Tag Archives: opening price

Opening prices so far

This post will be updated as announcements are made and can be confirmed. Wherever possible, there is a link to the processors’ full announcements if you click on their names below:
MG $4.70, revised to $5.20
Bega $5.50
WCB $5.50
Burra $5.45-$5.65 if farmers lock into three years of unknown pricing or $5.05 – 5.25 without commitment.
Fonterra $5.30 plus bonus 40 cents
Parmalat $5.70

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Mervis mans up and makes MG a leader again

Apology

The new CEO of Murray Goulburn, Ari Mervis, has done something small but truly fabulous: he’s apologised for stuffing up.

On Tuesday, Mr Mervis told listeners to ABC Radio’s Country Hour program that MG’s opening price of $4.70 was “…well above the cost of production” in an interview with Warwick Long. I wasn’t sure if he was out of touch or trying to spin a pig’s ear into a silk purse. Either way, it wasn’t a good look for the head of Australia’s largest milk processor.

In this apology totally devoid of spin, Mr Mervis cuts to the chase and recognises the difficulty facing its farmer suppliers.

While MG’s opening will not make it a price leader, Mr Mervis’ letter to suppliers signals that, after a couple of years in the wilderness, the co-op is back on the path of becoming a values leader in Australian dairy.

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What MG’s announcement means in plain English

This is a post written purely for my fellow dairy farmers in light of the MG announcement today. After speaking with the people at MG, this is what I have learnt:

Why the price must fall
MG opened at $5.60/kgMS. Its lower than expected sales, the rising Australian dollar and the fall in the value of its larger than normal (which are routinely high anyway) inventories mean it has a shortfall of between $170 and $200 million. This means the price paid to farmers must fall.

How far the price must fall
Depending on how the last two months of this financial year pan out in terms of sales and exchange rates, Murray Goulburn will finish the season between $4.75 and $5.00.

But the price can’t fall that far in two months…
To do that, it would need to pay farmers virtually nothing for milk supplied in May and June. Some rough numbers sent to me by an industry analyst puts those figures at about 4.75 cents per litre. Clearly, that would be disastrous for many suppliers. It would also cripple MG because farmers would have little choice but to leave MG and supply any other processor that would take their milk.

…so, here’s what will happen
MG will pay farmers for milk supplied in May and June as if the price was $5.47 all along. In other words, the price for May milk will be $3.38 for fat and $7.42 for protein. For June’s milk, it will be $3.45 for fat and $7.59 for protein.

If MG’s sales and the currency fall in line with the worst case scenario and MG really should have paid farmers just $4.75 for the year, it will mean there is a shortfall of 47 cents for every kilogram of fat and $1.03 for every kilogram of protein.

This money will be deducted from the price paid to farmers evenly over the next three years. It means the milk price will be lower for each of the next three years than it otherwise would have been by about 15 cents for fat and 34 cents for protein.

But it’s NOT a debt carried by individual farmers
The money to be deducted over the next three years will simply come out of the milk price. If a farmer leaves MG and moves to a different supplier during the next three years, no debt will follow that farmer. If a farmer joins MG in the next three years, that farmer will have a lower milk price than they would have received in a normal year.

MG will not apply a loan against an individual supplier and will not respectively apply terms and conditions to suppliers.

About this post and me:
I am a former MG supplier who still holds some MG shares and currently supply Fonterra Australia. This post is not designed to do anything other than clarify confusion surrounding the situation because I am fearful for the mental health of my fellow farmers. This post has been checked by MG for accuracy.

 

 

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How processors decide the opening price for our milk

Piggy Bank

With the anticipation of shoppers pressed against the doors of a Boxing Day sale, farmers look forward to the “opening price” for our milk every season. This year, the hype was bigger than ever.

Last season’s prices were high enough that many farmers have recovered from the year before, commentators continue to gush about the future of dairy and processors are on the hustings looking to poach supply. On the other hand, global dairy commodity prices are tumbling and the Australian dollar remains stubbornly high. Uncertain times.

The first of the major processors to announce its (edit: this post applies to the south eastern Australian states only) opening price was Fonterra, the giant NZ co-operative, at $5.80 per kilogram of milk solids, only to be trumped hours later by Australian co-op Murray Goulburn at $6.00. The two forecast closing prices were in the range of $6.10 or $6.15 to $6.30, making this year’s buffer between the start of season price and the forecast close one of the narrowest ever, suggesting an increased risk of a historically rare and confidence-busting mid-season price “step down”.

Opening prices are a little contentious, with United Dairyfarmers of Victoria president Tyran Jones, labelling them “misleading“. I invited the two big processors to answer some questions about how the opening prices are set. Thank you to Matthew Watt of Fonterra and Robert Poole of Murray Goulburn for their explanations.

 

Q1. How do you arrive at an opening price?

A: Matthew Watt, Fonterra:

We look at multiple information sources. The most important one of these is the market intelligence we get from the Fonterra Global insights team. I expect that others in the market take a lead from our and Fonterra NZ pricing to leverage this information as well. Other information sources include GDT futures, Fonterra Treasury (FX), Rabo Bank.

  • We extrapolate these information sources into a number of different commodity and currency scenarios (this season we ran in excess of 15 pricing futures through our model)
  • Model looks at weighted returns based on forecast milk flows.
  • Sensitivities are completed at different commodity prices and currency
  • Following this, we establish the most likely estimate of closing price – this becomes the forecast close range.
  • We then compare the forecast close to our lower price scenarios & calculate an opening price that is paying what we can to farmers but also ensure there is a level of protection from any market/forecast downside.

A: Robert Poole, MG:
At a high level:

Milk Price = Total Revenue less Total Non-milk Costs less Profit. As stated below the 2014/14 milk pool grew to $1.7 billion up from approximately $1.2billion in 2012/13.

An extensive budgeting process occurs across the business. We estimate milk intake volumes and composition, determine product mix, budget sales revenue (sales and other), budget company-wide costs, determine profit requirements (to manage balance sheet and funding needs, and dividends) which provides for a milk price. Throughout this process we make certain assumptions such as pricing, volumes, product mix, foreign exchange and sales channels for revenues and savings initiatives, efficiencies, wages and working capital for company costs.

Improvements in the budget position as the year progresses are usually passed through as step-ups.

 

Q2. How have the margins between opening price and forecast close changed since 2008?

A: Matthew Watt, Fonterra:
The traditional rule of thumb was that opening price was 85% of forecast closing although published forecast closing prices are a relatively recent addition. This year our forecast opening is 94% of midpoint of forecast close range. To actually track this is difficult because published forecast closing prices are a relatively recent introduction.

A: Robert Poole, MG:
Yes, these are slightly different each year. In determining the amount of buffer required, allowance is made for those areas where the co-operative is exposed to volatility; upwards, downward  and other adverse conditions or potential risks.  Generally MG has an opening price between 90 and 95% of its initial forecast.

 

Q3. Given the uncertainty of the exchange rate and falling commodity prices, is there an increased risk of a step down this year?

A: Matthew Watt, Fonterra:
As the variance between opening and forecast close narrows, there are an increased number of potential scenarios that provide a number that is on or lower than opening price.

  • Our current forecasts suggest that commodities will improve which is factored into our forecast close price. However, these are subject to global economic conditions and global production – both can move quickly and can impact commodity prices either way
  • The exchange rate has been anticipated to fall for some time but it remains high and a number of forecasts suggest that this could increase. As a rule of thumb, every 1 cent move in the exchange rate (across a full year) will have a 5 c/kg MS impact on milk price
  • At this stage of the season, we have limited volumed that is priced and sold. This means that, any moves in the commodities or exchange rate have a large impact on the actual, final milk price. As we move through the season, we get more priced and sold, meaning that movements that happen later in the season have a lower impact on the farmgate milk price.

A: Robert Poole, MG:
The difference between the opening milk price and the budgeted milk price allows for adverse variances to budget and a step down in price is historically very unlikely.

 

 Q4. What percentage of your Australian suppliers receive a price that is equal to or above the published opening price?
A: Matthew Watt, Fonterra:
All of our published pricing is based on best quality milk. The greater the level of penalty/incentive built into the pricing construct and the relative achievability of the premium quality standard will impact the difference between average quality and premium quality.

On our new, simpler pricing construct, between 25 & 50% of our farms will be at or above average quoted price, (assuming premium quality). Given we also have a transition payment in place from old pricing system to new, the number that will actually receive more than the published number will be over 50%.

60% of our suppliers are within +/- 0.15 cents per kg MS of average price, based on premium quality. Naturally, the poorer the individual farms actual quality that is delivered, the further they get from average price due to penalties incurred.

A: Robert Poole, MG:
Approximately 50% of milk supply is above the average and 50% below – hence the weighted average.  The majority of suppliers are within 2 cents per litre of the average.

[NOTE from MMM: I did follow up with Robert to clarify his answer in terms of the percentage of farms but the information was not available for the blog.]

 

Q5. Aside from the opening price, what do you think are the top three reasons farmers are attracted to supply your business?

A: Matthew Watt, Fonterra:

  • As a broader comment on price, I would like to think that farmers look past opening price as a reason for choosing a processer, particularly on opening average quoted numbers. On the price aspect, whilst opening is an important indicative number, what is really important is how that pricing construct suits an individual farm and, what the actual as opposed to projected or opening price performance is.
  • However, the three key reasons that we think farmers value are
    1. Leveraging our Global Leadership for Local Benefit – this means giving the best market information to our farmers to help better decision making on farm and, as a key extension to this, introducing fixed base milk price to enable farmers to better manage price risk. The other aspect of this is the multiple product streams, brands, domestic and global markets that we are active in. This provides access to the best and emerging opportunities in the market as well as a balanced group of customers and products which serves to reduce risk.
    2. Supporting Profitable Farmers – Profitability in farming is fundamental to industry success and our success if we are going to have long term, secure milk supply. We clearly don’t control all of the profitability factors. However, there are some that we do and some we can influence. These include simplifying our pricing structure. A critical aspect of this was ensuring we were aligning the value that we could extract from the value chain into  a clear construct, enabling suppliers to farm profitably to their set of circumstances and available resources. We be believe it is now better understood, reduces risk to farm business profitability and enables better decisions around optimising margin to be made by our farmers. It also includes our support crew work, where we assist where we can with specific opportunities within business to increase bottom lines – this year we have identified well over $1M of profit that has been generated by specific farmers through this program.
    3. Partners in Asset creation – this means getting to a stage of sustainable profitability and then leveraging that for future growth. Again, our fixed base milk price program plays an important role in helping to provide the certainty and confidence required for a farmer to make an investment decision to growth. We are also leveraging our support crew team to identify opportunities to support the growth of our farmers, where it makes sense for them. The support can come in many ways – technical, helping prepare information for banks, direct finance assistance and the like.

A: Robert Poole, MG:

Our suppliers are attracted to MG for a number of reasons. If I had to limit these to the top three they would be:

  • The strong understanding that whilst opening price is very important that having a Co-op that has the objective of growing the pool of money available to farmers. For example in 2013/14 we have grown the pool paid to farmers from $1.2 billion to approximately $1.7 billion.
  • A desire to supply the last Australian farm owned dairy Co-op, controlling the milk supply process from end to end and passing benefits to farmers.
  • Stability – MG has a proven performance, reliability and track record of successfully running a large and complex dairy company for 64 years and we have a clear strategy to improve business performance
  • Service and support

 

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Untangling how much farmers are paid for milk

The most anticipated email of the year popped into my inbox just before midnight. It was our co-op’s announcement of its opening milk price: “a weighted average price of $4.90/kg milk solids”.

Ironically, farmers are not paid for milk – just the fat and protein it contains, which we call “milk solids”.  Here’s the tricky part: protein is 2.5 times more valuable than fat, different herds (and the individual cows within them) produce different ratios of both, the price per kg changes almost monthly and the amount each cow makes shifts throughout her lactation and as her diet changes.

We are also subject to charges based on how often our milk is collected, if milk quality drops, and even milk volume.

For all these reasons, the price a farmer receives for a litre of milk is as individual as the farm.  To further complicate the picture, the co-op introduced  a new payment system last year that allowed farmers to select from three pricing models reflecting different pattens of production over a season.

I opted for the Domestic Incentive and committed the farm to supply at least 40% of our milk between mid-February and mid-August. It was the right decision at the time but that record-breaking wet summer affected the normal pattern of supply. With just one tanker of milk to be collected, it’s touch and go. About the same amount as the cost of my tractor engine rebuild is riding on how well the girls milk tonight. Wish me luck!

PS: The pricing system I’ve described applies only to our co-op. Other farmers, particularly those interstate, may have radically different structures.

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Filed under Cows, Dairy Products, Farm, Milk quality, Random