[This post was first published in the Fairfax NZ Sunday Star Times on 14 September 2014]
New Zealand agribusiness, led by dairy, has hit a rough spot. Some will see this as confirmation that dependence on China involves big risks. More important, is the need to recognise that China is also the solution.
Chinese demand for dairy products in particular has grown so rapidly that it was inevitable there would be speed wobbles. With hindsight, we can see that it was the New Zealand drought of autumn 2013, combined with increasing Chinese demand, that led to shortages of milk products in Chinese supermarkets during late 2013. The Chinese importers then over-reacted, and purchased heavily during our summer months. Increased autumn production in the current year has then coincided with Chinese inventories already fully replenished.
With hindsight, there is little doubt as to what has happened, but no-one saw it in advance. If the Chinese had themselves seen it, then they would have throttled back their purchases earlier in the summer, and then had to brake less hard in the last few months. Despite the speed wobbles, the 2014 calendar year will still easily set records for New Zealand milk powder sales to China.
Similar events have played out in China for some other agri-food industries, albeit for somewhat different reasons, leading to short-term over supply. However, the long term trends for both protein and luxury foods are all positive. For New Zealand, long may this continue, because otherwise there is no-one who is going to buy our agri-food exports in the quantities that we are producing and at the prices that we need.
From other directions there are some cold winds blowing. The biggest destabilising events are coming from Russia and the Ukraine. Now that Russia has banned dairy imports from Europe, there will be 700,000 tonnes per annum of cheese, butter and skim milk powder looking for a home. Even if political compromises can be found in the Ukraine, this by itself will not change what was already developing into an over-supply situation. As long as the West continues to impose sanctions on Russia, the Russian dairy markets will not re-open.
Accordingly, the likelihood of cheese and skim milk powder prices recovering in the next few months is now looking dismal. Increasing Chinese demand for cheese and skim milk powder could help, but it will not be enough.
Fortunately, the prospects for whole milk powder are somewhat brighter because the Chinese do still want and need lots of whole milk powder. Both the US and the EU will try to produce more whole milk powder but they are constrained by short-term processing capacity.
The high level of uncertainty for global dairy is reflected in the wide variation in farm gate price estimates for the current season here in New Zealand milk. Synlait, at time of writing, is still predicting $7 per kg, Fonterra is predicting $6, and Westland is at $5.40 -$5.80. In comparison, the latest auction prices of early September will only support a payment in the low ‘fours’. There is now no doubt that it is the Russian and Ukrainian situation that is dragging the market down.
The cash flow impact on dairy farms of a low milksolids price will not start to be felt until after Christmas. This is a consequence of the way the major companies pay farmers with advance and retrospective payments. Final payments from last season, when prices were high, are still to come in the next few weeks. In contrast, for the agri-servicing industry, the demand for anything of a developmental nature is already drying up. Whereas the last rural downturn of 2008/9 was not well-flagged in advance, this time farmers are getting the message loud and clear and are acting accordingly.
For sheep farmers the outlook is also of some concern. Both the euro and sterling are slipping in response to political events, and this will impact on returns when converted to New Zealand dollars. Once again, we have to hope that Chinese consumer demand will come to the rescue.
The American dollar, in contrast to both sterling and the euro, has been appreciating in recent weeks. This will help the beef industry. But once again, it is China which provides the potential for an overall increase in demand. Fortunately, the Chinese are rapidly learning to appreciate American-style hamburgers.
A key message in all of this is that for most of our products it is only Asia that needs us. As well as China, there are considerable opportunities in the ASEAN countries such as Indonesia, Malaysia, Thailand, Vietnam and the Philippines. Japan and Korea are also important. However, China stands out far above all of these.
If we cannot succeed in partnership with these countries, then there is nowhere else to go. In the meantime we have to absorb the 2014 speed bump. There may also be other speed bumps ahead.