Economists slash forecasts for returns to farmers after another drop in global dairy prices overnight

Economists slash forecasts for returns to farmers after another drop in global dairy prices overnight

ASB economists, who have long been among the more optimistic pickers of the milk price this season have slashed their forecast to just $4.10 per kilogram of milk solids.

Previously the ASB was forecasting a $4.60 price - which is what Fonterra is currently forecasting, though a downgrade of this figure is now widely expected.

Westpac economists have trimmed their forecast price from $4.50 to $4.20.

And the country's biggest rural lender, ANZ, is tipping that Fonterra will drop its forecast milk price for the current season to possibly nearer $4.25 per kilogram of milk solids.

The sharpening of pencils by the big bank economists follows another fall - although not a huge one - in global dairy prices overnight. The GlobalDairyTrade price index fell by 1.4%, while the key whole milk powder prices on average eased 0.5% to US$2188 per metric tonne. 

Fonterra re-affirmed its $4.60 price pick as recently as December 10, but has made clear that the forecast is dependent on an assumption that there will be reductions in production globally and that this would help to boost international prices in 2016. See here for the full dairy payout history.

Milk production is, however, now past its peak for the season and it is getting late for any pick up in global prices to help the overall outcome for farmers this season.

ASB rural economist Nathan Penny pointed the finger at China's woes as a key reason for the diary weakness.

"With China the largest dairy importer, dairy markets soon reflect any Chinese weakness," he said.

Penny said the two GDT auctions so far this year had seen prices fall circa 5%.

"If Chinese growth concerns recede, we expect dairy price strength to soon return. However, the farm-gate benefits of any dairy price recovery is likely to now accrue to next season. Our view remains that dairy prices will move higher over 2016. NZ dairy production and exports are tightening. But with Chinese concerns likely to persist at least in the short term, the price recovery is likely to prove stop-start. With over 60% of this season’s volumes sold, we trim our milk price forecast by 50 cents to $4.10/kg. In effect, we defer the farm-gate benefits of dairy price recovery to next season for which we stick with our $6.50/kg forecast."

Westpac senior economist Anne Boniface said in reference to the current turbulent global environment, with doubts over China, financial market upheavals and falling commodities prices, last night’s dairy price drop "perhaps wasn’t as bad as it might have been".

"Nonetheless, combined with the fall in prices at the early January auction, it’s certainly not good news."

Boniface said Westpac's $4.50 milk price pick was based on the potential for an El Niño induced drought to impact on New Zealand milk production.

"But after decent rainfall in many parts of the country so far this year, the risk of a severe drought appears to be receding. And as we get further past the peak production period, even if dry weather set in now, overall milk production would be less at risk."

Boniface said Westpac's updated $4.20 farm gate milk price forecast assumes whole milk powder prices over the 2015/16 season average around $2200 USD/tonne this season and an average conversion rate for the season of about 0.69c.

"That’s pretty close to where WMP prices are sitting today (WMP prices averaged $2188 in last night’s GlobalDairyTrade auction). Clearly there are risks on both sides of this forecast. European milk production continues to grow strongly and should concerns about global growth and financial market volatility intensify further, we could see prices fall. But balancing this risk, prices are already at very low levels and globally food prices have held up relatively well in the current round of financial market turmoil."

The Westpac economists have a more downbeat view of prospects for next year than ASB.

"Looking further ahead, our overriding view is that strong growth in global milk supply combined with subdued demand from China, is likely to keep a lid on prices for much of this year. Consequently, we are forecasting a farm gate milk price of just $5.20 next season," Boniface said.

ANZ rural economist Con Williams said that cash flow pressure on farmers would be maintained into at least early next year.

"We expect Fonterra to reduce its milk price for 2015/16 toward the bottom end of our forecast range of $4.25-$4.50/kg MS," he said.

He believed, however, that there could be "a slight offset" from a higher dividend due to a lower milk cost and smaller proportion of earnings being retained.

Fonterra's most recent prediction of a dividend for this year was in the 35c-40c range.

In its January Global Dairy Update Fonterra said that its milk collection across New Zealand in December was 3% lower than the same month last year. For the season to 31 December (seven months) it reached 932 million kgMS, 4% behind the same period last season. "Lower milk collection for the 2015/16 season is largely a result of the low milk price environment, where farmers have reduced stocking rates and supplementary feeding in order to reduce costs," Fonterra said.

Fonterra's currently expecting that for the complete current season total production will be down by about 6%.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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..Andrewj has been pretty close to the mark for the last few months...

Sounds like they are stockpiling for the final push.

next season for which we stick with our $6.50/kg forecast."

Ah well, ASB customers won't be worried if Fonterra reduces this seasons milk price. With the bank forecasting $6.50 next season they will be fully supportive of all their clients this season and no one will need to fear being sold up. Yeah Right.

To state $6.50 milk price for next season is no different to playing 'pin the tail on the donkey'. You are blindfolded and just take a stab and hope for the best - hardly the way to run a business let alone, control the livelihoods of others.

Can I make a radical statement? Some of these farms need to stop producing milk. Refinancing and cranking production is driving prices lower. Is milk heading the same way as oil? Could prices be forced lower by refinancing dairy farms when they should be closing some of them down.?

The most important thing is the value of the asset. The asset needs a certain amount of income to justify it's valuation. It will be asset revaluations that will cause all the pain and we are talking a whole lot of pain.

correct cheap credit is keeping supply cranking and even increasing, sounds hard but free market principals dictate the weak inefficient fail and the most productive survive, the cheap credit (interest free loans) is keeping some farms from folding that and the co-op system all farmers get to feel the pain of the weakest

Should all go and see " The Big Short " to see how hard it is to input an alternative view to the consensus
while the music is playing.

Coal, Ore, Oil, Gas, Copper, Nickel, Aluminium, Almonds, Shipping .. If it's a commodity it's price is at new lows - why do we think milk is any different ? Same oversupply scenarios.

None of the above producers see any price recovery any time soon .. maybe milk or WMP is going to stay low too for the foreseeable future.

A few cheap dairy farms coming up ?

2016 is shaping up to be all on for young and old. Declining asset prices will be good for young but bad news for old. I can't imagine that the powers that be will stand by and watch asset price decline for fear that banks will be found to be not as sound as touted. Should farm prices fall significantly there would certainly be short term pain, but the farms will still be there when the dust has settled. New owners with much less leverage would be in a much better position to ride out lower prices. Will not happen unless any attempted bailout is over whelmed by the market is my guess

The farms won't be sold to kiwis.

There certainly is a huge drive around the world for countries with insufficient farm land to buy up foreign farms then all the produce gets shipped "home". The locals then get to starve. The thing is at what point do voters say enough is enough and vote in "extremists" who stop it. Now for Kenya maybe not, for NZ I'd hope our democratic process survives. We are of course a long way from such events, I hope.

Personally I'd stop overseas purchases dead but the Govn cant see past its big toe in terms of time. So when we get a bank insolvency they'll allow sales to anyone with the $s so they dont have to bail out that bank.

It looks like dairy was a "get rich" scheme that now is backfiring for the players that entered last, and still carry the large debts from conversion, some people on here seems to think that if only the farmers cut production all problems will be solved, not taking in to fact that the rest of the world is quite capable of growing grass and breeding cows, the European union has given its farmers free hands to produce as much as they want, and im sure there wont be any restriction in china either, so the answer will be that like any business, the unsustainable will fold, sold at a loss, bought up by whoever, at a price that ,hopefully will lead to a profitable production for them, one mans loss, is another mans gain, but thats just what happens when you put all your eggs in one basket..

In military terms.
Its been about maintaining the advance

I agree Andrewj - Land Values are currently overvalued for the Return on Asset derived from them.
I personally don't think a 1 to 3% ROA is that great but if you add capital gain into the mix it does make it better (with a long term (decades) view) but that is only true & countable on the day payment is received from sale of asset/farm.
I laughed a lot when a bank manager said quote " don't worry about return on asset" !! = typical sales person, rural partner in business indeed. Cash flow is king but ROA is important too for every dollar invested the subsequent return received in the hand.
I would think in a perfect world for the equation to balance either land values come down or income would rise?
I am guessing land values are unlikely to fall significantly unless people are forced to sell as you suggested re "asset revaluation". The current rural market suggests that "some" buyers and sellers are not meeting on a mutually agreeable sale price resulting in a some farms being taken off the market unsold.
I don't like to be a "negative prediction-er of the future" but My concern is that if there was say a 20 to 40% drop in the land values that will very quickly erode equity pretty fast - where to from there? As you suggest a whole lot of pain?

I agree Andrewj - Land Values are currently overvalued for the Return on Asset derived from them.
I personally don't think a 1 to 3% ROA is that great but if you add capital gain into the mix it does make it better (with a long term (decades) view) but that is only true & countable on the day payment is received from sale of asset/farm.
I laughed a lot when a bank manager said quote " don't worry about return on asset" !! = typical sales person, rural partner in business indeed. Cash flow is king but ROA is important too for every dollar invested the subsequent return received in the hand.
I would think in a perfect world for the equation to balance either land values come down or income would rise?
I am guessing land values are unlikely to fall significantly unless people are forced to sell as you suggested re "asset revaluation". The current rural market suggests that "some" buyers and sellers are not meeting on a mutually agreeable sale price resulting in a some farms being taken off the market unsold.
I don't like to be a "negative prediction-er of the future" but My concern is that if there was say a 20 to 40% drop in the land values that will very quickly erode equity pretty fast - where to from there? As you suggest a whole lot of pain?