Mr. Joe Collins:

I will deal first with volatility then with the market and market outlook. Volatility is the term given to the frequency and significant and unpredictable fluctuations in a product or commodity value. It is a normal feature of the market but it has increased in the dairy sector for various reasons. Typically, it is a question of mismanagement between supply and demand but there are other factors at play. Understanding it is important because if we understand we can de-risk it and try to out-perform it.

Dairy and food are unusual in that minor changes in supply and demand, scarcity or oversupply can lead to major changes in pricing. The reason for that is the lead and lag in dairy is typically one to three years, unlike other industries, such as the auto business where production can be turned off and on very quickly. The frequency and magnitude of volatility have changed over the past 25 years. For the first 17 years the rolling average showed very little movement, at plus or minus 10 cent per litre.

Since 2007, the frequency and magnitude have increased quite dramatically. Members can see this on the graph that it moved from +/-10 to +/-24, a 240% increase in that period. That is more than commodities like oil have changed in that period.

There are five or six reasons that volatility is increasing. One is that we have moved in dairy from a regulated market to a free market. There is very little product subsidisation and there are no refunds nowadays. Intervention is well below market levels and we are operating in a global market. The second factor is that weather shocks are having a bigger impact. Food, particularly dairy, is now being produced at very intensive levels in parts of the world and it is more prone to weather shocks. Interestingly, about 700 notable natural disasters were recorded in the year 2000, while in 2014, there were over 900, so there are more global weather events taking place, which may be part of global warming. Trade policy also has an impact, particularly on the demand side. We have seen what the Russian ban has done since it was introduced in August 2014. Bilateral agreements have also impacted on trade. In terms of stock, since the credit crisis back in 2007-2008, there is much less of both private and public stocks than heretofore. The result is that when the market is overheating, there is no buffer stock to release onto the market to cool it down and when a market is very weak, buyers seem to buy less stock to tighten up the market. That has had an impact, as has the availability and speed of data, in terms of how quickly one can get data through the Internet and how quickly it is analysed. That has added to the volatility, as have hedge funds, dairy auctions and futures trading. We know from the dairy auctions that take place, particularly the GDT, that when the market is tight, prices shoot up very high. It magnifies the peaks and the troughs. A further complication in an Irish context is the seasonality or the grass-based nature of our milk production. As members can see from the graph, we have a peak to trough ratio of about 7:1, whereas the rest of Europe is quite flat. If 75% of the milk is produced over a short period - maybe 50% of the year - and the market is very firm then and much of the milk is bought at that price, or indeed if the market is very weak then, it compounds the volatility, whereas the flat curve, which occurs in the rest of Europe, almost has a natural hedge built into it.

What has Ornua been doing to help insulate farmers against volatility? We have a six-point plan, which we have been working on since 2011. That is around growing the brand, particularly Kerrygold. Brand prices tend to operate in narrower tramlines than commodity prices. That has worked quite well. We have also spent a lot of time on and have invested in technology and innovation to develop value-added ingredients. If customers are buying a value-added ingredient, they tend not to be able to switch to alternatives, so there is some protection in that. The third factor is diversification, both geographically - Ornua sells products in 110 countries - and in sectors. We operate in retail, food services, ingredients and across a wide range of products. That is probably a bit unlike our peers, who may focus on one market and one product. We have also worked hard on strengthening the supply chain with key blue-chip customers in that we do long-term contracts, we look at ways of working together and we build in price points and tramlines, which help to take out some of the volatility. For the past four years, we have supported the processors with guaranteed fixed milk price schemes, where we effectively link customers with the farmer on fixed price contracts. Since 2012 we have put much focus on, and resources into, building up a trading team, which will take some knowledge and expertise from other sectors to help manage volatility in terms of using the financial markets to hedge and de-risk our physical positions.

Has this strategy worked? We would say it has. Members can see on the graph the purchase price index, which is the index of what we pay for a product by month. It is based on 2010, which was 100, and members can see that over the past year or so, the swing has been about 10 base points, or about a 10% swing. This would compare to the GDT, the New Zealand auction, which has swung to the tune of 66% in that period and Dutch quotes, which are more representative of European prices, have moved by about 50% in that period. The strategy we have in place has helped take out some of the volatility but obviously not all of it.

Moving on to the market and where we are now and where we think it might move to, a good place to start is by looking back. If members look at the table, they will see that in 2012, particularly the latter half, milk production globally was quite low. That stimulated high prices. The prices in turn stimulated very strong production from late 2013 to late 2014. In fact, globally milk was up about 5% in that period year-on-year, or roughly twice demand or consumption, which was about 2.5%. That is probably the start of the current problem. As we moved into 2015, supply quietened down, back towards about 1.25%, but unfortunately the legacy of the stock that was made in 2014, plus the compound growth factor, continues to overhang the market. Looking at the GDT prices, and we mentioned volatility before, members can see at the start of 2014 whole milk powder, for example, was up at $5,000 per tonne. It then dropped 70% in the period to August 2015. It has recovered slightly but is now in slight decline at the last few auctions. In terms of looking at the current situation, New Zealand milk has slowed but unfortunately probably not enough. Six weeks ago, there were reports that it could slow by 8% to 10% for the current season. More recently, they are saying it could be less than half that at 4% to 5%. That has certainly affected the market in the last two to three weeks.

European production has been very strong recently. As can be seen from the graph, particularly as we moved into August and September, there are very strong flows year-on-year. The background to that is probably twofold. The weather has been exceptionally mild across Europe, typically 6° Celsius to 7° Celsius higher in temperature and feed cost has been quite low. Obviously, with no quota, farmers have pushed on. The real point is that European milk production in 2014 was up by 4.5%. It is likely to be up by 1.5% this year. That is a compounded 6%, which is a lot of extra milk. The other thing we need to remember is that Europe is seven times the size of New Zealand when it comes to milk output, so what happens in Europe is key.

Moving from the supply side to the demand side, the Russian ban has had a major impact on EU exports, particularly cheese. We must remember Russia was importing approximately 30% of EU cheese and butter, or 240,000 tonnes per annum. This was quite substantial. In total it accounted for 15% of all EU exports.

The second big demand player is China. In 2014, it imported a very large volume of powder. This equated to an additional 2.2 billion litres over the amount in 2013. At that time, the world thought this 2.2 billion litres was genuine demand, but what subsequently transpired on looking behind the figures was that domestic supply in China was down approximately 1.5 billion litres, and therefore the genuine demand was only 700 million litres. This reduction in supply in China in 2014 related to foot and mouth disease, poor weather conditions and farm regulations. Since 2014, these have been corrected, domestic supply has recovered and imports in 2015 have reflected this. Not only has domestic supply recovered but demand has slipped a little as the economy in China has slowed. China is still trying to digest the high stocks imported in the second half of 2013 and 2014. It is trying to absorb these stocks. It is also trying to digest its recovery in domestic supply and cope with somewhat reduced demand. This has affected its ability to import.

There is some positive news. Despite Russia and China being out of the market, European exports have been quite good in 2015. The euro has, thankfully, been very weak which has helped competitiveness. Dairy prices have been low, which has made them very attractive and competitive. Many companies, including Ornua, had been building routes to markets outside of Europe in anticipation of quotas being abolished and we are now feeding these routes to market. An important point to make is that overall Europe exports approximately 10% of its milk, but nearer to 40% of Ireland's and Ornua's volumes are exported outside of Europe. There is a high dependency outside of Europe and these are the markets that will grow.

On the demand side in the two big blocks there is positive news in the United States and Europe. Economic conditions have improved somewhat, especially in the United States with quantitative easing and low oil prices helping disposable income. In addition, daily consumption, particularly butterfat consumption, is making a recovery which is very positive news. This has started with butter. Ten years ago butter was the villain in health but now it is seen as a virtue. This is moving from butter to other dairy products and from retail into food services and food ingredients. This is very positive news. Over the past year, butter consumption in Europe has increased by 3.7%, having increased only 0.8% in the past ten years. There is also a positive story for cheese in Europe and for butter in the United States.

To summarise the market outlook, further supply correction is required. We have legacy stocks and compounded growth, which are concerning. We probably need a weather shock or certainly less benign whether to control this supply. If we do not have this, it will be up to milk prices to correct it. At this stage, it looks as though even allowing for supply correction with a weather event, it will be the second half of the year before we see a decent pick up. The market is still digesting the high stocks. Without China and Russia, demand is probably nearer to 1.5%, and we probably need supply to fall below this level to absorb some of the legacy stocks. If there is a recovery, it will probably take a little longer to get through to farmers because we need to remember many of the processors and much of the supply chain have absorbed or subsidised milk prices and this has impacted on their balance sheets.

The long-term future is positive. There are more people in the world, they have more disposable income and they are more interested in dairy as a fat and protein deliverer. There is no doubt volatility is increasing and it is here to stay. It will impact on everybody in the supply chain, from farmers through to co-operatives through to marketeers. From a farmer's perspective, the best approach to manage this involves open market returns, that is, the monthly milk price, with perhaps a volume of milk on a guaranteed milk price scheme. Certainly in time there should be derivatives and financial markets to hedge some of the risk. Managing costs and efficient financial planning will be key. We will continue to focus on the issues we mentioned and improve matters with a view to increasing returns and managing volatility.