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Keith Woodford sees overwhelming evidence our dairy industry will flourish as China's middle class expands rapidly & we maintain our huge cost advantages

Keith Woodford sees overwhelming evidence our dairy industry will flourish as China's middle class expands rapidly & we maintain our huge cost advantages

By Keith Woodford*

Thursday 16 July was surely a black day for dairy and Fonterra. Not only did prices on the Global dairy trade auction prices drop to a record low, but Fonterra announced it was cutting 523 positions.

It was also a black day for New Zealand, as commentators and exchange rate speculators started to realise that the downturn was going to affect the whole economy.  The exchange rate dropped close to 3% that day.

Regional New Zealand has seen the downturn coming for some time, but in the main cities the realisation is only starting to dawn.

Suddenly our newspapers and the airwaves are full of commentary. Some of it is good and some of it is way offline.

First the bad news. There is no sign that we are at the bottom of the dairy slump. 

I am expecting more bad news with the next auction at the start of August. Futures prices have dropped by several hundred dollars in the last few days, and although that is not a sure sign, it is indicative that auction prices will also drop.

At the last auction (Thursday 16 June New Zealand time), not only did overall prices drop by a further 10.7%, and even more at 13.1%% for whole milk powder, but Fonterra failed to sell all of the product on offer. At the next auction, and subsequent auctions, there will be a lot more product on offer as new season production ramps up.

In this current environment, the Fonterra end of season forecast price is largely irrelevant. No-one knows where things will be nine months from now. The key numbers are the advance payments that Fonterra will pay for milk produced through to the end of December.

As I write this on 21 July, Fonterra’s advance price is $4.17 for August, and $3.66 for September to December, to be paid on the 20th of the following month. But the latest auction prices are not enough to cover this.  So I am expecting an announcement from Fonterra in the coming days that these prices will drop.

The latest auction prices will struggle to support a final payout of even $3 per kg milksolids.  That is not a prediction about the forthcoming season. It is simply a statement of fact about the dire outcome of the last auction.

One of the uncertainties in the current environment is the effect of foreign exchange hedging policy. When exchange rates are dropping, it is a time when all companies wish they were not hedged. My estimate is that over the coming months Fonterra may still be hedged against the US dollar at about 70c whereas the spot price is in the mid- 60s.

In the current environment, with both global prices and the exchange rate dropping, there is a real risk that dairy companies will find themselves over exposed to exchange rate hedging. If dairy companies have hedged more foreign exchange than they now find themselves earning, then they not only take a loss on their earnings relative to the spot price, but they also become accidental speculators on additional amounts of US dollars. This is what happened to Westland Dairy Company in 2009, with disastrous results for their payout that year.

Currently, there is no good news coming out of Europe.  Overall EU production figures are only available up to the end of April, but early data from both the UK and Germany suggests volumes relative to 2014 are still climbing through to June.  European farmers are losing lots of money, but they are still covering their variable costs, so production has not declined.

For the last two years I have been predicting that 2015 would be the year when French and German dairy farmers would riot through the streets of the big cities, and I still expect to see that happen. It is simply not possible to remove production quotas as the Europeans have done without there being major turmoil.

Although I foresaw likely European turmoil from quota removal, neither I nor anyone else predicted the way events would evolve in the Ukraine and the subsequent shutting of the Russian market. Without that, there was always a chance that increasing Chinese demand would counter-balance the European turmoil. But alas, it is working out very differently.

Global Dairy Trade does not publish where the buyers come from for its recent sales.  However, Fonterra will of course know. Without this, it could not organise the logistics of supply.

Indeed Fonterra CEO Theo Spierings was quoted by Fran O’Sullivan in the NZ Herald on 8 May  as saying that "China was again more than 50 per cent of globally traded volumes [on the Global Dairy Trade auction]”.

This tells us that it is wrong to focus just on China as the predominant cause of the current problems. Much of the problem is that the rest of the world is not buying what it usually buys.

There are complex reasons why the rest of the world is buying less. But lower international oil prices are having an important effect on the oil producing countries, and that is where a considerable amount of our product has gone in recent years.

In the long run, I remain very confident that China will come to the rescue and that our dairy industry will flourish. In that context, I reject the notion from Labour’s Grant Robertson and others that New Zealand is over-exposed to the dairy industry. I also reject the widely expressed notion that we are over exposed to China. Quite simply, without China and without dairy, then New Zealand would indeed be in long term trouble.

However, I also believe that the Government is currently under-estimating the short term implications to the whole economy of this current downturn. Regional New Zealand in particular is going to be hard hit, but it will flow from there to the main cities.

A lot will depend on what happens to the exchange rate.  I am inclined to the view that it will go lower, but just like dairy prices, no-one really knows. I have been watching bank predictions for 15 years as to where it might be heading, and the reality is that one might as well toss a coin.

Indeed there is good economic theory, called price expectation theory, that tells us that current exchange rate, with minor adjustments for interest rate differentials between countries, is the best estimate of future exchange rates. Of course the exchange rates will change, but the current price represents the current market consensus where those who think it will increase balance those who think it will decrease.

In all of this, the key reason that I remain so confident about the long term for our dairy industry is that China currently produces more than 1 million tonnes of milk powder each year itself.  There is absolutely no way this can be cost competitive with milk powder imported from New Zealand.

As of last week, typical dairy farmers in China were receiving about 3.4 yuan per litre of milk. This equates to about $NZ11 to $12 per kg milksolids (depending on the components).  At this price these farmers are still making big losses.  Yet when converted into milk powder this has a cost of about $US6000 per tonne which is way above the global price even during the 2013 boom.

Industry restructuring within China is already occurring and it will continue. But industry restructuring always takes time. In the case of China, there are very important social issues that have to be dealt with. In the meantime, Chinese processors have to purchase local milk – which in some cases they then pour down the drain – when they would much prefer to purchase New Zealand milk powder.

The urbanisation of China is ongoing. Just this month China has announced plans to link Beijing with neighbouring Hebei Province to make a mega urban development of 130 million people. Let there be no doubt, the opportunities for New Zealand are huge.


Keith Woodford is Honorary Professor of Agri-Food Systems at Lincoln University. He combines this with project and consulting work in agri-food systems. This a regular column here. His archived writings are available at

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"Global Dairy Trade does not publish where the buyers come from for its recent sales. However, Fonterra will of course know. Without this, it could not organise the logistics of supply."

Actually Keith, I think you find Fonterra very much can't do that.
As a product supplier and the auction operator it would give too much advantage in they could use internal information to prepare for logistics of supply. They -must- operate at arms length in order to maintain a fair market. It's NZ's reputation and Fonterra track record that lets them do both - which is why it's even more critical to be doing it properly - and why attacks to Fonterra's international reputation are so important... and such plump targets for competitors.

This is a very mature and balanced view of the situation. I agree almost exactly with Keith's predictions in the short term - the likely economic effect of this downturn in dairy is currently being underestimated by all but those down on the farm, or very close by.

Heard some drongo today on national radio. He thinks things are going to be ok. Because as lots of dairy farmers go broke in the next year foreign investors will buy the farms. All good, no problem. Low cost I suppose.

A floating NZD is doing its job, now around 65c if Dairy stays bad gets worse it will continue to drop, into the lower 50's or even below, that will help farmers as will coming drops in interest rates. This won't help AKL property as it looks even cheaper to those with currencies pegged to USD...

If Vietnam is a microcosm of China, Fonterra is entering a period where competition at the brand level is fierce. Whether or not they can compete is not evident based on brand equity. Dutch Lady has it all over them and the UHT category is saturated. However, contracts for supply of milk powder to dairy companies in countries such as Japan should never be underestimated.

I think there is something missing in the article. It says nothing about the effect money printing and too much liquidity has had on the world economy. It has created distortions and bubbles of which dairy production is one. The world is trapped in low interest rates and can not escape without mass defaults and the collapse of the financial system. This article takes the narrow view, the broader view may be that this collapse is merely a symptom of a much bigger problem in the world economy.

"I also reject the widely expressed notion that we are over exposed to China. Quite simply, without China and without dairy, then New Zealand would indeed be in long term trouble."
Firstly you reject the overexposure and then you give the exact definition of overexposure. For me this is enough to label this article "overexposed" to the Chinese milk dollar

I think what he's saying is that our reliance on China is the reality - there's not much we can do about it, i.e. overexposed compared to what other option? It's a question of relativity. This is perhaps a little defeatist - we can still work to diversify our economy, but I do agree with his general premise.

how is that saying? if you are a hammer everything you see is a nail or something like this. It wasn't candles manufacturers that invented light bulbs. We need new fresh people with new ideas, not defeatist hoping not to be here when the milk era finishes.

Dunno.... don't use light bulbs. got LED's.
what are gonna eat? Solent Green? Algae ration bars?

It's a supply problem that won't be fixed until the supply is in line with demand. Other large producers have huge internal markets like the USA and the UK at over %90, even Aussie has %64of it's milk consumed internally. We are up the creek without a paddle, the worlds major dairy exporter with saturated markets and more competition coming online as well as more protectionism, consuming %5 of production.
The real action begins when farm values fall. It's the banks who will be scratching their heads looking for the exit door.

With President Vladimir Putin supporting moves to boost Russia’s “food security”, officials have promised to invest more in agriculture to make the country self-sufficient in milk, meat and fruit and vegetable production.

That's the "problem" with non free-market economies: they don't have to play the free-market game. They crash it. Good on them

Entirely agree with Tim12.
The same group of bankers/money traders/banks are still in control.
The printing of money has flooded the OECD with fiat currency. The fiat was not put into the system to rescue countries (ripped off by bankers and share-traders) it was used to shore up the criminal banks and bankers and Wall St and The London Whale.
No printed currency reached the people or production sectors.
The rip-off merchants who profited from the corruption in the banking industry have zillions of currency and are desperate to find tangible assets to consolidate their ill gotten wealth before the collapse of the world currency.
Isn't the term used my so many very professional, independent international commentators"kicking the can down the road." The can must be just about reduced to tin foil by now?
Our politicians, Treasury, bank economists failed to read the Geopolitics being played out around USA, Ukraine and Europe.
Not sure what we pay the above people for?
The outcome for Fonterra and our dairy farmers was clear 18months ago, and it was so simple for any person with a modicum of curiosity regarding international politics to predict.
Unfortunately the MSM are paid not to broaden their research horizons, but the information is constantly freely available from a myriad of independent professional international publications.
Too late when 'the chickens come home to roost,' and all we hear from the powers that be is Spin, Spin and more Spin!!

Keith - think you are dreaming mate! Commodities are going down and milk is not likely to recover in the next few years - farmers here will soon be at the mercy of the banks and we all know how banks operate when the farmer can't keep up his payments - the Aussie head offices will be shouting pull the plug - they are only Kiwis!

That's exactly what my previous boss had happen to him in the wake of the $7 peak.
The sale of cows fell through leaving him with double the herd, but he had two farm (land & animals) in Australian - so the Aussi banks slapped a "non-transfer"/no NZ spend condition on his accounts.
caused us some big problems.

While every business is different, normal business practice has it that if a product to a client reaches a share larger then 15% of your business then you better start looking at diversification. Either getting more clients or getting more products. Dairy is about a third of NZ export and a lot of that going to one client country. A good size client country as it is, even when you think that over 90% of that market will do better health wise to stay away from bovine lactose altogether.
So yes the statement that we are over exposed to dairy is correct on that basis.
That statement will remain a political football being kicked around the paddock. After all, the party of the person making that comment, as referred to in the article, had 9 years to do something about that in the not too distant past. And they did what? The current mob will say the same thing in 6 or so years when sitting as the opposition party.
While I fully understand that it is not easy for a small economy country at the end of the world to diversify into a vast range of value added export products and services, NZ has to put a lot of effort into this if it wants to reduce the size of international trade shocks as will continue to happen from time to time.
Alternatively, we just have to ride the commodity waves and learn to live with the cycles.
Busts spur innovation. Booms are for wave surfing.
Little told off this morning by Beijing, everyone bow down to our new overlords!! Might be time to start killing dairy cows and putting on beef cattle, to reduce our dependance on the communists.

cant stock pile beef and lamb. Surely these sectors are benefiting from the lower NZD even if they have come off peaks themselves?

$3! Sum Ting Wong?

Start beef farming ? A lot of the well breed beef cows have been long slaughtered

Not much fun farming beef cows. Gotta pay tax and acc on the old biddies for upwards of 5 years before you see a return. Calve down as a two year old and sell her calf as a weaner and reduce that to 3 years, but plenty calve as r3s and fatten the offspring which can stretch it out to 5 or 6. In the meantime that cow that was taxed as profit earned for all those years can kick the bucket. Or the calf can, which is also costing you taxes. Most beef cow operations work on 85% Mating to weaning. Such a long term commitment to an animal that is costing you all the way for at best 3 years. And 15 out of 100 produce nothing or die. Appreciate your steak. Its a tough road to hoe to get it to your plate. I forgot to mention the $3000 bull that is required for every 30 cows. He eats as much as a draft horse, and tends to have a gnarly attitude.

I think you have company Belle.

Farmers have been protesting in France for several days, blocking roads to towns and tourist sites. They are dumping waste and manure in front of supermarkets, which they say are keeping meet and milk prices artificially low. Read more

I suppose misery loves company, but it's a poor substitute for realistic prices.

Lol well belle we have to think of something , no one is picking up the creams cans from the nz dairy farm

Its been a great year for beef farmers Stephen. Best in my time farming. However to make money from a beef cow you need serious equity and scope (ie hectares, lots of them) Generally people seem to want more 'things' and cheaper tucker. In reality good food takes good money to produce. Even in these BEST of times getting $800 for a weaner steer calf is not conducive to farming cows. A property that runs 200 beef cows is on the larger side. Do the math, your average price including the heifers and taking out transport and agents commision . 200 X 85% =170 calvesx700=$119000 x .93% (commission)$110670 transport $15 ea $2550 =$108120. Not a lot to pay those rates and taxes. Let alone the power bill or fuel for the quad. Remember the 3k bull. Needed 7 of them. So one goes off a bluff, another breaks his dick and all the others devalue to 2k cos no meat works really wants them when they weigh a full tonne...I am over doing all this get the picture

We have to rear the dairy calves Marc. Buying milk powder is a better option than the beef cow. At least for smaller farms. If you have a big run in the bigger country and bugger all debt, it must be do-able. Perhaps the calf rearers should be buying fresh whole milk off the dairy farmer this year. What does a $4.00 payout equal per litre? A bag of cmr is about $71 I make a 20kg bag up to 160 litres. 44c per litre. It might be a better bet to buy fresh.

Lol fair enough , I had been told there was a lot of jersey in the dairy beef

Yep. The kiwicross has taken over. But farmers love their cows and love particular breeds so there are still plenty of straight friesians around.

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Days to the General Election: 37
See Party Policies here. Party Lists here.