US milk exports affecting NZ farms

TIM CRONSHAW
Last updated 06:25 20/06/2014
Fonterra chairman John Wilson
Fairfax NZ

LOOKING AHEAD: Fonterra chairman John Wilson says Fonterra is in a good position, and farmers are happy with today's milk payment, but are rightly looking ahead.

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Fonterra's milk suppliers are wary of the ability of United States feedlot farmers to step up or slow down milk production faster than they can.

When grain is cheap and commodity prices are high, as was the case in the soon-to-finish 2013-14 season, this can be to the advantage of operators keeping cows in confined feedlots. As they ramp up milking, this has a bearing on world supplies and the prices Kiwi farmers receive.

Logic would say they will ease off as global commodity prices falter, but narrowing down their next move is complicated.

Unlike Fonterra farmers, the bulk of their milk is consumed domestically, although US exports are growing quickly. Their market signals are tied to domestic prices and are "muted" compared with our clear signals.

This makes it difficult for the likes of Fonterra to weigh up what's going to happen next and calculate the next wave of milk payments for its own farmers.

It would be wrong to paint too bleak a picture. The starting point for the 2014-15 payout, estimated by Fonterra at $7 a kilogram of milksolids, is the same as for the previous season. Lower commodity prices and a bunch of factors including the US influence, however, have few farmers expecting a repeat of the healthy $8.40/kg forecast for 2013-14.

Fonterra chairman John Wilson says Fonterra is in a good position, and farmers are happy with today's milk payment, but are rightly looking ahead.

He says there are huge opportunities for Fonterra's global business, and to do this it has to continue to be globally competitive.

The United States is a growing exporter and one of the challenges facing Fonterra is gauging how long it will take before slow price signals get to their farmers and what impact this will have on world supplies. There will remain a delay before US farmers react to the change, he says.

"Our price signals are fairly immediate. You and I wake up every day and we see the exchange rate movement, every two weeks you see the transparency of [Fonterra auction] GlobalDairyTrade, and we give the best information to our farmers very much on what's happening on that global market, and we update our farmers as we need to, certainly if there's any movement [in the milk payment] and we generally work on about 30c/kg.

"In the US it's completely different, and they have got a very domestic focus, and that dairy industry has very complicated and generally regulated pricing schedules in what they call milk marketing orders. So it takes quite a significant lag between global prices shifting and the pricing signal going all the way to the farmers through their system."

How this pans out remains to be seen, but it seems likely there will be more milk around. What cannot be disputed is the influence of the US on world stocks.

About 16 per cent of their milk is now exported, with the rest consumed domestically, and their exports are up 15 per cent. They are increasingly becoming a global exporter.

In the first quarter of the US calendar year, milk production stepped up by about 1 per cent, and is expected to increase by about 2 per cent to 2.5 per cent in a 90 billion-litre milk pool, compared with New Zealand's 20 billion litres.

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Europe, meanwhile, is up 5.8 per cent for the first quarter based on lower grain and higher milk prices, with many dairy farmers starting to expand in response to quotas coming off in May 2015.

"That's created the challenges we are seeing at the moment in prices softening," says Wilson. "That's why it's so important that for NZ farmers we maintain that low-cost position, and why pasture- based farming is so important, and that's why technology is being adapted [to]maintain our low-cost position, because as global high prices come down, those farmers who are grain fed and have high- cost systems cannot afford to maintain milk production at those levels and then you see it come off."

Traditionally, the pasture-based systems of Kiwi farmers providing little supplementary feed to their cows have been run at lower costs than northern feedlots.

But Wilson says higher costs from labour and services and regulatory and compliance requirements are lifting the cost base "dramatically".

"In the US in particular, they have more scale farming, where they are able to grow crops at a reasonable price, and we are starting to see our cost base for our costlier systems starting to cross over with the lowest cost systems in the US. That's a real challenge to us that we continue to evolve and look after our cost base."

Fonterra knows a lid must be kept on all costs from the farms through the "supply chain" to major markets such as China.

Wilson says it is sometimes forgotten that New Zealand is not the only milk producer supplying China.

New Zealand's prized free-trade agreement is a "foot in the door", but by the first two to three weeks of January it has reached its tonnage level for zero tariffs for wholemilk powder sold into China, and has gone into stepped tariffs.

That said, Wilson sees the trading relationship between the countries getting better and better.

"But we are not alone. The dairy industries of Europe and the US and some of the Latin American countries are very, very focused on China, and Australia as well."

Yet to play out is the prospect of infant formula and other milk product sales lifting from China easing its one child policy.

"Moving to a two-child policy obviously broadens the infant and paediatric powder market. That's why we have got our Anmum brand launched into China, and those numbers are looking good at this early stage. The story is a lot greater than that, though, and one of the greater growing areas is what we call the mobility, or providing dairy nutrition for people as they get older."

Fonterra's Anlene brand targets the older generation and the nutrition market is expected to grow as emerging nations get over the wage limit of US$10 a day and their citizens can afford to buy milk.

The dairy co-operative has finished its first hub of five farms about a two-hour drive from Beijing. Each farm carries a herd of about 3000 cows, mainly to supply a liquid market. Plans for a second hub are being finalised and building will start soon.

When combined with other sources, this gives Fonterra about 5 billion litres of processed milk a year outside New Zealand. Fonterra milk from Australia, Sri Lanka and Chile is mainly consumed locally, but will increasingly be exported, and helps to top up milk produced by Kiwi farmers.

About 96 per cent of New Zealand's milk is exported - about 1.58 billion kilograms of milksolids this year - and Fonterra grows in line with its farmers' growth, which was about 8 per cent during the 2013-14 season, admittedly on the back of drought the previous year.

Is this enough?

Wilson says world demand for milk is growing at about 2 per cent a year, and over the medium term that means a new New Zealand milk pool of about 20 billion litres needs to arrive each year.

"What's interesting now is we are at a price point that milk turns up as others increase their capacity and that's why price point is important. Ultimately, in the medium term there is some very strong supply and demand dynamics, but in the short term there is more milk."

New Zealand is expected to do its bit by generating 2 per cent to 3 per cent milk growth.

That will not come without challenges, as farmers figure out how to deal with increased effluent going on farmland.

An upbeat Wilson sees the growth continuing, and progress being made through "huge" investment by farmers the last two to three years in planting and fencing around creeks, and effluent treatment systems.

Less land converted to dairying over time is expected to be compensated by farmers adopting new technology and innovation, and offshore milk adding to the milk base so Fonterra can remain "globally relevant".

Ahead for farmers is the likelihood of a lower milk payment for the 2014-15 season. They are already digesting a late cut of 25c/kg to the generous $8.40/kg milk payment for 2013-14.

"It's never a good day when you have got to drop the payout for our farmers, but that's just a reflection of the volatility," says Wilson. "So you have seen us bring the payout back this year slightly (to $8.40/kg), and that's been driven by these global milk prices coming down."

While farmers work on a May 31 end of season, Fonterra's close is July 31, and there is still six weeks to run before the final payment is settled and it can consider prices rising in its global auction this week for the first time in four months.

Fonterra's "best estimate" for the 2014-15 season milk payment is $7/kg and reflects commodity prices coming down from the high- US$4000s for a tonne of milk powder to high-US$3000s/t and a "frustrating" high dollar still strengthening. The dividend forecast will be announced after the budgets are signed off in July.

Only 15 months ago, milk powder was at about US$5000/t followed by a sustained run at the high-US$4000s mark. Since then, commodity prices have dropped just over 30 per cent.

Kiwi farmers responded to these hikes with some extra feeding and more grass was grown in better weather despite drought in parts of the North Island. On the back of 8 per cent more milk going through Fonterra processing plants, exports increased.

Wilson knows that among many imponderables, Fonterra can count on price volatility in shorter bursts, with higher peaks and lower troughs in a much different market than that of five years ago.

New Zealand's major exporter must navigate through unknown waters to retain its competitive edge.

- The Press

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