk prices.
Who can use them?
Purchasers of dairy ingredients
Dairy trading firms
For further details and information, please refer to https://www.nzx.com/derivatives
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9 April 2016