Dairy in the doldrums

Photo / Christine Cornege

Dairy farmers should be able to weather a low payout for the current season, thanks to last year's record milk price, but two poor seasons in a row would put the sector under financial stress, economists said.

Fonterra, the leading dairy cooperative, looks set to drop its farmgate milk price for 2014/15 next month to around $4.55 to $4.85 a kg of milksolids from its current forecast of $5.30 a kg after dairy prices resumed their decline at yesterday morning's GlobalDairyTrade (GDT) auction.

But farmers are still benefiting from last season's record payout from Fonterra of $8.50 a kg, which economists said would help to offset the low payout this year.

ANZ Bank chief economist Cameron Bagrie said yesterday's auction gave the bank less confidence over where to pitch its forecast for the 2015/16 payout.

"One year of low payout is problematic," he said. "It's challenging, but it's not terminal." Two years of low payouts would start to have ramifications for the New Zealand dollar and interest rate settings, he said.

"And at the moment, the risk is growing."

A farmgate milk price below $5 would mean many farmers would struggle to cover their cost of production, Bagrie said.

"There is a long way to go, but a second year of low prices would be a worry."

Reserve Bank deputy governor Grant Spencer, in the bank's latest financial stability report, said risks in the dairy sector had increased.

"The forecast dairy payout for the coming season has been reduced significantly, and could result in rising loan defaults should the lower payout level persist," Spencer said in the November 12 report.

ASB economist Chris Tennent-Brown said a high level of farmer bank deposits from last year's record payout would provide many with a financial buffer.

"But on the other hand, we know that at the current price, it's not enough for a lot of farmers to pay their production expenses and interest servicing costs," he said.

"There is an inevitability about it when you get a chunk of farmers in that situation, they will need the payout to pick up from current levels in the year ahead."

Tennent-Brown said market conditions in the first half of next year would determine how dairy farms functioned over the following two years.

At yesterday morning's auction, the GDT price index fell by 3.1 per cent, dashing hopes that the market may have stabilised following on from the last two sales, which saw the market flattening out after falling by close to 50 per cent since February.

The price of wholemilk powder at the latest auction was down 5.1 per cent to an average price of US$2400 a tonne, while skim milk powder was down 5.7 per cent to US$2299 a tonne.

Wholemilk and skim milk powder are the two main products Fonterra uses to formulate its farmgate milk price.

The co-operative has said the wholemilk price would need to reach US$3500 a tonne by March next year for its $5.30 a kg milk price for 2014/15 to be realised. Fonterra is expected to revise its milk price forecasts early next month.

ANZ Bank economists said the auction all but confirmed that a further cut to the farmgate price was on its way. "While some of the other products showed a bit more promise, the persistent weakness in milk powder prices has cemented farmgate prices in the low $4/kg for the past four auctions," the bank said.

The AgriHQ Seasonal Farmgate Milk Price for the 2014-15 season fell by 20c to $4.55 a kg after the auction result. AgriHQ dairy analyst Susan Kilsby said a recovery in dairy commodity prices was expected to be protracted.

ASB has revised its milk price forecast down by 40c to $4.70/kg of milk solids. The falls come as Fonterra has reduced auction volumes to try to generate upward pressure on prices.

To make matters worse, New Zealand production is running strongly. Fonterra's production to date is 4 per cent higher than at this time last year, putting more downward pressure on prices.

Dairy prices have fallen sharply this year, because of a build-up of inventory in China, the effects of a ban by Russia on many Western food imports - mostly dairy - and increased global production.

ANZ's estimate of $4.85/kg would mean a $750 million reduction in dairy's contribution to the economy, in addition to the $5 billion drop that Fonterra's $5.30 forecast will bring, relative to last season's strong performance.

Some farmers will have made up for lost ground on price by producing more milk, which will put more downward pressure on prices.

"The paradox is that the sector does not need higher supply, in aggregate, at the moment," said ANZ's Con Williams.

What's driving prices down

• Global dairy prices fell by 3.1 per cent at the latest GlobalDairyTrade auction.
• Milk powder prices have fallen by over 50 per cent since last November.
• Russia, a major consumer of cheese, has put a ban on food imports from some Western countries in response to trade sanctions that resulted from its support for anti-government rebels in the Ukraine.
• European producers have had to make more skim milk powder to compensate for the drop in demand. This has put more powder on to the open market, which has increased supply and diluted prices.
• Production has increased in New Zealand, Australia and many other major producers, as farmers seek to take advantage of the opportunities that a growing market for dairy in China presents, which has put more upward pressure on supply and downward pressure on prices.
• High dairy product inventory in China has also put a brake on price improvements.