Fact Sheet 12 – Buy right
Buy
Plan
Quality
Supply
Feed
− Store feeds
− Feed diet to herd
Price
▲
▲
From price taker to price maker
− Feed budget
− Target feed
price for profit
Review and replan
Having worked out how many tonnes of feed you need to buy and what price you
can afford to pay, you can develop your buying plan. There are more ways of
managing your supply and price risk than you may realise.
Developing a plan
First, determine how many tonnes of feed
you need to buy
The first step in developing a feed buying plan
is to determine a month-by-month feed budget
(see Fact Sheet 2 for more details).
Then, determine what price you can afford
to pay per tonne
The next step in the process is to calculate your
break-even feed price and your target feed price
– the price you can afford to pay and still achieve
a reasonable profit (see Fact Sheet 3 for more
detail).
Now, consider how you can shift from price
taker to price maker
i
Key tips
• Spot contracts may look quick and easy, but
they leave you exposed to market volatility.
• Be decoupling the fixing of feed supply from
the fixing of price, you can manage price
risk.
Figure 1: The first steps in
developing a buying plan.
1. How many tonnes of feed do
you need to buy? (see Fact Sheet 2)
With some solid numbers on how much feed you
need and what you can afford to pay, you can
now work on achieving the shift from being a
price taker to a price maker.
There are several pricing tools available to you
including:
• Spot contracts
A
S
O N
D J
2. What price can you
afford to pay per tonne?
(see Fact Sheet 3)
$
Bought-in
feed cost
Target
feed
price
All other operating costs
(except bought-in feed)
Finance costs
Capital costs (inc. drawings)
• Forward contracts
• Rise and fall contracts
• Derivative contracts (see Fact Sheet 13)
Spot contracts are what most dairy farmers use to buy feed.
While they may look quick and easy, they leave your feed cost fully
exposed to market volatility.
Buying feed – Fact Sheet 12
This involves decoupling the fixing of supply
schedule from the fixing of price, i.e. making time
of supply and time of pricing independent of each
other. You can negotiate with feed suppliers to
lock in a supply schedule for delivery over several
months, BUT you don’t have to fix the price at
the same time. You can agree the pricing method
which will apply for each monthly delivery.
1
Fact Sheet 12 – Buy right
Buy
Plan
− Feed budget
− Target feed
price for profit
From price taker to price maker
Spot contracts
Quality
Supply
Feed
− Store feeds
− Feed diet to herd
Price
▲
▲
Review and replan
Figure 2: Buying using spot contracts
Spot contracts:
In this example, spot
purchases are made
each month.
Tns
Spot contracts are a series of individual purchases
that occur ‘on the spot’ as feed requirements for each
month are due. (see Figure 2). You order the feed, it gets
delivered and you are sent a bill for the going price that
week.
• Fully expose buyers to market volatility and floating
feed costs.
• Will, at best, achieve the long-term average feed cost
(this has cash flow impacts).
Forward contracts
A
S O N
D J
Figure 3: Buying using forward contracts
Forward contracts cover several months forward at a fixed
(locked in) feed price, BUT you still take delivery and pay
each month as you use the grain.
• Allow buyers to know what the price will be for a given
period (see Figure 3).
• Can be either a flat price or price plus monthly ‘carry
cost’ (carry cost = storage fees plus finance cost per
tonne per month).
F1 F1 F1 F1
A
• You can fix the price for a tonnage on forward contract
for several months and ‘top up’ your monthly needs in
the spot market.
▲
Forward
Contract price
D J
Tonnes bought on
forward contract
Tonnes bought in spot
market
In a falling market ...
Spot price
$/t
S O N
F2 F2
F2 Second forward contract
for given tonnage at flat
price over two months
A combination of forward price contracts
and spot contracts can provide a good
blend of buying at the spot price as well
as avoiding major price upswings.
The purpose of forward contracts is to provide price
certainty and to reduce risk, NOT to minimise buying
price. For example:
In a rising market ...
F1 First forward contract for
given tonnage at flat price
over four months
Tns
Forward contracts:
In this example:
$/t
... forward price
puts a ceiling
on grain price.
Forward Contract price
... forward price
puts a floor on
grain price.
▲
Spot price
Time
Time
2
Fact Sheet 12 – Buy right
Buy
Plan
− Feed budget
− Target feed
price for profit
From price taker to price maker
Rise and fall contracts
Quality
Supply
Feed
− Store feeds
− Feed diet to herd
Price
▲
▲
Review and replan
Figure 4: Buying using a rise and fall contract
In rise and fall contracts, the buyer and the seller agree
to share the gains and losses above and below an agreed
benchmark price 50/50 (see Figure 4).
In the example shown in Figure 4 a rise and fall contract
has been struck in August with an agreed benchmark
price of $300/tonne.
Example:
M1
C1 $350
$400
$300
• In October, the market price (MI) rises to $400/tonne,
so the contract price (C1) = $350/tonne.
• In December, the market price (M2) falls to $200/tonne,
so the contract price (C2) = $250/tonne.
Rise and fall contracts therefore allow sharing of any price
risk between buyer and seller. They are most suitable for
dairy farmers and grain or fodder suppliers who wish to
maintain a direct long-term trading relationship.
Tips for using a rise and fall contract:
C2 $250
M2
$200
A
S
O
Market price (M1) = $400/tn
Contract price (C1) = $350/tn
N
D
Benchmark
price
J
Market price (M2) = $200/tn
Contract price (C2) = $250/tn
Derivative contracts
1. Run contract over a minimum of 3-4 years
As the price moves from the agreed benchmark
price, there is disadvantage to one party (price
rise disadvantages the seller, whereas price fall
disadvantages the buyer), so it is better to have a
sufficient period of time for both parties to see the
benefit of the risk sharing.
Derivative contracts allow a buyer to construct their
own price for their grain, independent of the physical
purchases they may make during a year.
This entails taking out futures, swaps or options
contracts which are financial instruments which will be
offset against the price paid for physical grain deliveries.
2. Be very clear as to how the “market” price will be
agreed at the time it comes to fix the difference
between the benchmark and the market price, so
there are no disputes. As an example, the market price
can be set by obtaining the average of three broker
quotes for ASW wheat for the five business days prior
to commencement of the delivery period for which the
price is being set. (i.e. For February delivery, use the
quotes for the last 5 business days of January).
These derivative contracts require specialist advice before
entering into, but can provide a useful tool for dairy
farmers to manage their feed price risk. See Fact Sheet 13
for more information.
Payment terms
Don’t just focus on the price tag and forget payment
terms. Negotiate payment terms with your feed suppliers
to suit your cash flow and milk payments. How many days
you have to pay your feed suppliers will impact on your
cash flow, your overdraft arrangements with the bank,
and your ability to finance opportunistic feed purchases
when you see a good deal.
For more information go to www.dairyaustralia.com.au
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information is a guide only and professional advice should be sought regarding your specific circumstances.
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2010
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