Rabobank: markets rebalancing , recovery in 2016
The last of the Rabobank Dairy Quarterly reports for 2015 is coherent with the views expressed by many market commentators. They make it clear that market prices have stabilised as supply and demand are starting to come back into balance, and the outlook is for a recovery in 2016, most likely to impact in earnest from mid-year.
The US and New Zealand output are slowing down due mostly, respectively, to weather factors and lack of profitability. EU output is set to continue to grow modestly for the year-end as farm investment for the post quota era has kicked in, weather during 15 has been favourable and farmgate prices have held up to levels that are less than full costs, but cover operational costs. EU output is predicted to ease in the first half of 2016 – though less than earlier suggested – as cash flow becomes more of a problem.
Output from Australia has fallen foul of El Nino drought in the last month (and this is also affecting most NZ dairy regions), while South American countries are also seeing either negative (Brazil) or easing growth (Argentina).
Output in China has been slowing down. Domestic farmgate prices are very high (50c/l or so) and unsustainable in light of domestic demand trends. Expectations are for price falls in 2016 which could lead to lower output, and increased imports.
EU stocks have not built up to excess due to strong exports helped by the weak Euro, and modest domestic demand growth reflecting improved economic conditions.
Taking the main exporting regions, the outlook is for no production growth for the first half of 2016, followed by a small pick up in the second half. Rabobank suggest that New Zealand is unlikely to increase production much at all in 16/17 after a year of negative profitability, while the EU will increase by much less than in the 9 months since the end of quotas.
With easier output, stocks will erode in the first half, setting the scene for a tighter market and lifting prices.
Demand picking up
Chinese stocks are reported to be down by at least half in the second semester of 2015.
Demand from China is increasing very modestly, especially for infant formulae and other powder products, but the Russian ban on EU dairy imports, and the poor state of the Russian economy where wages have fallen dramatically in recent months has reduced their dairy consumption.
Low oil prices play well in supporting increased consumer spend including on dairy in developed economies like the US, the EU and Japan, but reduces the affordability of imports for emerging countries whose balance of trade normally relies on oil revenues (Algeria and other N African countries, Nigeria, Middle East, etc.).
That said, the low dairy prices are also promoting demand growth from non-oil producing emerging countries with dairy deficits, many of which are also experiencing improved income growth.
Demand has been sustained by recovering economies in the US (which accounts for 15% of global dairy consumption) and the EU (accounting for 20%). Improving employment figures and rising household incomes, lower oil prices reducing the cost of motor fuel and heating oil, and some reduction in retail prices of dairy products have all fed into this increased demand.
A feature of 2015 is that trade has not really faltered. Exports have been to “mid-tier” importers stepping in to replace China and Russia, but at significantly lower prices.
Rabobank expects global dairy prices to have bottomed out, but foresees current price levels persisting till mid year, with few exceptions. From the third quarter, the forecast is for a recovery of all dairy commodity prices.
As any forecast is only as good as the accuracy of its assumptions (and even then, chance and unpredictable factors come in). Some negative or positive factors could speed up or slow down a market price recovery as against the Rabobank prediction:
1 – Negative factors
Further strengthening of the US$ could have a negative influence on US$ denominated dairy commodity prices
Global economic factors including financial market volatility, the difficulties of the Chinese economy, geopolitical tensions.
2 – Positive factors
El Nino is creating drought over Australia and New Zealand, and excess rain over Argentina. It is expected to last well into 2016, and to peak in early 2016. Its impact on milk supplies could tighten markets a lot faster.
Global stock levels, unlike institutional stocks (APS, intervention, etc.) can only be estimated, as there are no official statistics kept. Should they prove lower than estimated, market sentiment could change quickly as buyers fear shortages, and prices could lift quite quickly.
EU Dairy Market returns continue to ease very slowly – but holding current milk price remains realistic
Since the “peak” of 2015, which dates back to early March, EU dairy prices have eased slowly and progressively, better sustained than GDT prices by European retail domestic and real export markets (as opposed to the somewhat opportunistic trade represented by the GDT auctions).
Current estimated gross returns for an Irish product mix at EU average prices as at 13th December, as outlined in the two tables below, have remained pretty stable at just over 28c/l. This is because of a small recovery in the Cheddar cheese price (a very important element in the mix), a stable whey powder, and despite slight decreases for all other products.
When we calculate those gross returns (see tables below), we factor in 16% worth of returns from “other” products in this calculation and we have conservatively determined that this might return 15% less than SMP and butter.
However, this is very conservative. Given the substantial portfolio of added value products the majority of dairy co-ops have developed in the last decade or so, we believe we are understating the returns from “other” products in our calculation. We would therefore content that sustaining current milk prices is feasible at least for the next few months.