Milk production enters new stage of global competition

Cameron Bagrie – 

Potential limitations to further expansion of milk production vary from country to country, but include availability of capital and suitable land, environmental restrictions, competition from alternative land uses and other enterprises, fragmented ownership with poor liquidity in the land market (which slows consolidation and the creation of scale) and a restrictive regulatory environment. It all comes back to the milk price that farmers need in this part of the world to continue to invest.

New Zealand’s experience suggests limitations to expansion become less of a restriction if the numbers stack up.

Price-sensitive product

The European Commission projects that from 2014 to 2024, milk production will expand at an average of only 0.8% a year (half the annual growth seen since 2008), but this depends on the milk price assumption used. Research suggests that the volume of milk produced is very sensitive to the milk price farmers get paid.

The Study projects the farm gate milk price to average €0.350/kg in the coming decade, considerably more than the current €0.308/kg in May. Under this scenario, European Union milk could expand by a further 12 million tonnes over the next 10 years.

European Union exports would increase considerably over this period, with growth in the following categories expected: whey products (+50%), whole milk powder (+8%), skim milk powder (+39%), butter (+25%) and cheese (+50%).

But equally, should the milk price average around current levels, then the European Union could end up exporting less product than it does now, so there is a fine balance to be struck, with causality running in both directions.

The other issue is how the less efficient regions (i.e. the other 50%) will respond to increased competition from the more efficient regions.

Common Policy

Many support and regulatory mechanisms remain in place.

The key aim of the Common Agricultural Policy is to maintain food security, environmental standards, rural incomes, and animal welfare standards. Policy measures including intervention buying for certain products, a mechanism for smoothing seasonal production (private storage aid), support for products of a traditional nature or special geographic origin, and high import quota/tariffs all remain in place.

Taken as a package, these back-stops and the structure of some of the industries (small and vocal farmers) within the less-efficient regions suggest some risk that supply from this pool remains higher than expected despite increased competition from more efficient regions.

Processing capacity

There have been a number of public announcements of new milk powder processing capacity with new facilities being built in New Zealand, the EU and US, although not all will be built as planned now. A number of these plants have been commissioned to supply lucrative infant formula markets, which is expected to increase competition from Europe, particularly into China.

Historically, New Zealand has been the only provider able to meet China’s whole milk powder product specification in the volume required (using specific bags and gas packing to extend shelf life). Any newly commissioned milk powder plants are expected to have this capability.

The table here presents announced capacity investments in driers that are expected to have the capability to supply China. Adding the European investments together suggests up to 600,000 metric tonnes of capacity could be in the pipeline.

With a mature domestic market, a significant amount will be exported.

Boosting exports

New Zealand exported 1.8 million tonnes of powder in the last 12 months, so if all this is added, Europe’s additional capacity would be equivalent to nearly a third of New Zealand’s current annual exports. This would represent a significant increase in competition were it to come to pass.

While this increased capacity will no doubt be aligned with traditional strengths in skim milk powder production, the product mix is expected to be able to ‘flexed’ if market conditions are favourable. Many customers are said to have improved their ability to use different product mixes. Currently, most of the increased output has come in the form of skim milk powder but output and exports of whole milk powder need to be carefully watched as this is New Zealand’s “bread and butter,” so to speak.

Supply growth

New Zealand has experienced a very strong period of milk supply growth that has caught even Fonterra by surprise in recent years (i.e. they have struggled to process the seasonal peak).

This has been promoted by the industry as capturing the opportunities that have arisen over the last nine years, keeping dairy products ‘front of mind’ in many end markets (competing products are ever present), and continuing to maintain New Zealand’s global scale and relevance in tradable dairy products.

Over the last nine years, total New Zealand milk supply has increased by nearly 44%.

Two-thirds of this has been due to more cows, and the other third via more milk per cow. Indeed, productivity growth has been above trend over the last five years due to a change in farm systems and lift in farm management practices.

Cameron Bagrie is Chief Economist at ANZ Bank. The above is an extract from the Bank’s latest ‘Agri-Focus’ (August 2015) which features the Main Article titled, ‘Dairy: More Politics than Economic Logic.’

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