The refusal of Australian farmers to saddle up our cows and grow, grow, grow like our wonderful Kiwi cousins has been much lamented. In a recent blog about the subject, I suggested that we simply needed reliable profitability to do the same and followed it up with Ian Macallan’s integration vision.

In this second follow-up post, Fonterra dairy ingredients trader Scott Briggs answered a few questions about its innovative Fixed Base Milk Price, which promises to iron out some of the volatility in the price we get for our milk.

What is the FBMP and how does it work?

•  The Fixed Base Milk Price (FBMP) allows a Supplier to lock in a milk price at the start of the year for some of their expected production
• The price Suppliers lock in is based on matching where Fonterra’s customers are willing to lock in fixed product prices and where Fonterra’s Suppliers are willing to lock in a fixed milk price. The customers come from across domestic and export markets, so the FBMP will  tend to reflect full year milk price forecasts as made public in the market by various processors.
•  This year the FBMP was fixed at $6.22/kgMS , in line with the full year milk price forecasts at that time from Fonterra and other processors. This price was set via a tender, into which any Fonterra Supplier was able to make an application
• Suppliers can choose to lock in between 10-70% of what they expect to produce: so basically, it is like fixing some portion of your mortgage

Fonterra said it wanted to make pricing simple and transparent. Is that how you’d describe the FBMP?

•  Fonterra has made the milk price it pays all Suppliers more simple and transparent, which lets them make better margin and profitability decisions. Making our milk price simpler has been well received by our Suppliers, and has allowed us to begin innovating with things like FBMP.
• Using the FBMP is something a Supplier has to opt in to: if a Supplier doesn’t opt in to FBMP, then nothing changes.
• So Suppliers who understand their cost base and want to manage margins can choose to lock in milk price on some of their production: the FBMP is very similar to our normal milk price, and does not impact things like production payment, quality incentives or volume charges – so it is not too hard to understand.

Who will it suit?

We received interest in FBMP for a variety of reasons:  over 30% of our milk supply showed interest in learning more about FBMP, and between 100-150mL of milk supply was locked in under the FBMP, just under 10% of our expected total milk supply for the year. Size wise, we had Suppliers who produce less than 1m litres per year participate, all the way up to large corporate farming groups

Broadly speaking, there was interest for the following reasons:

1. Certainty of margin: Suppliers with a good understanding of cost of production compared that to the FBMP locked in a guaranteed margin, whatever the “normal” milk price ends up being . Based on the success of the FBMP, we are now receiving interest from grain companies who are keen to structure 12 month grain and pellet prices.
2.  Remove milk price risk: A lot of Suppliers wanted to take commodity and currency volatility and their impact on milk price, things they can’t control, out of managing their business – similar to locking in interest rates on their mortgage
3.  Show security of income to the bank: Suppliers could take the price certainty provided by FBMP to their bank, in order to discuss how best to finance their businessWe also had quite a few Suppliers who just wanted to try the FBMP out, so that they could see how it worked for their business and then be ready to “take it off the shelf” in the future

What are the potential pitfalls?

•  The FBMP is paid for a fixed volume of milk solids: so if a Supplier allocates 1000kgMS of their September 2014 milk solids to the FBMP, the first 1000kgMS they produce that month get paid the FBMP, with anything above that earning the “normal” milk price. If the Supplier doesn’t deliver 1000kgMS, the FBMP contract contains a Settlement Amount: more details can be found by emailing the contact details provided below.
•  The FBMP locks in a milk price: so in a year where there are many step ups, there is the potential that the FBMP ends up being lower than the “normal” milk price; likewise, if there are few step ups or even a step down, the FBMP will end up being higher than the “normal” milk price. While either of these situations may come to be, the Supplier who locks in some of his solids to a FBMP is able to benefit from that certainty in the ways outlined above.
•  It is important to note that the impact of FBMP is removed from the “normal” Fonterra milk price which Fonterra provides its wider Supplier group: at the same time as we lock in Suppliers to the FBMP, we lock in customers to ensure that a margin is maintained.

What percentage of the trial members signed on for a second year?

During the 13/14 milk season Fonterra ran a small FBMP trial with approx 10-12 farms. Of those, about half chose to participate in the FBMP for 14/15

If you are interested in learning more about the FBMP, email risk.management@fonterra.com