If you’re in the milk powder business as either a seller or a buyer, how do you know what a load is worth? And how can you hedge against price movements when prices are all over the board, each series has different rules on which transactions are included and each actor may price off a different series?
This isn’t an atypical example and these aren’t inconsequential questions: the NDM/SMP business is valued at nearly $3 billion in the United States and almost $12 billion globally. But our ineffective price discovery system makes it almost impossible to manage volatility and impairs our ability to respond to market signals, extracting costs to everyone in the supply chain.
What’s the price for a pound of NDM*?
$1.78 (average per pound). CME spot price for Grade A nonfat dry milk (NDM)
*Prices in mid-April.
Sources: Dairy Market News, Chicago Mercantile Exchange, compiled by the author
Effects on U.S. milk
This isn’t just a powder issue, either. The NDM price has a direct impact on more than one-third of the milk priced in the United States, and an indirect impact on just about all the rest, regardless of region.
While price volatility is a common feature of the dairy business today, many have learned to mitigate it where fully functional risk management tools are available. Unfortunately, because of the complexity and inconsistency of milk powder price discovery, risk management tools just don’t work here.
Futures and options aren’t liquid enough, in part because there’s no common benchmark price.
As a global category, milk powder price volatility is especially problematic. The United States now exports close to half of its NDM/SMP production, and has about a 25% global market share. That means U.S. pricing needs to quickly reflect changes in international prices in order to remain competitive. If it doesn’t, U.S. exporters lose value in “up” markets and can’t react quickly enough in “down” markets.
A pre-competitive industry work group, gathering under the auspices of the Innovation Center for U.S. Dairy is addressing this issue and formulating solutions. (The Innovation Center was established under the leadership of America’s dairy farmers through the dairy checkoff program.)
Most agree the CME cash market can be a good price indicator, but improvements are needed. They also agree government reports don’t always reflect current market conditions, rules regarding which transactions are included need to be examined, and lags in price reporting delay price signals to the market. These concerns don’t weigh specifically on either the California or Federal Orders. But the group recognizes that if you get price discovery right and link it to futures, the futures volume and liquidity will naturally come.
At a late-April meeting, the work group agreed to drive several potential fixes, including:
- a proposal to move CME spot trading to an electronic platform to boost activity and make the exchange more relevant;
- a request to directly link NDM cash and futures to enable traders to execute spreads between the two; and
- engaging in further consultations on the best ways to improve price reporting.
Preparation is underway to outline the solutions and engage interested industry participants.
The health of the entire U.S. dairy business is predicated on becoming a consistent supplier of milk powder. But unless the industry fixes its broken milk powder price-discovery process, it will continue to suffer from damaging volatility, lost competitiveness and eroding global market share.