El Niño's helping hand for global dairy prices

The onset of El Niño - set to bring dramatic temperature swings during the next three months, may already be impacting milk production around New Zealand. Lower milk production out of the key NZ market will put upward pressure on global dairy prices.

Some analysts believe the recent resurgence in global dairy prices on Global Dairy Trade (GDT) auction could be linked to worries around NZ milk production.

BNZ senior economist Doug Steel says they are now factoring in more of the rising risk of El Niño.

"Recent adverse weather, generally low milk prices, and elevated costs have already presented a challenging start to the dairy season," he says.

"Fonterra recently noted reduced milk production in the North Island, seen as 'a result of both costs and weather'."

NZ milk production fell 0.9% year-on-year in August, notes Steel.

"All considered, we have lowered our forecast for this season's milk production to a decline of more than 1% from roughly flat previously.

"If there is a silver lining here, some concern about NZ milk production appears to have contributed to arresting a large and lengthy decline in dairy prices. This is hardly the best way to generate price support, but it looks to be part of the mix."

BNZ lifted its forecast milk price for the season by 55c to $7.25/kgMS, a few days before Fonterra announced a revision of its forecast milk price range. The co-operative raised its price range to $6.50 - $8/kgMS, with a midpoint of $7.25/kgMS, up 50 cents.

Fonterra chief executive Miles Hurrell says the improved outlook reflects both supply and demand dynamics.

"Here in New Zealand we're forecasting collections to be slightly below last season, while aggregate milk growth in key export countries is expected to be below average for FY24. The El Niño weather pattern may have further impacts on supply, and this could be driving recent buyer sentiment," he says.

"On the demand side, we have seen increases in recent Global Dairy Trade events. While this has been encouraging, it is not yet clear whether the stronger demand from China will be sustained. For other key regions, customers remain relatively cautious in terms of their forward purchases."

But Hurrell warns that it is early days and the co-op still faces significant exposure to volatility in commodity prices.

Exchange rate volatility is another factor to keep in mind, he says.

"Our foreign exchange hedging strategy is designed to help lessen the impact of this, and also supports a higher advance rate level than would be possible without hedging."

GDT auction prices have surged in recent events, bouncing about 12% off their mid-August low. Steel notes that developments elsewhere appear to have also played a role in the bounce in dairy prices, including cost and weather challenges in other major producing areas.

"Some better (or less weak) news out of China of late has at least helped sentiment. Scheduled changes as part of the China-NZ FTA on 1 January are also supportive. Some demand signals have improved.

"Dairy prices also tend to be positively correlated with oil prices with the latter considerably higher than a few months ago. We see this correlation as the result of connections through various channels, one of which is changing dairy demand from oil producers with oil price fluctuations."

OPEC nations have been sizeable buyers of NZ core dairy exports, at just under $3b annually. That is a bit over 40% of what China buys from NZ, dairy-wise, so it is significant, he notes.

But Steel cautions that none of this is to say dairy prices are strong.

"Off the lows dairy prices may be, but they are still 18% lower than a year ago. So neither the recent bounce in GDT prices, nor the above associated developments to date, point to a high milk price in NZ.

"But, collectively, they have lessened downside risks and increased the chance Fonterra's 2023/24 milk price can be $7 or more."