Keith Woodford discusses how European and American dairy-production increases are creating pricing downside

Keith Woodford discusses how European and American dairy-production increases are creating pricing downside

By Keith Woodford*

Whenever I write about the dairy price outlook, the key messages are about volatility and unpredictability. Nevertheless, right now the risks are weighted to the downside.

There is considerable nervousness within the export trade about the next GDT auction in early November. The auction acts as a barometer for the overall market.

This next auction will either confirm or reverse an emerging trend where buyers have been purchasing for immediate needs, but then quietly stepping back to the sidelines in regard to later deliveries. 

The problem is that when buyers think prices are going to fall, they then step back and their collective action actually causes prices to fall. Conversely, when they collectively decide there is an emerging shortage, then their collective ‘rush to buy’ does indeed raise prices. 

A key reason that buyer sentiment has changed is that production is increasing again in Europe. The buyers think they can see plenty of product coming forth in the next few months.

The last two to three years have been a crazy ride for European dairy farmers. When production quotas were removed back in April 215, then production soared. Then, when prices dropped in response to the increased production, farmers sold some of their animals and production declined. Then. with farm gate prices rising steadily again this year as market prices rebounded, farmers have decided once again to increase production.

By the start of August, European production was setting new records. Given the lags between decisions and outcomes, this expansion looks likely to continue in the next few months.

The specific situation varies between European countries. Poland, Italy and Ireland have been leading the recent charge. Germany and the Netherlands are showing muted responses.  British and French production is still lagging.

In the USA, dairy production continues to increase each year. This year it is up by 1.6 percent. Right now, the apparently never-ending American increase in consumption of cheese is struggling to outweigh the ongoing decline in fresh milk consumption. So, more product is available for export.

The underlying message of USA dairying is an ongoing story of big farms getting bigger and small farms going out of business. Total cow numbers are close to static, but per cow production continues to climb. Productivity increases are fuelled both by increasing corn yields keeping costs down, and more productive cows that produce more than twice the milk of an average New Zealand cow.

The reason that Europe and the USA are so important in the dairy world is that between them they produce 250 billion litres of milk each year. This is about 12 times the New Zealand production.

Both Australian and Argentinian production is showing signs of recovery after a disastrous 2016. New Zealand is the only big producer that is not producing more this year.

So, if prices in the market place are to hold, then someone needs to step up with increased demand. But who will that be? 

As always, China is the hardest market to read. Their recent buying interest has focused on product that will be on the water by 31 December, and which can be logged into the new year’s tariff-free quota which opens on January 1. No one else appears to be putting their hand up for big deliveries in early 2018.

The last 12 months have seen a unique combination of prices, with fat products at record prices and protein prices very low. The current relativities between fat and protein have not been seen for at least 25 years.

Butter reached its peak of $US6000 and above in August and September, but now is slipping rapidly. Sales for delivery in 2018 are closer to $US5000, and still searching for firm ground.

At the record prices that we were seeing, it was inevitable that the food processing industry would re-evaluate its enthusiasm for butter and anhydrous milk fat (AMF). The financial difference between milk fat and the alternative vegetable oils selling at under $1000 per tonne became too much to ignore.

Manufacturers are always reluctant to make unnecessary changes to their ingredient mix, and so there are lags in the system. This acts in both directions. Once they do decide to move away from dairy fats to vegetable oils, they are equally reluctant to move back unless dairy fats drop by a very large amount.

Skim milk powder (SMP) has been struggling for more than two years. The Europeans have 380,000 tonnes in store, all owned publicly by the European Community. New Zealand SMP sold below $US1800 per tonne at the last auction. There is no joy with these prices.

The whole milk powder (WMP) market has stayed in more healthy territory, hovering around $US3000, per tonne, but only held up by short-term demand for product into China. 

An emerging risk for WMP is what is known in the trade as ‘fat-filled milk powder’. This is code for milk powder which has had the dairy fat removed and vegetable fats added. Many of the big dairy companies including Fonterra sell this commodity product, but they keep the trade below the radar of the general public. Indeed, very few farmers at Fonterra or elsewhere even know that this trade exists.

Fat-filled milk is often loosely described as fake milk, and that can be a fair description. But in terms of nutritional quality it is not necessarily inferior. It may even have a superior ratio of unsaturated to saturated fat. It is sold mainly to developing countries.

The fat-filled trade would still exist without any direct involvement of the dairy companies. This is because there are plenty of independent supply chain intermediaries who can buy SMP, add in vegetable fat, and then sell the synthetic product. The only gripe that I have is the lack of transparency as to what is happening.

One thing for sure, is that the combination of cheap SMP plus cheap vegetable oils, together with high dairy-fat prices, has created big margins to be exploited with fat-filled product.

My key message in all of this is that the farmgate milk price pathway for the rest of this dairy season is full of uncertainty. There is nothing new in that. However, there has been a developing perspective in New Zealand over the last year that perhaps some of the dairy volatility of recent years might now be behind us. It is not that simple.


*Keith Woodford is an independent consultant who holds honorary positions as Professor of Agri-Food Systems at Lincoln University and Senior Research Fellow at the Contemporary China Research Centre at Victoria University.  His articles are archived at http://keithwoodford.wordpress.com. You can contact him directly here.

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23 Comments

Fat filled milk. Interesting article thanks.

From California milk producers
"The European Commission added further pressure to the milk powder market. The government sold 40 metric tons of SMP out of its Intervention program. While the volume represents a drop in the bucket relative to Europe’s immense SMP stockpile, the price made quite a splash.
The Commission accepted a bid of €1,440.50 per metric ton, well below the €1,690 maximum price for
Intervention purchases and roughly equivalent to NDM at
Page 2 of 3
82ȼ per pound. Until now, the Commission has been so reticent to depress the milk powder market
that it has offered product at laughably high prices. The Commission has clearly lowered its sights.
This week’s sale represents a marked shift in tactics and lends credence to the rumors that the
government is inclined to revoke the Intervention program’s minimum price structure. The
Commission’s de facto SMP floor price may indeed be a thing of the past.
Europe has plenty of milk powder to move, and that is unlikely to change anytime soon. In August the
European Union sent 147.7 million pounds of SMP overseas, 80% more than in August 2016. That
brings Europe’s year-to-date SMP exports up 44% from last year. The driers are likely to keep running
hard. Preliminary data shows European milk output in August at a record high of 28.7 billion pounds, up 3.1%
year over year. That is Europe’s strongest year-over-year gain since March 2016."

Keith, interesting article.
Can you expand, in a future article, on the difference in milk production in the various regions. You mention the doubling of milk production per cow in the US. But how does that relate to milk fat content and costs per kg of fat. Also the likely reason of this increase. Is it purely a matter of keeping the herd inside and feeding them corn, vitamins and anti biotics. Are they milking the herd longer as in days per year? Etc.
If the US is moving towards ever bigger conglomerates and the individual farmers are falling away it would seem to indicate that despite the doubling of production per cow they don't make ends meet unless they can cut costs.
If that falls too much outside the scope of this site can you please provide some links to sites which may give more insight in this? (I know it is the lazy way out but would be much appreciated)
Thanks
Jake

Feed is super cheap in the States at present.

https://www.reuters.com/article/us-usa-meat-profits/u-s-chicken-processo...

There is soo much food in the world, and I don't see a quick fix. Brazil has increased it's corn crop %46 in two years. They will have an extra 25 million tonnes to export this year, USA beef on feed up16% this year, last year up %6 next year predicted double digit increases, that on a 100 million head herd.

Thats the problem with dairy the big boys are increasing production while the local markets have matured and in some cases shrinking, also the old eastern block in increasing production. 10% of Europe's massive SMP stockpile is in Poland.

All this extra production all ends up exported and most of it is trying to squeeze into China. Add to this dilemma the new technology and it's all a bit over whelming.

There is no shortage of food in fact the opposite. Huge stockpiles snake across the Mid-West.

http://www.reuters.com/article/us-usa-grains-storage-analysis/grains-pil...

The West failed to understand the impact of the CIS states and Brazil, on a world market that used to be in a sort of equilibrium, now bouncing all over the place as news travels via the web at the speed of sound.

Last month Brazil had 900,000 tonnes of Soy waiting to be unloaded in China, stuck due to insufficient wharehouse space.

http://www.shippingherald.com/soybean-cargoes-piling-up-at-chinas-ports-...

Jake
Here is somethingn I wrote about 18 months ago on the US dairy industry.
https://keithwoodford.wordpress.com/2016/04/08/americas-mega-dairy-farms/
Keith W

Thanks Keith
Interesting
Regards
Jake

nearly 25 years ago I was on a committee of the National party, we had a meeting in Wellington where Orr from the reserve bank spoke.John Fallon was the minister of agriculture .

The gist of the message we got from them was that NZ had to stop inflation running well ahead of our trading partners or we would face very serious consequences in the future.

Guess what, the future has arrived, no amount of pimping asset prices will put us together again, we need drastic reform of our economy, we need real productivity gains and realistic return on assets.

Looking at the number of dairy farms on the market in the last couple of weeks one would wonder if the floodgates have opened. Factor in the new govts aversion to foreign sales, the stagnant...at best...milk product sales. It might be a very slow season for rural real estate. A lot of older guys wanting to get out and are pretty much stuck. Grim maybe.

Belle: We track dairy farm sale listings weekly and have been doing so for about two years. Yes they are up strongly from prior weeks, but it is entirely seasonal, similar to last year and the year before for the same period. It was slightly lower until the last week or so, now slightly higher y-on-y. No floodgates that we can discern.

We track it nationally, and by main dairy region. Horizons (Manawatu/Whanganui) is the only area where it is up strongly, although slightly elevated in Northland. It is 'normal' everywhere else, even softer in Taranaki, Southland, West Coast.

I had a conversation with a livestock agent from a national stock and station agency very recently. His story was different to yours. There is a humungous number of dairy stock listings. That is yearlings and herds. The talk is larger than usual numbers of farmers want out. They see unsold farms that may not be on anyones books at the moment. I know locally here there are many dairy farms that have been on and off the market for years. Never sold. Current listings dont really mean a hell of a lot. We what live here know the real story. Unsold farms. Fed up owners. Apparently there is no live dairy export market at present either. Autumn could be tough on the incalf dairy heifer sales. Many will end up on the table.

"we need real productivity gains" - what does that mean for farmers?

Productivity gains either come from more outputs from the current level of inputs, or less inputs to get the current level of output. Both are the result of on-farm decisions - they won't be 'given' by others (central or local government) although they can be undermined by them.

Rural productivity gains that will mean anything worthwhile are almost all up to on-farm choices. Land use choices, input choices, farmed-product output choices. Others can help or hinder, but the key choices are those made by farm management.

"we need" is more "you need" - changes, that can give a realistic return on assets. Farm what customers want to buy. Forget trying to find buyers for what you can farm. (talking generally here, not you specifically).

And forget looking back 25 years - look forward 5-10.

I don't have any answers David. Costs have climbed and climbed, things like rates and insurance which I never used to even think about are a big deal. We still have to compete in international markets but with costs often higher than our competition and with small local markets.
A big issue will be debt, when I started farming in the 80's debt was for most of us our biggest cost. Thats why I think we need a big restructure, when I started farming my costs were %35 of my gross sales, slowly and inexorably they climbed to %80. The moment prices lifted farmers capitalised it and went on a debt spree with the backing of the banks, slowly financialising the industry.
In the UK, the EU and USA the biggest trend I am noticing, is the desire to buy local.

There have been massive productivity gains on farms in the last 20 years. Genetic; ewes can rear 3 fat triplets and have them killable at 4 months of age. I have seen that with my own eyes over the last couple of years. Its incredible...those ewes are incredible. The dairy cow has got smaller, she seems to eat less and produce way more. And getting that milk out would require a lot more human input. Now the big rotary with cup removers does away with a fair few human hands. We have 100 teat cafeterias. Rearing 400 calves is now a one person job. Farming has made large gains. Trouble is we gave it all to the 'previous' owner when we overpaid for the farm.

Wow that's quite frightening Belle and with worrying implications for NZ's meat industry when you think about it. I've often thought NZ should try and be the organic food supplier for the world although it would be a big gamble.

Belle, you would have to hard feed those ewes, no way could you do it on grass without her losing weight.
I'd be concerned about the move to high fat and away from high carb processed food. In the USA Mac donalds have gone fresh , the next big move will be away from lean mince and back to healthier fat mince. Thats our bull beef gone.

People are getting sicker, diabetes, cancer, dementia, and it's looks more and more like the cause is environmental, not one State in the USA has an obesity rate under %25 and in 1985 there was not a State over %10. The food we eat is making us sick. In the UK breast the cancer rate has risen to 1 in 8 women.

I think in the future people will want to know more about what goes in their mouths and that could be the secret of our success, but we will probably miss that train.

https://medium.com/@drjasonfung/searching-for-the-causes-of-cancer-d37aa...

Can I just say I found your comment profoundly sad, especially the bit about smaller, less hungry cow producing more milk. I have noticed them in the paddock and I reckon they are getting bonier and bonier their udders bigger and bigger, and watching them walk along a race is painful, although of course, crossing Jerseys with Fresian is likely, eventually to produce a smaller cow.

On the whole the dairy cow is better fed now. She has to be or she wont get back in calf. I agree with some of your sentiments but generally if the cockies didnt have a resilient cow they wouldnt have a business.
Aj, feed your ewe like a dairy cow and boy she can produce some big lambs in a short time. I am lambing earlier while the ewe still carries a lot of body fat from autumn. Then feeding her like stink. Killing lambs now to get the premium. And today I will be picking triplets for the works. The ewes seem fine. Blardy fun dagging them the heavy sods.

Aj its my opinion too many are caught up in the numbers game with ewes still. Why have a great lambing produce triplets and sell them for 50 dinero store. AND pay commission and trucking off that. Lamb two months earlier for $130 per lamb net. Think about how many less ewes you winter. On a one year ewe policy there is $30 easy on the ewe. Plus 2 months (dec and jan) free of sheep. Less is more. And the ewes these days are great milkers and mothers. Production gains are there. You have to look for them.

Belle - I have seen a few lengthy 'threads' on Facebook farming groups in the last week where Sharemilkers / Contract Milkers and Farm Owners are discussing the minimum wage increase and how to work around it. Common themes were actually charging market rates for farm houses but there was agreement that the employees still needed money in the hand per week to live. In then end S/M & C/M concluded they'd need slightly higher rates to cover these expenses and as AndrewJ points out around farm debt, those with lots of it may not / can't wiggle on the kgms rate.

It will be interesting to see if it pushes more Farm Manager roles to Contract Milkers as labour is the C/M's responsibility

So to summarise a couple of posts above. Workers, CM and SM will need to pay for the excessive debt accrued by farm owners.
Been hearing that advertising for 50/50 sharemilkers is coming up a bit empty. Have farm owners finally killed that off? They've been trying for a while.

The overseas buyers have been holding up the top end of the rural market. If that has truly been knocked on the head. (And I am waiting for the new govt to weasel out of it). There will be interesting times ahead. I heard of a chinese deal falling over as the new govt took its place at the helm. Who else is left to buy at the prices required to cover the debt?

Was that the Jericho Station sale, no way on earth should bids have been taken from foreigners for govt land, no way.

No it was a dairy farm.