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20 Jul 2015

Dairy Market Blog

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How long can this downturn last?

This, and “how low can prices go”, are probably the main questions on dairy farmers’ minds this month. As yet, there is no certain answer. While Rabobank takes a pessimistic view that an upturn will have to wait well into 2016, there are very good reasons to believe a rebalancing of supplies could happen sooner, and bring with it a recovery first in dairy product prices, and then in milk prices.
What is clear, however, is that this will take some time. What no-one can predict in any way accurately is how long that is.
In today’s blog, I propose to examine why we are where we are, and what the factors are that may get us out of it sooner rather than later.

“Old milk” and production momentum the main current cause of imbalance

Some of the extra milk produced during 2014, benefiting from strong milk prices and good production conditions, remains available in the system in the form of product stock. Also, the momentum of production created by the strong profitability and good production conditions experienced by producers in all milk production regions continues to carry a slight surplus production over demand – though this is dwindling rapidly in most regions.
Global supplies are estimated to be only up 0.7% for the first 5 months of 2015 compared to the same period last year. Much of this additional production originates in the US – where it is mostly consumed domestically – with strong demand for butter and cheese in particular. Australian and New Zealand production have made more modest contributions to the oversupply over that period (see graph below).

world milk supplies

Source: Ornua

EU supplies were constrained by superlevy concerns for the first quarter of 2015. Consequently, supplies for January to May were up relatively modestly.

However, since 1st April, we have seen two main developments: the big producers (Germany and France, which together account for approx 36% of all EU milk) increasing either not at all or very modestly, while the medium size producers (Netherlands, UK, Poland, Ireland – together around 28% of all EU milk) increasing very significantly.

Production in most other EU member states was either static or negative.

EU milk supplies

Source: Ornua

The graph below shows the share of each member state in total EU milk output, and we review below the most recent data available for the most important producers.

EU supply share

Source: Eurostat

The most recent indications from France (week 26 from 22nd to 28th June) was effectively no change either from the previous week or from the same week a year ago. However French output for that week was 5.2% above the 5-year average for that same week.
Cow culls (both suckler and dairy) were up 1.4% in May, and the heat wave of late June early July also had an impact. Furthermore, many French Departement have now been declared officially in drought situation by the Ministry for Agriculture, which allows farmers in those regions to graze set aside without cross compliance penalties. Officially drought stricken or not, all regions report moisture deficits.
Reports in recent days are of a further heat wave, with temperatures up to 40 degrees in many regions – though more modest temperatures are reported in the North Western dairy regions of Normandy, Brittany and the Pays de Loire (just South of Brittany) which between them produce over 50% of France’s cow’s milk output.

French suppliesSource: France AgriMer

In Germany, production for week 24 (early to mid-June) was also down seasonally (-0.7% relative to previous week), and modestly up on the same week last year (+1.7%).

German supplies

Source: ZMB

UK milk deliveries continue well up on last year, despite poor profitability on many farms. Most recent week (early July) was 3.1% higher than same week in the previous year, and over 7% above the average of the previous 3 years. The growth appears to be slowing slightly, however.

UK supplies

Source: AHDB Dairy UK

For the Netherlands, LTO reports output increases of 6.6% for May year on year, and something similar for June.

Poland’s output is reportedly 3% up for May 2015 compared to previous year.

Profitability plummets in New Zealand

Fonterra have openly admitted that their current milk price (2014/15 at NZ$4.40/kg MS, equivalent to approx 21c/l) was 20% below production costs. The opening forecast milk price for 2015/16, at just above that or NZ$ 5.25, will not improve the situation much.

The graphs below, from a NZ Ministry for Primary Industry report published earlier this month, outline the evolution of production costs on New Zealand dairy farms. Even allowing for extraordinarily strong milk prices in 2013/14, their profitability was clearly already dwindling as costs were rising rapidly, especially feed costs.
2014/15 prices – which are not factored in in those graphs, will certainly have worsened the situation considerably.

NZ production costs 1 NZ production costs 2

Source: DairyNZ, MPI

Demand suffers from China’s and Russia’s absence, and from exploitative buyers

EU exports have been growing apace through 2014, by 10% in value despite the downturn in prices, and by 13.5% in volume.

Reports into 2015 are for continued strong increases in exports. January to April exports of butter were 8% up in volume, while SMP was up 17%.  Cheese exports, badly affected by the Russian ban, were down 12%, and WMP by 10% over the same period year on year.

Chinese buyers have not been very active in recent times, partly due to increased domestic production, but most of all because they had overbought in 2013/14. Some concerning reports about the Chinese economy (lower GDP growth than previous, volatile stock market, etc.) have also influenced market sentiment.

However, recent commentary by Fonterra shows they expect Chinese buyers to be back within 3 to 6 months.

Another very problematic issue is the fact that the buyers are exploiting the vulnerabilities of sellers. With product stocks coming closer to its shelf life end, and with sellers suffering from shortages of working capital (cash flow), buyers are seizing the opportunity to put further pressure on prices and to look for sellers to commit for longer contracts at those lower prices.

Market signals and the EU intervention review

This is one of the main reasons why IFA has been seeking a review, by the EU Commission, of its so called “safety net” intervention level.

The announcement by the EU Commission of such a review would send the kind of strong market signal which would help sellers resits the unreasonable pressures on those exploitative buyers.

See the details of our campaign on this issue here

International dairy prices

The GDT average auction price on 15th July last shocked all observers with a 10.7% further fall, affecting all products except lactose.

The GDT index has now fallen just below the 2009 level – a clearly unsustainable situation, when Fonterra admit that their producers are currently receiving a milk price 20% below production costs.

The next GDT auction will be 3 weeks from the last one, on Tuesday 4th August.

GDT 1 GDT 2 GDT 3

Source: GDT

The last GDT prices are equivalent to a gross (before processing costs) 22c/l for SMP/butter, and just below that for WMP.

EU market prices and returns

While EU market prices have been sliding since early March, they remain at least 10c/l higher than the GDT returns. Butter is holding up best, hovering around €3,000/tonne, while SMP, WMP and whey powder have all eased a good deal more. Reported SMP prices, at €1760/t, are less than €100/t above intervention levels.

EU commodity prices

Based on: EU MMO

The Ornua PPI for June, at 95.3 points, would justify a 3.3% protein 3.6% fat farm gate price of 28 c/l – which is what many co-ops are currently paying for June milk.

Conclusions

Available milk and product continues to overhang demand, but this is diminishing as a combination of poor profitability and weather related factors are slowing down international output.

Demand is good from the US, North Africa, the Middle East (especially now with the end of Ramadan) and South East Asia at a price, but depressed by the absence of China and Russia, and further affected by buyers looking to exploit sellers’ shelf life and working capital concerns.

While many commentators do not expect a rebalancing of markets to happen before 2016, there are a number of factors which may speed this up:

  • Moisture deficit and heat all around Europe is both constricting supplies in some of the bigger countries, and increasing demand for ice cream, yoghurt and milk drinks.
  • Drought continues in California, which accounts for 20% of all US supplies.
  • El Nino has been declared as ongoing by the Australian Bureau of Meteorology, and many commentators expect that it could result in moisture deficits affecting both Australian and New Zealand milk output.
  • Lack of profitability is increasingly an issue for EU dairy farmers, and a very big problem for New Zealand suppliers.

It is clear that volatile dairy markets can lead to relatively protracted periods of both high and low returns. Farmers, the last link in the chain, are not equipped to carry the full brunt of these long downturns for their full duration.

It is crucial that the Irish dairy industry would factor this into its development plans. This must mean looking internally to ensure optimal efficiency on the one hand, and developing more optional solutions for farmers to fix their milk price and/or margin for a portion of their milk on the other.

At EU level, it is crucial for the EU Commission to understand that signalling that a review of the intervention safety net level will take place, as much as the actual review and increase in the intervention prices, is vital in influencing buyers’ behaviour, and therefore in speeding up the end of the current downturn.

CL/IFA/20th July 2015

Cow

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