Who hedged my cheese?

By Kyriba May 21, 2013

First, let us start off with this – pretty much everyone loves cheese! However, there are exceptions, such as people that are lactose intolerant, and food manufacturers’ risk managers that are responsible for hedging their cheese programs. Companies like Kraft and Bel-Brands have large exposures to the cost of producing this often gold-colored commodity. In turn they must minimize the fluctuations in their costs, so that we as consumers can enjoy the delicious benefits of cheese!

I remember my first indoctrination to cheese hedging and I started to ask myself many questions that you may be asking yourself at this very moment. Why hedge my cheese? How to hedge my cheese? Who hedged my cheese? My goal is to try and answer those questions for you. The best way to accomplish this in a limited time frame is to discuss the basics and then the complications that treasury managers face when applying their risk management objectives within cheese hedging strategies.  Hopefully, at the end you will have an idea of why cheese hedging is my favorite hedging program and why it is a great party discussion when somebody says “Wow, look at all this cheese! I wonder how they put this all together.” OK – it probably depends what kind of party you’re at, and who the other guests are.

First Question: Why?

Companies in the consumer consumption business – in this case, cheese – must maintain their profitability through cost-effective production management. Production of the cheese requires a major commodity component: milk. There are several types of milk, but the most common in our discussion is cow’s milk. The importance of milk as a main ingredient to cheese and several other products (and the consumption by itself) subjects a manufacturer to the basic economic factors of supply and demand. As the milk price increases or decreases, the cost of producing the cheese will have a direct correlated effect with the cost of purchasing the milk. A simple illustration can be seen in the Consumer Price Index from the Bureau of Labor Statistics between the consumer prices of cheddar cheese and milk.

The top graph outlines the Consumer Price Index (average price across a range of cities) of one pound of cheddar cheese, and the bottom graph outlines the same data for a gallon of milk.


Second Question: How?
Risk managers responsible for cheese hedging programs will often use several derivative instruments such as Futures and OTC Swaps to reduce the exposure to the price volatility of milk. While not a perfect 100 percent hedge, there is enough statistical evidence to demonstrate historically that milk contracts or OTC milk derivatives can be an effective hedge for the production of cheese.


In today’s commodity market, the cheese demand is fairly robust and it has increased the need for more effective instruments to hedge cheese exposures. The CME has recently listed futures in certain types of cheese to keep up with the demand. However, since the listing is limited to specific types of cheese, which can be many, milk derivatives are the dominant natural hedge which can be tricky to manage.

Complications: What The Whey…?

Okay… So, we have overcome how we hedged our cheese. But wait a minute, what is this by-product that is produced from the milk in order to produce the cheese? And, what is that, you say, I can sell the whey?

Yes you can. A very interesting concept, using the milk commodity which is considered an expense to produce the cheese, a company is left with an asset, the whey protein. In fact, it is such a widely-used ingredient in other consumable products; the Commodities Exchange lists whey futures to help corporations manage their price volatility. On the surface, it may sound like a good thing to have an asset emerge from an expense, but from an accounting and hedging perspective it does add an additional element to be considered when reporting to company shareholders.

Some points to consider before hedging the cheese:

  • Supply vs. demand between cheese vs. milk. Interestingly enough when you do implement many cheese hedging strategies you do get to see some market anomalies.   For instance, the increase demand for milk for consumption rather than ingredient. At what point is it more profitable to sell the milk vs. using it for cheese production?
  • Different classes of cheese can be produced with different classes of milk. Higher class of the ingredient will produce a higher class of the product. 

Hopefully this gives you an overview of how hedging can be used across a wide range of industries. If you’d like to know a little more, please feel free to email meStrangely, after writing this, I do have a craving for something…

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