End of quota will steady prices - bank

Europe will be producing more dairy products now the quota has gone. Photo / Paul O'Driscoll

No sudden transition expected because production in Europe has already anticipated the change of rules.

The end of the European Union's quota system poses a challenge to New Zealand's dominance of global dairy trade and is likely to put an end to the sharp upward spikes in prices seen in the past, says Westpac.

April 1 marked the end of the EU's quota system, which had been in place since 1984 to curb overproduction.

The bank's economics team had been asked whether the EU's move would pose a challenge to New Zealand's dominance as an exporter of dairy products.

"Over the longer term, the answer is clearly yes," the bank said in its latest agriculture update. The quota system was a big factor behind the lack of flexibility in the global milk supply. Between 2008 and 2013, the growth in China's demand for whole milk powder was almost entirely met by New Zealand, with minimal production growth elsewhere.

"The removal of the quota system means that global milk production can be more responsive to changing conditions, such as regional droughts or rapid shifts in demand," it said.

"Hence, the sharp upward spikes in dairy prices that we've seen at times in recent years could be a thing of the past."

But the bank does not expect to see a sudden transition now that quotas have been taken away because production in Europe has already risen sharply in anticipation of its removal.

Also current milk prices don't favour a further ramp up in production from these already high levels, it said.

After a long period of flat or subdued growth, the EU's milk production began to rise sharply in 2013. For the season ended March 2014, eight countries were forced to pay a total of 409 million ($590 million) in fines for producing more than their quotas.

It was a sensible decision at the time, because high world dairy prices more than covered the cost of the fines, and expansion provided the economies of scale that would be necessary for survival in a post-quota world. The season ending this March started off in a similar vein, with production continuing to rise rapidly, but the price story has been very different this time.

"The near-record world prices at the start of the season gave way to a steep decline as the months went on. By late 2014 prices were below the cost of production for many dairy farmers, even before accounting for the overproduction fines," it said.

As a result, European milk production had begun to turn down since last September, although it remained at a very high level.

The European Commission has forecast a lift in production of just 1 per cent for the next season - and that forecast was made when prices were at a higher level than today.

"The removal of EU quotas is likely to cap the upside potential for dairying returns in New Zealand in future years. But for the coming season at least, it's more likely that low milk prices will suppress competition from the higher-cost producers in Europe," the bank said.

Commenting on last week's GlobalDairyTrade auction, the bank said the 10.8 per cent fall in the price index suggested that the "drought premium" has been fully unwound.

"We're inclined to wait and see whether the fall in prices reflects anything beyond drought effects, but our payout forecasts for both this season and the next are clearly on notice," it said.