Uncertainty and risk with forecast prices

Fonterra put a wide, but realistic, range on its opening 2024-25 milk price forecast. The $8/ kgMS midpoint came along with a range of $7.25 to $8.75 attached.

The new season midpoint forecast is higher than the current $7.80 forecast for the 2023/24 season. But it is lower than some might have expected. The SGX-NZX futures pricing for the 2024-25 season has been hovering around the $8.50 mark recently. That said, the latter is market pricing for the actual outcome not a forecast of Fonterra’s forecast.

Fonterra’s new season milk price forecast seems consistent (on our calculations) with softer-thancurrent GDT prices on average over the season ahead. An $8 milk price would be close to, but a touch under, average on an inflation-adjusted basis.

Fonterra’s forecast looks cautious. In fact, it says so itself. The co-op noted that ‘given the early point in the season, the uncertainty in the outlook and ongoing risk of volatility in global markets, we are starting the season with a cautious approach’.

That seems a fair view. Indeed, our own 2024-25 milk price forecast, that has remained unchanged for months at $8.20, could be seen as a bit conservative too given it also factors in lower GDT prices on average over the season ahead compared to current levels.

Labels like cautious or conservative might give some a feeling that upward adjustment is more likely through the season than downward adjustment. That might turn out to be the case, all going well. We will happily revise up our own forecast if developments suggest this is appropriate. But the opposite is also possible. That is the very nature of uncertainty and risk. We have certainly seen plenty of forecast adjustments in previous seasons and this one is mostly likely to be no different.

This begs the question whether milk price forecasts at the beginning of the season are so cautious that they tend to underestimate the actual outcome? Or, more generally, how does the actual milk price outcome compare to Fonterra’s first forecast for the season?

To get a feel for this we have had a quick look over the past 10 seasons and compared the final milk price result with Fonterra’s first forecast. The following chart shows the difference between those two figures. We have assumed the 2023-24 milk price finalises at $7.80. Some observations are:

• The average milk price forecast error over the past 10 years has been close to zero.
• The number of overshoots has equalled the number of undershoots (at 5 apiece).
• There have been some very large misses.

If nothing else this highlights the inherent difficulty in forecasting – more than 12 months ahead – something that depends on many, and highly volatile, components like commodity prices, currency fluctuations, weather conditions, and costs.

Despite some very large misses, the forecast errors average close to zero. This is consistent with no forecast bias over time. The unders and overs have tended to balance out over time.

Does this give any guidance for the season ahead? To be frank, it is difficult to know whether the 2024-25 milk price will end up higher or lower than $8.00 (or our $8.20 forecast for that matter). In the end, what matters most is what happens, not what is forecast. So, it is back to watching the regular GDT auctions, and fluctuations in the NZD.