[This article was commissioned by the NZ Herald. It was written on 8 August 2016 and published on 31 August 2016. Since being written, some 24 days ago, we have seen substantial increases in dairy commodity prices, and in the short term (i.e. the forthcoming GDT dairy auction on 6 September GMT, and possibly subsequent auctions) these increases are likely to continue. However, the fundamentals remain unaltered; i.e commodities are highly volatile and will remain so, but there are also many traps for the unwary along the value-add path.]
There is increasing recognition within New Zealand that the dairy industry is in some trouble. Heading into a third year of low prices, questions have to be asked whether the industry is on a false path. And if so, where is the path back to firm ground?
Some will argue that the answers are simple: that we should reduce the dairy footprint on our land, and that we should focus on value-add. In reality, it is not that simple.
For those who live in the cities, it is easy to miss the importance of agribusiness to the overall economy. Much of New Zealand’s economic growth of the last 15 years is a direct consequence of a bountiful economic environment for agriculture in general and dairy in particular.
The economic benefits from agribusiness have not only flowed through the economy from multiplier effects, but have underpinned the increasing strength of the New Zealand dollar. When city folk head overseas for their holiday, or buy petrol at the local service station, they typically give no thought that the cost thereof would be so much greater if it were not for the strong dollar. Nor do they consider where the foreign exchange comes from to purchase Pharmac-funded health care. Without a strong agribusiness sector, we will all be in trouble.
On most dairy land, there are no attractive production alternatives. Yes, we could produce more beef and lamb, but both the farm gate returns and the export income would be low relative to dairy, even at current prices.
Also, there is minimal scope for increased lamb and beef exports to Europe or the USA, so it would have to be exported to Asia in general and China in particular. But there are limits to how much China can and will take, so caution is needed there.
The economic problem that New Zealand faces with dairy is not with dairy per se, but rather a dominant focus on one particular product, being whole milk powder (WMP). Similarly, the environmental problem with dairy is not with dairy per se, but with the uncontrolled return of nitrogen-rich urine to the paddocks in late autumn and winter. Both issues need to be and can be addressed.
Conventional wisdom seems to be that the current economics of dairy have been created by over-production in Europe consequent to removal of production quotas in 2015, combined with Russia banning the import of European cheese. Both are relevant factors, but neither are the dominant factor. Indeed, for WMP, European production has decreased by nearly 20% in the last eight years, and nearly 40% since 2000.
Most of New Zealand’s production increase over the last 15 years has gone into WMP, with much lesser amounts into SMP (skim milk powder), butter and cheese. While developed countries have been getting out of WMP production, New Zealand’s production of WMP has increased more than three-fold since 2000, and doubled since 2008. Overall, about two-thirds of national production goes into powders.
WMP is a product used mainly in developing countries where cool-chain facilities are limited. Until recently, much of the demand increase came from oil-producing countries where the governments used oil funds to purchase WMP. There was even a time when Venezuela was New Zealand’s biggest customer. But those days have gone, at least for the meantime.
Then, starting about 2008, China became an important customer and is now New Zealand’s most important WMP customer. In 2013 and early 2014, the demand from China went crazy, consequent to foot-and-mouth disease in their own herds, and a shortage of local product. This coincided with and immediately followed the 2013 drought in New Zealand, and the combination sent prices skywards. Since then, China’s local production of WMP has increased markedly and so import demand is back to about the same level as 2012.
To understand the global WMP market, there are several factors of importance. First is that Chinese consumption makes up about 45% of global consumption. Second is that there are only two big producers, with China leading and followed by New Zealand. In terms of exports, New Zealand is globally dominant with 70% market share.
Whereas China’s overall dairy consumption has been increasing, WMP consumption has plateaued. This reflects the overall economic transition that is occurring in China. So with China having also increased its own WMP production, New Zealand is squeezed from both sides.
The reason that New Zealand went down the WMP path is easy to explain. WMP dryers are the simplest and cheapest way to turn a short-life product into a long-life product. Also, WMP fits nicely with the New Zealand seasonal production curve. It was the easy option.
Apart from Ireland, Tasmania and parts of Victoria, nearly everyone else in the world focuses on 12-month production systems. These systems tend to be higher cost, but they open up many value-add opportunities. This is why most of the world has been happy to leave the WMP market to New Zealand, apart from as a dumping ground for short-term surpluses.
In the past, there have been good times for commodity production of WMP, with much of the last 15 years being excellent. But it was predicated on the oil-producing countries having money available for internal welfare programs, and on burgeoning Chinese demand for WMP.
In future, there may well be good times again for WMP, but it is unlikely they will be as good as the past. Almost certainly, the WMP market will be highly volatile, and that creates its own risks.
Shifting a proportion of existing WMP powder production to value-added consumer products, which is where international-demand growth is occurring, will require major restructuring throughout the value chain.
I estimate that shifting one-third of current production from commodities to value-add would take at least $6 billion investment in processing facilities and another $4 billion for market development. Back on the farm, many things would need to be done differently.
Currently, I am working with some farmers who produce milk 12 months a year, and the best of these are developing systems that have modest costs of production. It can be done, and it will work as long as a share of the increased returns flows back to these non-seasonal producers. As part of those systems, the cows must be off-paddock during the winter so as to minimise the nitrogen leaching issue.
Despite the opportunities, it is going to be a long journey, with major industry players currently in denial. And it won’t be easy. To succeed in value-add, it is essential to have products that are differentiated from other products in the minds of customers. Not everyone succeeds at that game.