Surviving the dairy downturn

In recent weeks the short term dairy outlook has turned from bad to awful. Fonterra’s recently revised milksolids price estimate of $4.15 for the current 1015/16 season has already been overtaken by events, and is once again looking decidedly optimistic.

I now see a figure of about $3.90 as being more likely, but still with plus or minus 40c around that. Even more important, no longer can we ignore the likelihood that dairy prices are going to stay low for at least the first half of the 2016/17 dairy season, and possibly for all of that season.

Most but not all of the farmers I have contact with are going to come through relatively unscathed. But that is not the case for those who have both high costs of production and high debt. We are now facing a situation which New Zealand farmers have not faced since the 1980s.

The key issue is now survival. And the focus of farmers has to be on finding the right strategy the assist with their own individual situation. There is no one strategy that applies across all farms.

It is easy to blame others for the situation we are in. Increasingly, the bad guys are seen to be the European and American farmers who are supposedly subsidised, or the Chinese who are supposedly inconsistent in their buying behaviours. Well, we need to get over using others as the fall guys.

The reality is that European farmers get very substantial support for environmental protection measures but this support is decoupled from production and milk prices. More importantly, it is WTO-compliant and we have no leverage to change those policies. To the extent our leaders choose to bang the table on such issues, then it is essentially just grandstanding for our own local New Zealand constituency.

Similarly, the notion that American dairy farmers receive substantial subsidies is largely a myth. Once again, the US would seem to be WTO compliant in relation to dairy support. The key so-called subsidy is a disaster insurance program. Anything beyond disaster level insurance and farmers have to buy into it. Many of them have not done so given the cost thereof.

As for the Chinese, well, it would be nice if there was more transparency as to what is happening over there. But the bottom line is that apart from 2013/14 when China’s own industry was in turmoil from local shortages, and the subsequent import step-down when those issues were resolved, the overall pattern remains one of onwards and upwards.

If we want to find the most important causes for the downturn then we first have to look at global geo-politics. The Russian ban on dairy imports from Europe was in response to European and American financial sanctions and trade embargos imposed on Russia as so-called punishment for events in Ukraine.

The major downturn in oil prices also links into global politics. It is just unfortunate that the oil producing countries tend to be the countries that purchase our whole milk powder. So currently they are out of the market.

Whereas both of these factors were unpredictable, there is a third key factor which some people did recognise as a possibility. This factor was and is that the removal of milk quotas in Europe would unleash entrepreneurial enthusiasm amongst some European farmers.

We all knew that production deregulation in Europe was coming, but there was no consensus as to what the market consequence would be. Well, now we know.

In the Netherlands, some farmers have figured out that their marginal costs are less than the marginal returns, and so they have increased production. Overall, milk production in the Netherlands is up 9% since quotas came off in April.

In Ireland, farmers also thought they saw economic opportunity and have increased their production a remarkable 16%. But in most other parts of northern Europe production is also up, including the big producing countries of Germany, France and the UK.

My estimate is that it will be at least April before European production stabilises on a same-month basis and also year-on-year basis. Whether we will see declines thereafter is debatable. Some farmers with low marginal costs will continue to increase their production while eventually some smaller farmers will decide to get out of dairy altogether. But the timing is unknown.

Currently we are still at a very early stage of major European dairy industry restructuring that the removal of quotas has unleashed. There is turmoil ahead for European dairy.

Here in New Zealand, our industry has always argued for deregulation of both the European and Canadian dairy industries in the naïve belief we would somehow benefit. Well, in Europe it is occurring and we are now reaping the bitter harvest thereof.

Looking beyond the European restructuring, the reality is that there are always going to be unexpected global events, some of which stimulate demand for commodities and some of which depress that demand. At the moment we are in a big trough.

What has been poorly understood in New Zealand is that whole milk powder and skim milk powder are the most volatile of all dairy products. Echoing that Longfellow nursery rhyme about the girl with the curl on her forehead, when milk powder is good it is very good indeed and when it is bad it is horrid.

Back in the days when I was lecturing at Lincoln, I always used to say to farm management students that some time in their career they would face a big downturn. This was regardless of whether they were producing milk, lamb or beef. Neither I nor anyone else could tell them when that would be, so it was a case of following the scout motto of ‘be prepared’. Of course that is easier said than done. In these matters, timing of major investments is crucial.

Given the situation we are now in, it is no good crying over spilled milk. For those who are in difficulty, the focus has to be on finding a path to survival.

The starting point is to recognise that it is the banks who will make the key decision as to who survives and who fails. So all farmers needs to be presenting their banks with their survival strategies. Banks need to see that there is indeed a plan.

It is not the banks job to produce that plan and they will not do so. The only decisions they will make are whether or not to provide ongoing finance.

Fortunately, it is not in banks’ own interest to put the squeeze on productive farmers, as they do not want their own asset protection values to fall. We all have to hope that the overseas-based CEOs and governance boards of our major banks will, in that regard, get it right.

The second point is that cash is king. What does a specific reduction in cost do to income? Most farmers have already made the easy cost reductions.

The third point is that now is the time to be setting up for next season. In some cases that will mean selling cull cows early to ensure more feed available for wintering cows on the home farm. In many other cases it will mean wintering less cows and going into next season with lower numbers.

One of the fascinating outcomes from this current year is that despite cow numbers being down markedly, overall seasonal production is looking like being remarkably close to last season. This is despite the poor start to spring. There have to be some lessons in there.

I continue to hear poor advice in relation to supplementary feed. We all know that pasture is the lowest cost feed – as long as the fixed costs of land ownership are not included. But pasture does not always grow when we need it.

I know of one large farming group that works on the basis of feeding only half the calculated deficit. That can and does work in some circumstances and for short periods. But hungry cows always find a way to penalise their owners. In broad terms, for every 7kg of feed deficit, a cow either produces 1kg less milksolids, or loses 2kg of liveweight, or some combination thereof.

Every farmer needs to work out for his or her own situation what are the best methods of dealing with a feed deficit. The cheapest way to produce additional feed is often to apply nitrogen fertiliser, but of course there are limits. In other cases, there is definitely a place for the sometimes maligned PKE. Or it may be best to take another look at cow numbers.

The key point is that reducing feed in isolation from other system changes is a recipe for disaster.

Also, many farmers and rural professionals are prisoners to the notion that a low input system will be a low cost system. The evidence I have seen over the years shows very clearly that most of the differences in cost of production are due to factors other than system intensity.

My concluding message is to emphasise that right now is the time to get plans in place for next season. And it is much better to plan on the assumption that it is indeed going to be a very tough year, and then be proven wrong, than to assume the reverse and be proven wrong.

In particular, don’t be mislaid by early estimates of the payout for 2016/17. Quite simply, no one can predict prices for 2016/17 with any confidence. All we can say it that it is more than possible that the early season payments will be distressingly low, and that the view beyond there is totally foggy. That is the nature of commodity markets.

About Keith Woodford

Keith Woodford is an independent consultant, based in New Zealand, who works internationally on agri-food systems and rural development projects. He holds honorary positions as Professor of Agri-Food Systems at Lincoln University, New Zealand, and as Senior Research Fellow at the Contemporary China Research Centre at Victoria University, Wellington.
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1 Response to Surviving the dairy downturn

  1. Pingback: Rural round-up | Homepaddock

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