Dairy price estimates are consistently wrong

As occurs each year, the media have focused on Fonterra’s opening forecast for the coming year, predicted this year to be $4.25, as if it has significant meaning. To put that in perspective, here are Fonterra’s opening forecasts and actual payments for the last five years.
Fonterra price estimates

The overall tendency has been for Fonterra to be over-optimistic by $0.58 c per year. However, the average error in the prediction is $1.27c, ranging from minus $2.60 to plus $1.40. In three of the five years, Fonterra has been out by more than $1.30.

The accuracy of Fonterra’s forecasts has been getting worse, with an average error of $1.78 for the last three years compared to 50c in the first two years of the comparison.

So the overall conclusion has to be that Fonterra has minimal skill in predicting payout at the start of the season. And as volatility has increased, their predictive skill has got even worse.

Despite this lack of predictive skill, the forecast is of some use in that it influences the advance payments that Fonterra plans to pay in the first few months of the year. These numbers are not publicly announced in Fonterra’s press releases, but are available to Fonterra’s farmers by logging on (with password) to the Fonterra website.

For this coming year, Fonterra plans to pay $3.01 in July for June milk, $3.01 in August for July milk, and $3.21 in September for August milk. Then in October they will pay $3.00 for September milk, in November they will pay $3.30 for October milk, and in December they will pay $3.30 for November milk.

There will also be ‘top-ups’ in some months, linked to when the advance rate moves up, and bringing previous payments up to that level. But it is not quite as simple as it may seem, because off-season premiums of 51c per kg milksolids are built into the monthly amounts mentioned above through to the September payment. And these premiums start again for January milk paid February. These off-season payments do not have top-ups.

Also of relevance, is that Fonterra pays ‘retro’ payments in July to October for the previous year. Last year these ‘retros’ only totalled 13c per kg milksolids because Fonterra had miscued by predicting $7 early on, but ended up paying 4.40. So there was very little left to payout. This year, retros will be 50c.

If this all sounds very complex and confusing, then don’t despair. It is confusing, but it is the reality of being a Fonterra dairy farmer. Estimating cash flows is something that even experienced farmers find challenging.

To try and simplify things, I have provided a table showing the expected cash payments for the next 12 months for a typical seasonal milk producer, and comparing that to the 12 months just gone.
Fonterra cashflows

For both years, this actual cash payout is significantly lower than the ‘headline’ rate, largely because of the vagaries of retro payments.

The positive message is that cash payments will be considerably better in the coming months than for the same months last year. For example, by the end of September there will have been an extra 36c received per kg milksolids compared to September 2015.

For an average farmer producing 150,000 kg milksolids, this will be an additional $54,000, which will reduce the winter deficit accordingly. But of course for most farmers it will still be a winter deficit.

Individual farmers will also vary from these figures depending on their fat to protein ratio, and the overall milksolids percentage. These differences can add or subtract more than 30c per kg milksolids from the cash payout. Calving date also has an effect on cashflow.

For those farmers who are shared up (but excluding sharemilkers and Fonterra MyMilk suppliers), there are also expected payments of 10c in each of June (this calendar year) and October, compared last year to only 15c, paid in October 2015. And then another dividend, of unknown amount, will be due next April (it was 20c this year).

Synalit and Open Country suppliers will receive returns broadly in line with Fonterra (minus dividends), as these companies pay what they need to pay to remain competitive. However, their monthly cash flow schedules may look somewhat different. In contrast, Tatua will again beat to its own value-add drum, and over the full year should come in at no less than $6 per kg milksolids.

Placing any reliance on the Fonterra figures beyond September could be considered brave. If we look at the last three years in order, by late September Fonterra had lifted its estimated opening price by $1.30 in 2013/14, decreased it by $1.70 in 2014/15, and decreased it by $0.65 in 2015/16.

As the season progresses, Fonterra gets more accurate. This is to be expected, given that increasing quantities have actually been sold. But even in December, Fonterra can be out by 70c, with this last season being the worst, with a December prediction of $4.60 compared to the latest estimate of $3.90.

So the big message currently has to be to treat all Fonterra forecasts with great caution. It is highly likely that prices will jump around until at least December, and may jump around well after that.

I am on record as saying that I hope to see a good uplift in price in early 2017, but I have been explicit that it is a hope rather than a prediction. In the last few weeks, as I watch carefully what is happening in the markets, in particular the way European production is holding up and with surpluses building, I am increasingly concerned that my hopes and the reality are not going to coincide.

According to legend, it was either Mark Twain or Niels Bohr who supposedly first said, ‘forecasting is always dangerous, especially when it involves the future’.

Accordingly, Fonterra needs to be explicit, and farmers need to recognise, that based on its track record, these latest Fonterra estimates could easily be wrong by somewhere between $1 and $2 per kg of milksolids.

About Keith Woodford

Keith Woodford is an independent consultant, based in New Zealand, who works internationally on agri-food systems and rural development projects. He holds honorary positions as Professor of Agri-Food Systems at Lincoln University, New Zealand, and as Senior Research Fellow at the Contemporary China Research Centre at Victoria University, Wellington.
This entry was posted in Agribusiness, Dairy, Fonterra. Bookmark the permalink.

4 Responses to Dairy price estimates are consistently wrong

  1. Matthew Grierson says:

    I like to not only have the dollars (in forecast error) highlighted, but the percentage.
    For interests sake, the error percentages from 2011/12 going forward were 10%,6.18%,20%,37.1%,25.7%.
    I don’t think many industries could sustain a business with not only the volatility of market prices, but also taking a lead from their head office’s grossly inaccurate predictions.

  2. Keith Woodford says:

    My criticism of Fonterra is not that they are inaccurate, given that volatility is the nature of the commodity beast. My criticism is that they should ever pretend that they can predict with any accuracy.
    Imagine the laughter if they were to add the disclaimer: “in recent years our estimates have more often than not been wrong by more than $1.30 (20%) and on average we over-estimate prices by 59c”. But that is the reality.

  3. Pingback: Rural round-up | Homepaddock

  4. Oscar says:

    Thank you Keith!

    Totally on board with this analysis. We just lauched a website at dairyanalytics.co.nz trying to quantify this uncertainty and bring a bit more transparency to the forecast space. Our current estimate for the 2016/17 season is $5.63, but we expect that it could be anywhere between $4.72 and $6.83. That basically is to say we have no idea!

    I would hesitate to draw conclusions like “their accuracy has been getting worse” given the limited dataset. If you ignore any one season you can come to very different conclusions.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s