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Commodity risk in European dairy firms

Journal: European Review of Agricultural Economics

Date: 2022

Author: Guillaume Bagnarosa, Mark Cummins, Michael Dowling, Fearghal Kearney

Abstract:
We apply a multivariate mixed-data sampling (MIDAS) conditional quantile regression technique to understand the dairy commodity exposure of European dairy firms. Leveraging a theoretically sound hedonic dairy pricing framework, we show our approach is able to identify both market and operational risk. Profit margins for butter and milk price are particularly important for operational performance. Additional tests are provided, including an application of MIDAS quantile on a period of amplified dairy market risk. Our approach thus allows dairy firms to gain new perspectives on the significant risks posed by the current structure of dairy production in Europe.

Link: Google Scholar

Background and Context

Industry Evolution

European dairy production has shifted from heavy regulation and state intervention to free-market production and price-setting over the past decade, introducing new risks for dairy firms.

Market Challenge

European dairy firms must adapt from stable supply and pricing to volatile dairy commodity prices, with limited risk-hedging options available in EU markets.

Research Approach

The study applies a multivariate mixed-data sampling (MIDAS) quantile regression technique to analyze how dairy commodity prices impact operational performance of European dairy firms.

Impact of Firm Size on Operational Performance Sensitivity

  • Large firms show higher and more stable operational performance compared to small firms
  • Small firms have more than double the performance volatility of large firms
  • Demonstrates how firm size affects ability to manage dairy market risks

Operating Leverage Impact on Firm Performance

  • High DOL firms show higher but more volatile performance
  • Operating leverage significantly impacts risk exposure to dairy price movements
  • Demonstrates trade-off between operational flexibility and performance volatility

Dairy Product Margins Over Time

  • Cheese margins show higher average values but lower volatility than butter margins
  • Butter margins can turn negative, creating significant risk for producers
  • Demonstrates different risk profiles of dairy product lines

Milk Price Sensitivity Across Firm Types

  • Small firms and high DOL firms show greatest sensitivity to milk price changes
  • Large firms and low DOL firms demonstrate more resilience to price fluctuations
  • Illustrates varying degrees of exposure to input price risk

Model Performance Comparison

  • MIDAS Quantile model shows superior performance compared to alternatives
  • Demonstrates value of combining mixed-frequency data with quantile regression
  • Validates methodological approach of the study

Contribution and Implications

  • First study to formally demonstrate direct connection between dairy prices/margins and operational performance of European dairy firms
  • Provides practical framework for dairy firms to understand and manage commodity risk exposure
  • Highlights need for better risk management tools, especially for small firms and those with high operating leverage

Data Sources

  • Size and DOL performance charts: Constructed using data from Table 1, Panel A
  • Dairy margins visualization: Based on statistics from Table 1, Panel B
  • Sensitivity analysis: Derived from Table 2 coefficients at 0.05 quantile
  • Model comparison: Created using p-values from Table 3
  • All data covers period from 2005 to 2018 for 15 European dairy firms