The dairy year ends on a note of Christmas cheer – but what will 2017 be like?

With milk prices improving in Ireland since July in response to a mostly supply driven recovery, the mood on Irish dairy farms has improved immeasurably as Christmas approaches, even if many bills have yet to be paid and catching up with cash flow needs remains a top preoccupation.

The prospect of viable and profitable milk prices for peak 2017 is very real, as Ornua predict an average 2017 milk price of 33c/l at 3.3% protein and 3.6% butterfat.

In this final Dairy Market Blog of the year, I propose to examine the positive trends, the possible headwinds, and the sources of uncertainty which will shape 2017.  No one can ever claim their predictions are guaranteed, and mine are no different.  But there is a lot we can tell from the trends and factors identified by dairy operators and market commentators all over the world.

Will global milk production start increasing again in response to improved milk prices?

The short answer to this question has to be yes, in time.  In the absence of volume restrictions (quotas), it is the normal response you would expect from farmers faced with the prospect of improving incomes from higher prices and increased volumes.

However, this assumes a sufficiently sound financial situation on farms to be able to push up production (feeding, extra cows…), and it also assumes a sufficient number of animals.

The reality in the last 2 to 3 years is that prices falling to below production costs in all regions bar the US have eroded profitability, to the point in some cases of bankruptcy.

Also, cow culls have increased very substantially especially in the EU (+7.5% in the year to September), but even in New Zealand in the earlier part of the year – though that trend has now turned around there.

For the short to medium term, it is hard to see farmers who are still struggling financially with prices which have yet to rise above their production costs increasing cow numbers or feeding extra to increase output.

Source: EU MMO

Milk output by the main five production/exporting regions in the world has been tracked by FCStone International for the year to October.  Cumulative milk production increases are now down to 0.6% (see graph below), reflecting a major downturn in the EU (-3.4% in October), New Zealand (-5.5% for peak month October, and -4.5% for November), Australia (-11.4% for October, and -10.3% for the season todate) and Argentina (-12% for October, 14% for the season June to October), and continued but moderate growth in the US (+2.6% for November, and +1.75% for 2016 todate).

Source: FCStone

Source: AHDB Dairy

Apart from poor profitability, there are other factors.

The Netherlands have failed to obtain concessions on phosphates as part of their implementation of the Nitrates derogation.  Consequently, they face having to reduce the national dairy herd by around 11% – that is up to 200,000 cows.  As the Netherland has been, together with Ireland, the most dynamic European dairy country post quota, this will have a major impact on overall EU milk supplies.

New Zealand’s peak was this year affected not just by poor milk prices, but also by a La Nina event at coinciding with its peak (just before and during October).  La Nina is the antithesis of El Nino, and it has resulted in overly wet and cold conditions, especially in the North Island (check this).

The EU voluntary production reduction scheme also played a part in reducing supplies.  This is starting to show in the most recent French and German production figures (see graphs below) – both countries applied for around 45% of the reduction quantities for which payment will be available in the New Year.  In the case of France, the Government topped up the payment for reduction by 10c/kg for the first 5% of reduction.

Source: Ornua

How much of a threat to the dairy price recovery is the 355,000t SMP intervention stock overhang?

Intervention played probably the single most important part in 2016 in helping take product from the market and rebalance supply and demand.

The EU Commission has both a good track record, and legal and budgetary obligations to only release product out of intervention cautiously, so as to avoid market disruption.  Failure to do so would have made a non-sense of the up to €1bn spent in the last 15 months in support of (mostly) the dairy sector.

The recent attempt by the EU Commission to sell over 22,000t of SMP in store prior to Nov/Dec 2015 resulted in only 40 tonnes changing hands, at a minimum price €2,151/t.  20 tonnes sold at that price, with another 20 at €2,200 – somewhat above current market prices.  Bids were received for around 20,000t, priced at between €1,700 and €2,100/t.

This showed two things: firstly, the EU Commission was probably a bit premature in seeking to offload product at a time when SMP price increases have been less than half those of butter.  Secondly, though it was a bit early in its move, it was sensible in the line it drew in terms of price.

The next tender has been scheduled to close on 3^rd January, at which the remaining quantities unsold in the first tender will be put up for sale again.

Meanwhile, it is fair to say, to paraphrase an Ornua spokesperson, that the presence of the intervention stock has prevented SMP prices from “standing tall” even if they rose since May by 24% (see graph and table below).

Based on: EU MMO data

Gross returns from those increased dairy prices have been around 35-36c/l before processing costs throughout November, and slightly higher than that 35-37c/l in early December – equivalent to a farm gate price of around 31c/l + VAT.

This augurs well to allow co-ops in Ireland break the 30c/l + VAT barrier even before calving begins!

Based on: EU MMO data

What about oil prices, and the impact on demand from emerging countries?

Many emerging countries in Sub-Saharan Africa, North Africa and the Middle East depend for their balance of trade and their ability to import food and other necessities on their oil export revenues.

In the last three years, those have dropped considerably, with oil going from a high of US$105 per barrel in mid 2014 to a low below US$35 in early 2016, to return to above $50/barrel in recent weeks (see graph below).

Source: NASDAQ

Though low oil prices are lowering processing costs in milk producing countries, they do reduce revenue for customer countries.  The “sweet spot” is deemed by the dairy industry to be around US$70-80/barrel – low enough to affect costs positively, but high enough to ensure emerging countries can afford imports.

Falling, then low dairy prices through 2014, 15 and the first half of 16 has ensured a brisk trade with emerging countries despite the low oil prices, with significant increases in exports out of the EU, despite the Russian ban and the quasi absence of China through late 14 and 15.

In recent weeks, oil prices have been increasing as OPEC’s efforts to manage the market appear a little more successful.  In 2017, the ability of oil producing emerging countries to afford what are now higher dairy prices will depend on those higher oil prices, and it now looks like they are set to rise further.

What further milk price increases can Irish farmers expect to receive over the coming months?

Based on the Farmers Journal monthly Milk League to October, and our estimate for November, in the period from July to November, prices increased by 4.5 to 7.5c/l, or a simple average of 5.45c/l (see graph below).

Based on Farmers Journal Milk League – November own estimate

At the Dairy Forum meeting held by Minister Michael Creed earlier this month, Ornua predicted an average milk price at 3.3% protein and 3.6% butterfat of up to 33c/l for 2017.  Bearing in mind that most co-ops currently pay around 27.5c/l + VAT (29c/l incl VAT) – a little more in the case of some of the West Cork co-ops and Glanbia, which are either coming close to or exceeding slightly the 30c/l incl VAT barrier – this leaves scope for further increases.

Also, EU commodity price quotes as stated above would have supported through November and into December farmgate milk prices well in excess of 30c/l, and this will undoubtedly impact on the Ornua PPI into December and beyond.

Finally, as the global slowdown in output will almost certainly last through the Irish seasonal spring peak, Irish dairy farmers should be able to benefit fully from stronger milk prices on their maximum output levels.

Anything we should worry about for 2017?

Volatility has not gone away – we are witnessing the upswing in the cycle.  And many factors feed into volatility, some of which are straightforward economic factors, and others more geopolitical or climatic, but with an impact on the said economic factors.

Brexit

2017 will more than likely be dominated by Brexit, the invocation of Article 50 by the UK Government in March, and the beginning of negotiations.  Some might think it will bring greater certainty, but I think it will simply swap one type of uncertainty for another.

The value of Sterling has a major impact on the value of exports from Ireland to the UK, and our competitiveness relative to imports from non-Euro areas.  Since the referendum, Sterling has fluctuated between around 76p for €1 and over 90p for €1 (see graph below), with spikes almost every time some member of the UK Cabinet or Parliament makes a controversial statement!  This type of currency volatility would account for fluctuations of up to €600 on a tonne of mild cheddar at current prices!

Another worrying impact of currency, is that it makes UK food imports dearer, which could challenge demand.  Around one third of Ireland’s dairy exports go to the UK, and the quasi totality of our Cheddar exports.

Source: XE.com

The currency issue is very much in the present.

Other uncertainties feed into the future, but have implications for the present.  Uncertain future trading conditions will have implications for the investment both the processing and farming sector will be willing to make.

The presence or otherwise of a hard border between the Republic and Northern Ireland is a massive issue for the dairy sector, bearing in mind the level of cross border milk collections and processing which does take place.

Trump as US President

The implications for trade deals (especially TTIP) of the types of policies pursued by Trump remains a concern.  If his actions reflect his rhetoric, the progress of those deals, which tend to be better for dairy than other agri sectors as suggested by the EU Commission Joint Research Centre, will grind to a halt.

General political and economic instability

The crises in the Middle East and East Africa, and the consequent migration crisis spilling into Europe has had a major destabilising effect on the political world in most of Europe.  Not too differently from the dynamics which saw Brexit and the election of Trump, there is a tendency towards retrenchment.

In practical terms, this could worsen the trend of renationalisation of markets in Europe, which is a worrying issue for an exporting nation such as Ireland.

Also, global food and dairy demand depends on the economic health of big emerging country customers such as China, and with the EU further extending its sanctions against Russia, the import ban will remain a feature next year, if not beyond.

In conclusion

From a dairy farmer’s perspective, 2017 should allow for a return to profitable levels of milk prices in time to pick up on peak volumes, restoring dairy incomes to more sustainable levels and allowing farmers to resolve outstanding cash flow problems.

While there are undoubtedly some headwinds which may prove challenging, I would expect at this stage that lower supplies will suffice to keep 2017 dairy markets strong in terms of returns, so that it should rate as a good year for dairying.

CL/IFA/22nd December, 2016