Keith Woodford says the latest downturn in milk powder prices suggests considerable caution is appropriate for next season’s budgets

By Keith Woodford*

The latest dairy auction on 7 March has brought a cool breeze to the dairy outlook. There are signs it could turn even colder at the next auction.  

Whole-milk powder (WMP) at this last auction was down 22 percent to US$2785 from the 6 December 2016 high of US$3593. Skim milk powder (SMP) was down by 20 percent compared to December.

The decline has come as a surprise to many farmers and commentators, but the signs were there and had been building. As one derivatives broker said to his clients in the week before the latest auction, it was going to be ‘wretched’. And it was.

The futures price for 2017/18 milksolids has dropped from around $6.30 some weeks ago and is now trying to find a new level somewhere in the ‘fives’.  It could go either direction in the next few months. That is the nature of commodities. 

History tells us that when auction prices drop precipitously, it is seldom a single-auction event. One week out from the 21 March auction, the futures market prices are suggesting physical prices could easily drop by another 5 percent or more for both WMP and SMP.

Recent optimism around the industry has been remarkable. High quality farms have been selling at very good prices. It was as if the last two years had been forgotten, despite the fundamentals not changing a great deal.

It was reasonably clear in the New Zealand spring that the increasing dairy commodity prices were caused by declining production in many parts of the world, and that some of these declines were due to adverse weather. A big question was always going to be what would happen in the southern autumn.

The Chinese buyers learned the hard way in 2013 about the cost of relying on strong New Zealand autumn production, which in any year may or may not occur. It seems that this year most of them bought up what they needed well in advance. With this year’s autumn production now looking assured, there are problems as to where to sell that product.

Fonterra increased its supply of SMP for the March 7 auction by 49 percent. This sent a clear message that Fonterra was struggling to find sales away from the auction. Some will be critical of Fonterra for showing their hand so clearly, but holding back product usually creates further problems later. Taking the ups and downs is all part of the commodity game.

SMP from New Zealand has in recent months been selling well above the price of SMP from other parts of the world. A resetting of prices was always on the card, and became inevitable with the increasing volumes. But the extent of the drop, and the momentum around that, is a worry.

There are emerging signs of a new global surplus of SMP. Butter prices are very strong, and this is great news, but SMP is the currently unwanted co-product.  There are still over 400,000 tonnes of SMP in store in Europe, and that too is casting a shadow. Many are hoping that the European stocks, now between six and 12 months of age, will end up as stock feed.

The six-month WMP outlook is not as gloomy as for SMP, but it seems that buyers are in a position where they can afford to sit back and wait. As always, China is the wild card on the demand side.

The next big buyer of WMP after China is Algeria. New Zealand has had some good sales to Algeria in the last year, but that has meant that the EU has been selling less to Algeria and that product now has to find a home somewhere.

My reading of the EU situation is that their dairy production will now stabilise and even increase over the next 12 months. The prices that farmers are currently receiving for their milk equate to about NZ$6 per kg milksolids. This is up some 25 to 30 percent on prices of nine months ago, and this is enough to encourage some farmers to seek production-cost efficiencies by increasing production.

Production in the United States also continues to forge ahead, with the latest statistics for January 2017 being 2.5 percent above the same month for last year. The Californian drought is well and truly over and that should lower feed costs for the big Californian industry.

The uncertainty for American farmers is whether President Trump’s immigration policies will affect their labour supply, and whether Mexico will continue to buy their cheese. Mexico is the most important destination for American dairy.   

I am saying to the farmers I talk with to be cautious about next season. It could be wonderful or it could be disappointing. As always, it only takes one global event to shift prices a long way in either direction.

Part of our New Zealand problem is that we are heavily reliant on WMP which is only used in big quantities by developing countries. However, shifting across to more value-add price-stable products is going to be a long-term rather than a short-term journey.

With our seasonal production, we remain at a disadvantage for many of these value-add products. Seasonal production means low overall utilisation of costly processing plants, high inventory costs, and also increasing scrutiny from buyers concerning older-aged product. We have to balance that against the lower on-farm cost of production from seasonal milk systems, the lower cost of processing and marketing of commodities compared to value-add products, and the inherent volatility of commodities.

*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