Considering milk price volatility for investment decisions on the farm level after European milk quota abolition

Abstract

After the abolition of the milk quota in the European Union, milk price volatility is expected to increase because of the liberalized market conditions. At the same time, investment appraisal methods have not been updated to capture the increased uncertainty. Therefore, the objective of this paper is to assess the effect of changing price volatility due to quota abolition on investment decisions at the dairy farm level. To contribute to the objective and to approximate milk price volatility after the European milk quota abolition, the risk-adjusted discount rate for risk-averse dairy farmers is derived based on the milk price volatility of a milk price series from New Zealand. New Zealand dairy farmers have faced liberalized market conditions for more than 3 decades. Afterward, the risk-adjusted discount rate is applied to appraise milking technology investments for an average German dairy farmer. The results show that it is still more reasonable to invest in a parlor system than an automated milking system, although the net present value of the parlor system investment varies between €191,723 for risk-neutral dairy farmers and €100,094 for modestly risk-averse dairy farmers. For the automated milking system investment, the same calculations lead to €132,702 for risk-neutral dairy farmers and €31,635 for risk-averse dairy farmers. According to higher levels of milk price volatility after milk quota abolition, the reduction of the expected utility of the underlying investment decision for modest risk-averse dairy farmers is almost similar to a milk price decrease of 5% for risk-neutral dairy farmers. Therefore, the findings urge finance providers and extension services to consider the change of increasing milk price volatility after dairy quota abolition when giving dairy farmers financial advice. The risk-adjusted discount rate is a flexible tool to do so.

Productivity and Efficiency in European Milk Production: Can We Observe the Effects of Abolishing Milk Quotas?

“…The removal of milk quotas significantly changed the dairy business environment. Dairy farmers have started to face considerable milk price volatility, which affects their production and investment decisions [1,[20][21][22]. New business strategies have also changed the dairy sector structure (i.e., the number of farms and farm size distribution) [23].…”

Technological Change in Dairy Farming with Increased Price Volatility

“…If a farm has sufficient funds of its own or might be able to provide the necessary assets as collateral (e.g., by owned land), it might still refrain from investment if a combination of additional loan payments and increased price volatility puts the future liquidity of the farm at risk. Schulte et al (2018) showed that increased milk price volatility can considerably affect the profitability of investment decisions if farmers are risk-averse. A negative effect of milk price volatility on the investment propensity of dairy farms was confirmed by Zimmermann and Heckelei (2012) for a dataset on European farms.…”

How Farmers Make Investment Decisions: Evidence from a Farmer Survey in China

“…It is difficult to match the agricultural technology services with the technical needs of the farmers effectively, which is reflected in the farmers' relatively blind choice and adjustment behavior in grain production investment. Due to the differences in natural resource endowments, economic and social foundations, scale of operations, and farmers' conditions, the farmers' investment adjustment behavior varies significantly [2][3][4].…”

“…A variety of research methods were used in previous research to study farmers' investment adjustment behavior from different perspectives. For example, Factor Analysis [3,7], Multinomial Logit Model [8,10,11], Deterministic Discrete Event Model [9], Mixed Logit Model with Flexible Mixing Distribution [12], Tobit Model [13,14], Probit Model [15][16][17], and Structural Equation Modeling [18,19].…”