Despite the speed of rising dairy prices in 2016, Rabobank sees more to come as supply is constrained in many countries. But affordability may also become an issue for consumers

Content supplied by Rabobank

Reduced milk supply out of key dairy export regions – including New Zealand – will fuel further dairy price increases in the early part of 2017, according to Rabobank’s latest global dairy outlook.

In its recently-released Dairy Quarterly report, Rabobank says dairy production in the second half of 2016 dropped significantly in six of the seven key dairy export regions with 2.6 million tonnes less milk produced compared to the second half of 2015.

Report co-author Rabobank dairy analyst Emma Higgins says of the key dairy export regions, the US is the only region to buck the trend of falling production.

“Strengthening producer margins have driven a lift in US production which was up 2.5 per cent in October from the same period in 2015,” Ms Higgins says.

At the same time as declining global milk production, Ms Higgins says dairy demand in the US and Europe has strengthened, enabling stock growth to grind to a halt – and global dairy prices have “rocketed upwards” as a result.

And the recent rally in global dairy prices has further upside to come, she says, as efforts to increase global production take time.

“Reduced cow numbers and challenging production conditions mean we expect the recovery of global dairy production and volumes for export will be delayed until the second half of 2017 – and this will create further upward price pressure in the short term,” she says.

These challenging production conditions are particularly evident in New Zealand, Ms Higgins says, with disruptive weather at the beginning of the season severely hammering spring pasture growth in the North Island, setting the scene for the rest of the season.

“The South Island has fared better, however, and we are still picking milk production for the full season to be down between five and seven per cent,” she says.

While prices have improved across the board, Ms Higgins says the recovery will remain “bumpy”, as prices across the dairy complex become increasingly divergent.

Results from the most recent Global Dairy Trade auction – where the index declined 3.9 per cent – provided confirmation of this bumpy road with many buyers absent from the market due to the holiday season.

“Whole milk powder has posted the strongest recovery in recent months, with prices increasing by more than 45 per cent in the last six months of 2016, while consumer and food-service demand for butter is behind much of the upswing in in dairy fat pricing,” she says.

“In contrast, surplus protein stocks in the form of skim milk powder continue to weigh on the market, which has limited its upside.”

Increases in Fonterra’s forecast farmgate milk price for the 2016/17 season will have pushed many farmers back into the black, Ms Higgins says, but the current season’s theme is likely to be one of recovery.

“Given the speed at which dairy prices have increased since mid-2016, we see further upside to Fonterra’s 2016/17 farmgate milk price, but, despite this, the focus for most will be on recovering the ground lost over the last two seasons,” she says.

What to watch in the first half of 2017

The report identifies five key factors to watch in early 2017 that have the potential to impact dairy markets: currency moves, affordability, Chinese buying, Dutch environmental emissions and Californian regulations. “How developments unfold in relation to these areas will influence the direction of global dairy markets in the first half of 2017,” Ms Higgins says.

Ms Higgins says with the continued strengthening of the US economy, US interest rates are expected to continue to rise resulting in a stronger US dollar. “This will provide headwinds for US exporters and, at the same time, act as a limiting factor on the level of price rises in US dollar-denominated markets,” she says.

A stronger US dollar would also reduce the affordability of dairy products in emerging markets and test demand threshold, she says.

And this “affordability” issue is likely to counter some of the upward price pressure as the price rally continues to develop.

Developments in dairy industry environmental regulations in The Netherlands are also a key factor to keep an eye on, Ms Higgins says.

“The Dutch industry is wrestling with the issue of how to operate within the limited levels of phosphates and nitrates which can be applied to soils under European environmental regulation – and complying with these regulations is likely to require a significant reduction in their cow numbers,” she says.