Rabobank points out that surviving future dairy downturns will be much harder now the absolute cost advantage has all but disappeared

Content supplied by Rabobank

The traditionally low-cost pasture-based dairying regions, such as New Zealand, have lost their cost advantage as input prices have risen, and now compete on the global market with a similar cost of production to producers with more intensive farming systems, according to a recently-released industry report.

In the report, No longer low-cost milk ‘down under’, agricultural banking specialist Rabobank says global milk production costs have converged between dairy-exporting countries, as the traditionally low-cost milk producers have seen their production costs rise, off the back of volatile global feed prices and the increasing use of feed in traditional pasture-based regions.

Report author, Rabobank director of dairy research, New Zealand and Asia Hayley Moynihan says New Zealand milk producers will need to structure their businesses and production systems to withstand ongoing high price volatility – for both dairy commodity prices and inputs.

Ms Moynihan says lower-cost regions, like New Zealand, have already “largely capitalised their efficiency gains in a high milk-price environment into the price of land and other assets”.

Therefore there is a need to adapt to this loss of absolute competitive advantage in milk production as efficiency gains become more difficult to obtain.

“It is likely that optimal supply chain efficiency could at least partially mitigate this loss,” she says. “Efficiencies achieved downstream in milk processing and marketing via a strong route to market and established supply chain relationships will likely play a greater role in differentiating competitive export companies and industries into the future.”

Ms Moynihan says to ensure that competitiveness is based on more than just the cost of producing milk, the New Zealand dairy industry will need to work hard to ensure that it stays ahead of the pack in supply chain efficiency, market access, marketing and sensible regulation.

Global milk production costs converge

Historically, countries in the Southern Hemisphere have been well known for their low-cost dairy exports. Ms Moynihan says that extensive pasture-based production systems, plentiful natural resources and low opportunity costs in alternative land uses gave this region a competitive advantage.

“Countries such as New Zealand and Australia had abundant milk production, relative to the demands of their small population base. Recognising that exporting was not a discretionary activity for them, they developed focused export strategies."

"By contrast, dairy sectors in the EU and the US were highly regulated, resulting in production costs at least 50 per cent higher than the Southern Hemisphere as recently as 10 years ago."

However, Ms Moynihan says that between 2002 and 2012, the local currencies of New Zealand and Australian dairy exporters have strengthened 75 and 90 per cent respectively, against the US dollar, accelerating the convergence of production costs and making US exporters relatively more competitive.

Traditional low-cost producers lose their edge

The cost of producing milk in typically low-cost extensive pastoral production systems, such as those found in countries in the Southern Hemisphere, has increased since 2002.

Ms Moynihan says producers in these lower-cost export countries have enjoyed buoyant returns and capitalised them into high valued assets, primarily land, bringing on-farm production costs to levels similar to those in intensive feed-based dairy systems.

“Productivity, in terms of feed produced per hectare, has increased but this has been well outpaced by land prices,” she says.

Furthermore, the Rabobank report says that farming systems in historically low-cost production regions have intensified by lifting inputs, thereby increasing production, but at an additional cost.

New Zealand production costs step up a gear or two

The New Zealand dairy industry, most well-known for its low-cost production, has moved, perhaps irrevocably, to a higher cost farming system, the Rabobank report says.

Ms Moynihan says the structural increase in milk prices globally and locally has driven the quest for increased production, almost at any cost.

“The first signs were there in 2002 when , on the back of milk prices increasing 42 per cent over two seasons, farm working expenses surged 33 per cent per kilogramme of milk solids produced,” she says. “The reality check of a 32 per cent lower milk price in 2003, which remained at a similar level over subsequent years soon saw expenses fall back into line.”

However, Ms Moynihan says the 72 per cent lift in milk prices in 2007/08, and higher prices on average in the years following, brought a steep increase in production costs that show little sign of abating without a significant change in farming systems or an economic crisis.

Farm working expenses increased 72 per cent in 2007/08 on the prior season and interest cost rose 29 per cent with both expenditure categories oscillating around these higher levels ever since, she says.

Additionally, higher interest costs per kgMS have been driven by New Zealand dairy farmers’ increased debt, not higher interest rates, Ms Moynihan says.

“The significant increase in dairy land values over the past decade combined with an increased focus on land acquisition resulted in aggregate farm debt across the dairy industry more than doubling since 2002 to almost NZD 20 per kgMS produced,” she says.

New Zealand producers are likely to experience upward pressure on milk production costs over the coming years as they are confronted by a rising interest rate market and the likely impact of future environmental regulations on farming systems and milk production levels.

“Tackling environmental issues is likely to result in a variety of measures that may include increased infrastructure on-farm, altering pasture management or decreased intensity of farming systems which all impact production cost dynamics”.

New Zealand’s competitive advantages

Ms Moynihan says milk producers in New Zealand should consider where the competitive advantage lies for their own operations.

“Increased exposure to the global dairy market for some milk producers and greater intensification on-farm for others has added complexity to many dairy farm businesses,” she says.

“A flexible production system at a higher average cost may still be competitive if it provides resilience during a downturn.”

With high volatility expected to continue for both milk prices and production costs, the ability to lower inputs and/or costs during periods of abundant global supply would be a distinct advantage, Ms Moynihan says.

“Southern Hemisphere producers previously survived global market downturns for prolonged periods due to the size of their absolute comparative cost advantage,” she says. “With this cost advantage now minimal to non-existent, other strategies to survive the inevitable downturns – albeit likely short-term – will be required.”