Fran O'Sullivan and Alexander Speirs: Dairy faces volatile times

Dry conditions have already had an impact on the dairy sector, with milk volumes down.

There's a new norm emerging in the agribusiness sector as a range of trend-setting episodes impact.

This week we canvass some of the trends which are being tipped by key banking lenders to the rural sector.

First - the drought.

Thankfully there has been some rain. But the dry conditions have already had an impact on the dairy sector. Milk volumes are down and, while the shortage of supply has helped kick the auction price up again for whole milk powder in particular, the farmgate milk price for this season is expected to be the lowest since 2008/2009.

This is impacting on some farms, taking them to below break-even level.

Westpac notes that with prices low farmers have limited scope to bring in additional feed to maintain milk production, instead relying on their own stores and rainfall to spur on grass growth. As a result, milk production is even more vulnerable than usual to drought.

Fonterra expects its full-season milk production to be down 3.3 per cent - this will clearly flow through to perceptions of dairy as an investment via the Fonterra Shareholders Fund reminding investors that agribusiness investments are different to those in other sectors.

The dryer conditions are also having an impact on other growing sectors such as wine and grain, which are at a critical seasonal period.

Second - global commodities.

Again, with New Zealand as the world's largest dairy exporter, supply disruptions here can impact on the global market. Westpac makes the point that the last few droughts underpinned world dairy prices, which soared to new heights because the other global competitors were not able to adjust quickly enough.

They have now. There is new competition from North America and parts of Europe on the back of new supply agreements China has directly arranged to reduce its reliance on New Zealand product and provide some risk assurance. China has also invested directly in new dairy plants in the Northern Hemisphere.

New Zealand will have to much more aggressively market its value-added products in the dairy sector to keep pace - and try to retain its global position - as other competitors stretch their wings. This will require new strategies.

As ANZ points out, dairy is still the key localised downside risk to the New Zealand economy though NZ is firmly in expansion mode. That's why it is important dairy bounces back.

Third - lower NZ dollar.

ANZ makes the point this will help support farmgate prices. But the ability to benefit depends on exporters' hedging polices.

Westpac adds that the NZ dollar has been a pawn in a bigger game between the world's heavyweight currencies. It's fallen against the US dollar but remains strong on a trade-weighted basis. The bank anticipates more of the same for the time being before a recovery in global risk sentiment spikes a rise in the US/NZ dollar cross rate later in the year.

Fourth - farm prices cooling.

ANZ makes the point the rural property market has cooled a touch. The bank says turnover has remained fairly resilient, continuing to oscillate around the 10-year average, but the average all-farm price is easing.

While dairy-aligned property prices have softened, arable and horticulture prices remain on an uptrend and grazing property prices are down. This leads us to the next point.

Fifth - interest rates.

Indicative rural lending rates have moved sharply lower since the end of last year, led by the long end.

Lower interest rates will help those farmers with flexible borrowing programmes. But, with the banks warning liquidity may come under pressure globally, betting on bucking the trend carries considerable risks.

In all, these variables make for a potentially volatile time ahead for the sector and farmers.