Guide to Dairy Derivatives NZX Derivatives Market

CONTENTS INTRODUCTION

4

NEW ZEALAND DAIRY MARKET

5

Industry Growth

5

Global Growth

6

NZ and International Global Export Market

7

NZX DAIRY FUTURES MARKET

9

Background to dairy derivatives market

9

How do futures contracts settle?

9

Participants

12

TRADING IN NZX DAIRY FUTURES AND OPTIONS

13

Trading Dairy Futures

13

Characteristics of Futures

13

Trading examples

13

How Futures accounts work

15

Trading Options on Dairy Futures

17

GLOBALDAIRYTRADE

20

How does it work?

20

What products are sold?

22

Who buys and sells on GDT?

23

IMPORTANT DAIRY INFORMATION

25

CONTRACT SPECIFICATIONS

26

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Disclaimer: This document is provided is for information purposes and is not intended as, and shall not constitute, investment advice or an offer to acquire or dispose of securities. Although NZX Limited (NZX) has taken care to ensure the accuracy of the information as at the date of publication, NZX does not give any warranty or representation as to the accuracy, reliability or completeness of the information in this document. To the maximum extent permitted by law, NZX and its subsidiaries, employees, officers and contractors shall not be liable for any loss or damage arising in any way (including by way of negligence) from or in connection with any information provided or omitted or from anyone acting or refraining to act in reliance on this information. NZX Derivatives Market is a registered market operated by NZX, a registered market operator regulated under the Securities Markets Act 1988. © Copyright 2014 NZX Limited. All rights reserved.

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INTRODUCTION An increase in global demand for dairy products and ease of availability for these products provided by the GlobalDairyTrade (GDT) platform has assisted in seeing phenominal growth in NZX Dairy Futures in recent years. Milk powder is one of the most volatile commodities globally driven by the increase in awareness of milk’s nutritional value and improvement in living standards in developing economies (and demand for proteins). As a result of the spike in demand and multiple unpredictable supply side factors creates a difficult operating environment for all those in the dairy supply chain. Dairy futures and options provide a useful tool for farmers, producers, and manufacturers, among others for management of the price risk inherent to the global dairy industry. It is now more important than ever to understand how to use these risk management tools. This booklet is designed to provide an overview to the global dairy industry with a particular emphasis on the New Zealand Market and International Trade. This booklet then goes on to explore what futures and options contracts are and how they can be used by industry participants as a viable risk management tool.

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NEW ZEALAND DAIRY MARKET New Zealand is the world’s largest exporter of dairy commodities, representing approximately one third of 1 international dairy trade each year. Dairy products are amongst the most important of all traded food products and trade is dominated by a few particular dairy commodities: Whole Milk Powder (WMP), Skim Milk Powder (SMP), Butter, Anhydrous Milk Fat (AMF) and 2 Cheese. Of these, WMP and SMP are the most basic and important - containing all the vital milk proteins. New Zealand is a major global player in these products, exporting approximately 95% of its milk production in the form of dairy commodities. Nearly half of all WMP exports come from New Zealand. The New Zealand dairy industry is predominantly pasture-based, with a temperate climate ensuring adequate feed for herds year-round. Dairy farming occupies 1.6 million hectares out of a total of 12 million hectares of pastoral land. Dairy has been three times more profitable per hectare than other pastoral land use, encouraging conversions from other farming systems, such as sheep and beef, to dairy – especially in the South Island of New Zealand. Fonterra is by far the largest processor of milk in New Zealand. It processes approximately 96% of all milk solids from dairy farms. Other dairy companies that collect and process milk in New Zealand are: Open Country Dairy, Westland Milk, Synlait, Miraka and Tatua. As the volume of New Zealand dairy exports has risen, production has also increased to support the growth. Between 1992 and 2013 dairy cattle numbers have grown from 3.5 million to 4.9 million and the value of dairy exports from $2.5 billion to $18 billion (year ended June 2014). Also between 1992 and 2013, China moved from being New Zealand’s 31st destination for dairy products to being number one – annual exports to China increased from $12.8 3 million to over $6 billion, over the 21 years.

Industry Growth New Zealand farmers look set to increase the milk supply in 2014 to a forecast 20.6 million metric tons (MT). This represents a 4.5% increase from an amended estimate for 2013 of 19.7 million MT. WMP is the key commodity produced in New Zealand comprising approximately 40% of the total production and in 2014 is likely to reach 1.3 million MT, increasing 2% from estimated production levels in 2013. For 2014 it is likely SMP production will show a marked upswing to reach 420,000 MT, which would represent a 7.7% increase on the 2013 estimate of 390,000 MT. Annual butter production in 2013 was estimated at 9 million MT, with over 500,000 tonnes exported globally. New Zealand remains the dominant exporter of butter accounting for approximately 49 4 percent of total trade among major exporters. Butter production is expected to increase in 2014, with total output 5 pegged to grow by 4 percent relative to 2013.

1

Fonterra, NZ

2

Dairy NZ, 2010

3

Statistics New Zealand, 2013

4

World Trade Atlas

5

www.fao.org

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Global Growth Global demand for dairy is continuing to grow. In particular, population growth, rising incomes and an increase in demand for protein in diets in developing countries such as China and India, are leading to increased demand. However, milk supplies in these developing countries are not keeping pace with this growth. As such, these markets are becoming increasingly important for global dairy companies, who are helping to meet the demand with dairy ingredients, as well as locally produced consumer products. China's share of whole milk powder exports from New Zealand increased significantly during September 2013, with this single market accounting for more than 60%. Demand for imported milk powder is very strong at present in China 6 as they look to secure supplies to make up for a shortfall in domestic milk production. In developed countries, where consumption is already high, there is a more consistent outlook with demand expected to remain stable.

OUTLOOK TO 2020 Demand Volume

Demand Growth

Supply Volume

Supply Growth

7%

10%

1%