[This post was first published in the Fairfax NZ Sunday Star Times on 12 October 2014]
The latest Global Dairy trade auction of 1 October has placed a new complexion on the current dairy downturn. There is now widespread concern that the downturn is going to be longer and deeper than almost everyone had expected.
Rabobank’s latest quarterly report on global dairy prospects is also just published and there is no good news in that. Rabobank is suggesting it could be the later part of 2015 before there is a substantial turnaround.
European and American production are both increasing. New Zealand production is also buoyant. On the demand side, Russia has shut the gates on dairy imports from Europe because of the Ukrainian crisis. The Chinese are still buying but not fast enough. The dollar is high and may stay that way, despite efforts by the Reserve Bank to nudge it down.
It is still far too early to predict the final milk price with any confidence. Fonterra’s initial prediction last May of $7 per kg milksolids has now dropped to $5.30. If the downturn continues, then it could still be downhiill from there. Current auction prices at less than US $2500 per tonne for whole milk powder, and a little higher when averaged over all products, will at best support a price in the ‘low fours’.
No-one knows when the market will turn. I remain hopeful that the price for whole milk powder will soon start to rise, but the 10% decline in the last sale was a real shocker. I am less hopeful for cheese and skim milk powder.
There is no point in panicking. This is the nature of commodity markets. There are good years and bad years. Volatility has been increasing in recent decades as markets have become more internationalised and free from regulatory controls. In the foreseeable future it will remain that way.
For the last 15 years, I have been telling Lincoln students that at some time in their professional lives they will have to deal with an unexpected downturn. I tell them that neither I nor anyone else can tell them when this might happen. All I know is that it will happen, when for one reason or another, supply and demand get out of balance.
Rural businesses need to have their strategies thought out in advance. The key is to focus on survival and still be there for when the good times return.
Some people are already using the downturn to push particular viewpoints about the dairy industry. However, the bottom line is that dairy is the highest and best land use wherever that is consistent with an acceptable environmental footprint. Even in the bad years, the economy would be much worse off if it were not for dairy.
So what everyone has to do is just ride it out. For dairy farmers, that means putting aside all capital and discretionary expenditures. Many farms will lighten the superphosphate applications, but any reductions in nitrogen fertiliser or supplementary feed will quickly impact on income.
Farm operating costs are typically between $3.60 and $5.00 per kg milksolids. The average farmer also pays about $1.50 of interest per kg milksolids. Livestock returns provide about 30c. Most farmers will also get a dividend of perhaps 25c on their Fonterra shares. So the milk price needs to be about $5.25 for the average farmer to break even.
In the real world very few farmers are average. But this is the farmgate milk price where about half the farmers will run a deficit.
Cash flow and profit are of course two different measures. The dairy year starts on 1 June. Farmers get their first payment in the month after supplying the milk and then the rest dribbles in over the next year through to October. This means that farmers are only now about to receive the final 30c per kg from last year. In each of June, July, August and September they have been getting top ups from the previous year of 40c per kg.
On their current year’s production, Fonterra farmers have so far been paid $5. As from October, this drops to $4.48 and then $4 in November.It will not be until late summer and autumn before the lower payments really bite with minimal top-ups. Winter payments next year look like they might be negligible.
The banks will not mind too much. They will simply capitalise interest and one way or another they will be paid eventually. Interest will be charged on interest.
The banks understand that it is counter-productive to force farmers to sell their farms at these times. Every forced sale drops the market price and reduces the security they hold over other clients.
The most pain will be felt by those who depend directly on dairy farmers for their income. In the dairy regions, the effect on rural servicing businesses will be profound. This is already starting to occur.