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.