Fonterra has revealed the worsening drought will cost diary farmers as much as $500 million by the end of the season in May.
Chairman Henry Van Heyden said farmers had already lost about $60 in milk payouts, and on-farm losses were mounting.
"The weather is key. And every day without rain is hurting farmers, and will have a flow-on impact for local communities and the broader economy.
"This has really taken the shine off what should have been a fantastic season for our farmers, with a record payout ... farmers are facing up to some very real challenges."
He said season-to-date production levels were well below last year, despite Fonterra's expectation of a 3 per cent increase in milk supply for the 2007/2008 season.
Regionally, production in Waikato is down 27 per cent, Bay of Plenty is down 21 per cent, Taranaki is down 9 per cent and Southland is down 1.5 per cent.
Van Heyden said feed shortages were one of the most pressing challenges, as dry conditions were forcing farmers around the world to rely on supplementary feed.
"While Fonterra is now facing something of a double whammy of a drop in milk production and a Kiwi dollar close to US80 cents, we are holding to our forecast of a payout of $6.90 per kilogram of Milk Solids," he says.
Fonterra CEO Andrew Ferrier today remained confident that all contracted orders would be met, despite supplies being tight.
"Given our expectations of significantly reduced supply in New Zealand, we now find ourselves effectively booked up for the season. This is forcing us to advise customers that we may not be in a position to take all new orders for New Zealand supply," Ferrier said.
"Local market supplies of fresh milk, chilled product in New Zealand and products sourced outside of New Zealand supply will be unaffected."