Using futures to read the market

Published 17 August 16

Tracking European futures pricing can help shed some light on market prospects, keeping in mind these are likely to adapt as more is learnt about associated supply and demand.

When looking at prices of futures contracts*, it is best to think of them as the equivalent to a forward price. In other words, an agreed price between a buyer and a seller for goods that will be delivered in the future, as with forward purchasing feed/fuel. They are not predictions of what prices will be in the future and should not be used as a determinant of the actual price the product will sell for in the future.

That said, the price of a futures contract gives us information on what the market currently expects supply and demand conditions to be at the time of delivery (or expiry of the contract) relative to what they are now. Because of this, quoted prices for a particular futures contract react to changes in the market.

This can be seen in the graph which shows how the Sep-16 butter futures contract price has reacted to the downturn in milk production. At the beginning of March, when expectations were that milk production would remain high, the market was willing to pay €2,498/tonne for a Sep-16 butter futures contract (which would fix the price paid for butter for delivery in September). Tracking the price of the Sep-16 butter futures contract through to the end of July shows how the price of this contract has risen to €3,435/tonne. This shows how the drop in production has changed expectations. Now that the market expects supply to be lower, traders are willing to pay more today to secure the price they pay for butter delivered in the future.

Futures graph 17.08.16

Tracking how prices for a specified futures contract moves month on month can therefore paint a picture of how the ‘market’ thinks supply and demand will change between now and then. Futures markets currently only operate at an EU level and therefore reflect events on that market. However, as UK dairy markets typically move in line with the EU trends, outside of occasional short term differences, futures markets can also provide an indication of how UK markets may change in the medium term.

*A futures contract is an agreement to a pay a fixed price today for a fixed volume of product (such as butter or skim milk powder) at a fixed date in the future. For example, the price of the EEX Nov-16 butter futures contract price on Friday 5 August was €3,585/tonne, indicating a commitment to pay that price today for a tonne of butter delivered in November. It does not mean that the price for butter in Nov-16 will be €3,585/tonne, rather this is what the market is willing to pay now for delivery of that product in November.