Is a supply led recovery a lesser being than a demand driven one?

Now that global dairy prices are staging a meaningful recovery, which at long last is translating into higher milk prices, it is interesting to hear and read some commentary suggesting that the recovery is somehow suspicious or less sustainable for being due mainly to falling/slowing global milk output.

To be fair, it is clear that strongly growing, affluent demand is an important part of a balanced market.

Demand would be strengthened by the return of Russia to the market, an increase in oil prices, and greater purchasing power in the SE Asian, Middle Eastern and African markets that import dairy products.  In many of our markets consumers are price sensitive, and some are suffering from a variety of demand sapping geopolitical crises (Syria, Iran and more).  The truth is that we should always be weary of fast rising commodity prices actually burning out demand.

However, demand has not been in the doldrums.  Global trade has grown strongly throughout 2015 and 16 – admittedly partly on the back of lower commodity prices.
China has returned to markets in 2016, for powder, infant formula and (in smaller volumes) for UHT milk and cheese.

Also all sorts of factors can lead to volatile commodity prices.  The build-up of global surpluses over the last 2 ½ years, not the failure of demand, was the main reason for the slump we have just lived through.

Commodity price decreases, and now thankfully increases are not any less real if they are mainly caused by supply factors.

Improved product prices – whatever their cause – must be passed back to hard pressed producers who have just suffered over 2 years of non-stop falling milk prices and need every last cent to catch up with business bills and provide for their families.

Lower output trend continues

Total EU 28 milk production has fallen below last year’s level for the first time in June, by 1.6% (see graph)

Source: EU MMO

EU cow cullings are also well up, underpinning the fall back or slow down in output.

French and German production has fallen below year earlier data for the last number of months.  Week 33 (week ending 21/08) was down 1.5% in France, and 0.9% in Germany.
French output for July was estimated to be 3% down on the same month last year.
UK output, which fell 8.3% in July, is estimated to be down 6 to 7% in August.
Spanish supplies were 0.3% back in July, while Polish collection were 2.7% back for the same month.  Danish production was 0.3% lower than July 15.

Intervention intake down to a trickle

SMP intervention intake fell back further last week.  Only Germany (86 tonnes) and France (264 tonnes) contributed to a total of 350 tonnes – the lowest weekly volume since  March.

The highest week was in mid-March when 22,000t went in, but this had slowed dramatically to around 7,000 a week by late May.

This is as a result of market recovery.   SMP is currently making around €1,900/t, a damn sight better than the €1,698 intervention buying in price – which also has associated costs.

This leaves an intervention stock of close on 300,000t +, and some worry about this overhang.  However, the EU Commission has obligations when it comes to releasing product out of intervention to avoid market disturbance.

It also has a strong track record of releasing intervention product without damaging markets: it did so after 2009 and many times in the older days of CAP.

Also, it has spent in excess of €1b in the last 12 months to support mostly dairy farmers’ incomes – however successfully – and it seems unlikely that it would undo its own work by releasing product irresponsibly and preventing a necessary market recovery.

Source: EU MMO

GDT shoots up for third time in a row

While European dairy prices have been rising for the last 4 months, international prices have been responding to lower volumes too.

The last three GDT auctions have reflected strong uplifts for all products.  In August, the weighted average price reached increased by 6.6% in the first auction, a whopping 12.4% in the second, and in the first September auction earlier this week (see graph below), it jumped further, by 7.7%.

Remarkably, over those three auctions, butter prices rose by 40%, SMP by 15% and WMP by 34%.

The 6^th September auction butter/SMP return, in Euro cents per litre, before processing costs is 32.6c/l – or 27-28c/l farm gate price equivalent.

While total volumes traded have been trending down, it is interesting that this tender, at 36,758t, sold just under 1,000t less than the same tender in Sept 2015.

Source: GDT

European product prices now rising more rapidly

EU spot quotes, which are as usual predicting the trend of other sides of the markets (forward sold contracts etc.), have been rising strongly in recent weeks.

Butter quotes have broken through the €4,000 mark in Germany, and most other products are also on a solid upward trend.

Based on EU MMO data

Based on EU MMO data

Those price increases obviously influence the returns available to dairy processors.

The most recent available figures, for the week ending 4^th September, are equivalent as an Irish-type product mix to an EU average gross return of nearly 33 c/l (28c/l + VAT or 29.45c/l incl VAT assuming 5c/l processing costs).

The lower Irish butter and SMP prices would yield, for the same mix, and with the same 5c/l cost excluded, 25.88c/l before VAT, or 27.22c/l incl VAT.

Based on EU MMO data

Ornua PPI up for the second consecutive month

Clearly, it is hard to argue against the reality, and the substance, of the current dairy recovery.

For the second time in two months, the Ornua PPI, which represents the returns for product traded by Ornua on behalf of its members for that month, and which would include a degree of forward sold product at lower than current prices, increased to 85.8 points.

This, as per Ornua’s own calculations, is equivalent to a farm gate milk price equivalent of 24.3c/l incl VAT.  Interestingly, the Ornua formula factors in a processing cost element of 6.5c/l, netted from the gross returns before the farm gate price equivalent is announced.

We have been using 5c/l in our calculations, and have sometimes been criticised for it.  The truth is that there is no independently measured processing cost, and whether we use our 5 or Ornua’s 6.5, the returns from EU products outlined above justify meaningful milk price increases for August milk, and beyond.

Source: Ornua

What will be the impact of the EU production reduction scheme?

It can be argued that EU and global milk production was already slowing or falling back before the scheme was announced.

However, it has most definitely provoked a lot of interest among Irish farmers, if the number of phone calls we have been receiving is anything to go by.

There is no penalty for applying by the very tight deadline of Thursday 15^th September and not proceeding with production reduction after all.  So farmers who are interested but unsure should secure an application form from their co-ops and return it filled in in good time.
They will have time after that to decide what is best for them to do with greater certainty, as we should know within a matter of days whether the scheme is oversubscribed or not.

From a co-op perspective, it is important that farmers who wish to avail of the scheme are given every opportunity to do so.

The most persuasive thing co-ops can do to keep the milk flowing is to increase milk prices over the coming months, as market improvements justify.

Any farmer interested in the scheme should check out our information page at ifa.ie/interested-in-the-eu-milk-production-reduction-package/#.V9LN4jV-3Ps

IFA Regional Dairy Farm Income Meetings

This month and next, IFA will be holding 4 regional Dairy Farm Income Meetings, and we would urge you to attend the one nearest to you.

Find details here, to be updated in coming days: bit.ly/2c3m3TH

The first meeting will be held Wednesday 14^th September 2016 at the Newpark Hotel, Kilkenny, and will be addressed by IFA President Joe Healy, Joint Oireachtas Committee on Agriculture Chairman Pat Deering TD, Glanbia Chairman Henry Corbally, IFA National Dairy Chairman Sean O’Leary and Dairy and Liquid Milk Executive Catherine Lascurettes.

The purpose of the meeting is to keep all stakeholders firmly focused on the fact that, though milk prices have thankfully started to recover, farmers are still receiving prices below their costs of production.

Milk prices must increase as the market justifies, and the Government must do everything it can to utilise optimally EU aids and state aid concessions to support farmers’ very badly dented cash flow.

CL/IFA/9^th September, 2016