Farmgate price up, total down

Drought conditions have pushed international dairy prices to record highs and may bump up farmgate returns, but farmers have no cause for celebration.

Prices at Fonterra's latest online dairy auction soared to five-year highs on Tuesday night, marking their seventh straight gain.

The price of a basket of dairy goods surged a massive 14.8 per cent compared with the last sale two weeks ago, reaching its highest point since December 2007.

"While it's nice to see very big price gains on international markets, it's not a good news story when you look at what's driving it - which is a lack of milk in New Zealand," said BNZ economist Doug Steel.

The volume of dairy products sold has halved in the space of a month to just 15,994 metric tonnes, as production winds down through the tail end of the season.

"It's economics 101, really," said Steel. "With very tight supply, we've seen a big squeeze higher in prices."

The entire North Island was declared an official drought zone last week, and parts of the mainland also remain very dry.

Steel said there was likely to be some upside to Fonterra's forecast payout of $5.50 a kilogram of milk solids, plus a 40-50c dividend.

However, he warned that the dairy co-op had already factored in rising prices during its last forecast update in late February, so it would be a question of degree.

The average winning price at the auction rose to US$4683 (NZ$5685) a metric tonne, up from US$4216.

Seven of the nine product categories rose, and two were not traded.

The key whole milk powder product category, the largest by volume, rose 21.2 per cent.

The auction saw 185 participants out of 785 qualified bidders take part, with 82 winning bids.

The successful result also saw Westpac economists firming up their return forecasts.

The bank's agri-economist, Nathan Penny, was picking a payout of at least $5.65/kg plus dividend for the current season, and $5.90/kg plus dividend next season.

But the total income that many farmers will receive is not so rosy.

Westpac is warning that the country's milk production could drop for the first time in five years if drought conditions persisted.

In the very best scenario, production would remain the same.

Penny said milk production for the 2012-2013 season may fall by as much as 2 per cent, despite growing herd sizes and a bumper spring.

"It all depends on when the rains come," he said.

As recently as last month Westpac was still expecting total production to rise slightly from last year, but the drought had since pushed production levels "off a cliff".

Westpac agribusiness head David Jones warned that the full financial effects of the drought may still be several months away.

He said many farmers were still in a fairly strong cash position after moving quickly to shed stock.