Following the herd a questionable strategy

This article by Andrew Gawith in the NZ Herald raises many issues that the rural sector must deal with in respect to the rapid rise of dairying as a land use in agriculture.

Historically part of NZ's agricultures competitive advantage  was our production of cheap grass from our temperate climate and reliable weather.

But the recent dairy expansion nationwide have left that cost advantage behind as the drive for perfomance has seen costs of production rise rapidly and many are relying on bought in feed, high nitrogen use and irrigation to remain profitable.

The question remains when the supply reaches a point that drives the price down will many of these new developments be sustainable given the higher costs.

Are we in danger of unbalancing our livestock production in NZ's agricultural portfolio with an emphasis trending too much the dairy way? Your views.

Thank goodness for the dairy industry, for without it NZ would have been economically challenged over the past decade or two.The value of dairy exports is now around $12 billion per annum, and they account for over 25 per cent of total goods exports. But is the economy becoming too dependent on just one industry, especially one so vulnerable to the weather, disease, trade impediments and world market conditions? Not to mention the fact that this industry is dominated by one player - Fonterra - that has an unusual and somewhat constrained commercial model.

The dairy industry also dominates bank business lending with around $30 billion of loans outstanding or just over 20 per cent of all business lending in the economy. Banks have fallen over one another to fund dairy conversions, herd expansion, new dairy factories, etc. Any hiccup in such a capital dependent industry could have some uncomfortable consequences for the banking system.

But just as a concentrated investment portfolio ratchets up risks, so also does a high dependence on one industry yank up the risks for an economy. While the rising dependence on dairying carries dangers for the economy, the expansion of the dairy industry is an entirely rational response to the price signals. The dairy industry is vulnerable to the weather as any farmer will tell you. To reduce the impact of weather on production, many farmers have invested heavily in irrigation.

The Government, bless it, is now providing substantial funding for irrigation projects to increase the area of farmland capable of milk production. Leaving aside the potential environmental risks of radically changing land use, such investment will further increase our exposure to dairying. The world market for agricultural products is notoriously fickle both from an access and a price perspective. That's not surprising - only a small proportion of the world's dairy production is actually traded - most countries are close to self sufficient and the international market for dairy products is where they go to cover a shortfall in domestic production or unload surplus production.

As noted above, that has led to a doubling in world dairy product prices. But it would be naive to think that New Zealand dairy farmers have been the only ones to respond to the higher prices. World milk production is undoubtedly responding to the high world prices of the past five or more years. Past experience and economic logic tell us that eventually prices will push supply ahead of expanding demand. At that point prices could head into a prolonged slump. Interestingly, Fonterra's recent auction prices have been trending downwards - a short-term slip or the start of a slump? It's too early to tell, but it sends a shiver through the economy and the banking sector given how much we have riding on dairying, and indeed on the acumen of Fonterra.