Dairy Crest has announced a new milk price formula, offering a cross between a market-related and a cost-of-production price.
Most retailers also operate ‘aligned’ pools, made up of farmers paid a premium by the retailer. More than 25% of milk produced in the UK goes into such pools and as the liquid milk market is highly concentrated, when these retailer contracts are tendered, much is at stake.
Retailer contracts typically work on a cost-plus system, with farm input costs calculated independently and the milk price fixed so the farmer receives a defined rate of return.
Seen through a global lens, UK retailer milk pools appeal to farmers precisely because UK dairy is relatively inefficient compared with other dairy exporting nations. Take New Zealand, blessed with well invested farms and supply chains, a perfect dairying climate and acres of land.
It is very unlikely farmers there would be interested in cost-plus pricing from a retailer because their production costs are so low. Kiwi farmers feel they can secure export prices way ahead of their cost base?
Could this happen in the UK? It depends whether you are bullish or bearish about UK dairy. Bulls cite the stability that the large liquid market gives by consuming half of all milk supplies, growth in UK dairy consumption, 25% growth in cheese exports in the last five years and consumer preference for British provenance.
Bears point to overcapacity in the competitive middle ground of milk processing, a relative lack of investment in assets, consumer scepticism about larger and more efficient farms and the threat of Irish expansion into the UK.
If you sympathise with the bulls, you can envisage a situation where UK processors feel they have to pay a premium over retailer pool prices to guarantee a steady milk supply. Farmers could then feel that by pegging their prices to the costs of production via a retailer contract, their profit would be capped. If this is right, we may be approaching the high water mark for retailer milk pools. If you are a bear, then retailer pools may have much further to go yet, into foodservice and other areas.
Hamish Renton is MD of Hamish Renton Associates