$3.8b farming pay cut possible as dairy price dives

08:01, Jul 16 2014
A graph showing the percentage change in the GlobalDairyTrade index said February 4, 2014.
GOING DOWN: A graph showing the percentage change in the GlobalDairyTrade index since February 4, 2014.

Farmers could be facing a $3.8 billion pay cut next season after an unexpectedly sharp drop in dairy prices overnight.

Prices fell another 8.9 per cent in Fonterra's latest Global Dairy Trade auction, and are now down by a third since January.

Prices for whole milk powder led the decline, down 10.9 per cent, while butter prices fared better, down only 1.1 per cent.

Minister for Primary Industries Nathan Guy says dairy farmers were ''extremely resilient'' and would cope.

Guy said farmers were used to dealing with price fluctuations, just as they had to deal with floods, droughts and earthquakes.

New Zealand was still well-positioned to take advantage of a growing demand for protein in Asian countries over the longer term, he said..

Fonterra had previously forecast a farm-gate milk price of $7 a kilogram of milksolids for next season, well down from this year's bumper return, but still a solid price by previous standards.

A spokesman for the dairy giant said it would not be reviewing its forecast today, and the next update was likely to be in late July or early August, as scheduled.

However, bank economists have cut their forecast returns sharply.

ANZ chief economist Cameron Bagrie said the bank had already "slashed and burned" its forecast payout to $6.25 after the previous auction.

"We just didn't like the price action," he said.

While the bank had expected softer prices overnight, Bagrie said it had been surprised by the extent of the fall, and would probably cut the forecast further.

ASB slashed its forecast from $7 to $6.20, and Westpac went even further, cutting its expected return to just $6.

Based on last season's milk production of 1.6 billion kilograms of milksolids, that would equate to a payout of $9.6 billion, excluding shareholder dividends.

That represents a huge decline from this year's estimated payout of $8.40 per kilogram, for a total return of $13.4b.

Westpac senior economist Anne Boniface said the $6 payout forecast assumed prices softened a little further, before rebounding later in the year on the back of a seasonal lift in Chinese demand.

However, she cautioned that the bank's view on the whole milk powder prices underpinning the forecast could yet prove to be too optimistic.

"We will be monitoring forthcoming auction results closely," she said.

ASB rural economist Nathan Penny said the overnight decline was unexpected and he had been anticipating prices to remain unchanged.

"It was another chunky fall after what was a reasonable chunk down in the last one," he said today.

"We had been expecting it to stabilise, but it hasn't got there yet."

Penny said the price slide was mainly due to producers, particularly those in New Zealand, having strong seasons and effectively flooding the market.

"But it also appears China bought up strongly at the start of the year and doesn't need to go to market as much," he said.

Penny said the weakening dairy market would have widespread implications for the economy.

"It's going to reduce farmer incomes, and depending on where this ends up - it's hard to tell where this is going - it could put downward pressure on interest rates," he said.

Penny said most farmers had built a buffer off the back of the current record season.

''There are some farmers who have recently expanded, converted to dairy...who will find it tough if the price gets below $6, but they are in the minority,'' he said

The fall is a "wake up call" for New Zealand farmers, Federated Farmers dairy chairman Andrew Hoggard said.

"Farmers budgeting for the coming season need to be conservative and wary, and not to assume that we're going to get a $7 a kilogram milksolids payout and to prepare for something less than that," he said.

Hoggard said he had heard figures of between $6 and $6.25kg/milksolids for the next season's payout, lower than Fonterra's recent forecast of $7.

"Farmers with high costs of production who are highly geared, they will run the risk of having total costs that may be above that amount on a per-kilogram of milksolids basis," he said.

Hoggard said 25 per cent of farmers had costs of production of more than $5kg/milksolids.

"If they are highly geared, or if they have just bought a farm, then the drop in prices could put them over," he said.

Farmers had to plan far ahead. They would not know until October if the final payout figure for the season would be the $8.35 forecast.

It would not be until October next year that the impact of the latest price fall on the payout would feed through.

Hoggard said farmers could farm smarter by focusing on doing everything well and increase production that way. Alternatively they could reduce costs by taking some cows out of their operation, but still try and produce the same amount of milk.

"One would hope the Reserve Bank will reconsider interest rate rises next week. The price drop will impact on the economy which should have a dampening-down effect on inflation, but if they raise interest rates they could kill growth, and hurt dairy and other export businesses," he said.

Hoggard said that although China took 20 per cent of New Zealand's milk products, "we've still got fingers in pies all around the world".

"Fonterra aren't focused on China like people try to think, they are focused on building other markets," he said.

"But on the other hand if someone is offering to pay more than anyone else for your product, the commonsense thing is that if they want more, let's put it there. It's a balancing act."

According to the Global Dairy Trade exchange, prices are now the lowest since the end of 2012.

While the drop was expected to be mitigated slightly by a higher forecast milk supply, volumes traded were also down with 36,656 tonnes sold, from 41,513 tonnes a fortnight ago.

The dairy sector is an important part of the New Zealand economy, with a DairyNZ report earlier this week saying it contributed $14.32b to the national economy last year.

The news knocked two thirds of a cent off the New Zealand dollar in early trading, which saw if slip from US88.14c to settle at US87.68c prior to this morning's inflation announcement that saw the consumer price index rise just 1.6 per cent in the June year.