Farmers in survival mode, trimming costs and raising productivity

The dry summer nationwide has undoubtedly had an impact on the global dairy market. Fonterra’s announcement of an expected 3.3% less milk than last year and a corresponding expected reduction in GDT volumes was met with an unexpected spike in whole milk powder (WMP) prices. 

Since then, milk production predictions for this season have been lifted with DairyNZ estimates currently sitting at similar volumes to last year. Any chance of a lift in the $4.50/kgMS milk price has now diminished with declines in recent auction prices putting a further dampener on the season.

Supply and demand factors

While most analysts were forecasting an improvement in milk price over the next six months, there are many reasons why farmers should proceed into next season with caution.

Russia’s one year ban on imported food from Western countries (although this does not include New Zealand) may be extended beyond August of this year. This means any surplus European Union (EU) production is likely to make its way into developing markets such as North Africa, the Middle East and Asia.

The EU have now removed milk production quotas and while this may not have much initial impact, the Netherlands, Germany, France, Denmark and Ireland will look to increase production over the next five years.

Chinese stocks of milk powder should be largely worked through now, but uncertainty remains as to when we will see a substantial increase in demand from this key market. Reduced cow numbers and lower milk prices will constrain milk production in China over the next couple of years, creating a larger supply gap and adding to the requirement for imported powder.

US milk production continues to grow in line with positive milk:feed price margins. The exception is California, which is much closer aligned to international milk prices.

In mid-2014 the exchange rate for NZD:USD was 0.86. Just six months later in the beginning of 2015 the exchange rate had dropped to 0.74. While there is some expected appreciation later this year, it is unlikely to increase to the 0.80 mark. However, the New Zealand dollar is performing strongly against the Euro and Australian dollar.

Oil prices are currently very low, and there is a strong correlation between whole milk powder prices and crude oil prices. Forbes economic commentator and forecaster Bill Conerly expects there may be temporary market volatility, but doesn’t expect a higher oil price to be sustained in 2015. His estimate is $60 a barrel with some rise possible in 2016.

2015-16 milk price

Cashflow this season wasn’t as grim as the headlines portray, and was still manageable, largely due to the high 2013-14 retrospective payments. However, the retrospective payments next season (2015-16) will be less than 50 cents when compared to this season of $1.50. To put things in context, just one of the month’s retrospective payments paid this season (40 cents) is close to as much as what will be received over four months next season. 

Recent auction results on the GDT have shown substantial movements. Some of the major banks have been quick to adjust their forecasts for this and next season. Most analysts are forecasting a milk price of $4.50-$4.70 for this season. (See table below). Most farmers should be well placed this season to manage their way through on the back of last season’s record payout. However, the outlook of a stronger milk price for next season has taken a blow following recent reductions in auction prices.

This cycle in milk prices is very similar to the 2008/09 downturn. If you believe history may repeat itself, the milk price will begin ‘with a five’, still a way from the five year average of $6.50/kgMS. This is based on an anticipated milk price of around US$2800-$3200/tonne and an average exchange rate of 0.74 to 0.77 NZD:USD.

In times of low milk price such as New Zealand is experiencing it is a case of survival firstly, through trimming costs and improving productivity. There has been higher early culling of cows, indicating farmers will take this route as well as once a day milking and early drying off, rather than relying as much on purchased supplementary feed, as occurred last season.

Capital spending and discretionary expenditure will be knocked right back. However, if milk prices do not reach $6/kgMS next season it will be core operating expenditure that will need to be looked at further to prevent debt escalations. This will require difficult on-farm management decisions. 

Farmers who are proactive rather than reactive will be better equipped to approach the volatile fluctuations in milk price. Maximising margins through considering the cost of production is crucial, and New Zealand dairy industry’s competitive advantage has always been converting pasture into milk at reasonably low cost.