Caution advised as commodities rebound

BY RICHARD WOODD

THINGS are looking positive for New Zealand global dairy products sales, but don't take any risks - just in case.

That was the message from Tim Hunt, leader of Rabobank's food and agribusiness research global dairy team, who addressed a seminar in New Plymouth recently, organised by the Fonterra Shareholders' Council.

Mr Hunt, of Sydney, is one of 80 Rabobank research analysts around the world. Rabobank is a co-operative based in the Netherlands, which has developed into a successful international bank that lends only to farmers and food companies.

"In practical terms that means we stay out of trouble and we get a better business partner. Our job as analysts is to explain to the bank what's happening in the markets into which we lend," he said.

He opened by analysing what happened last year: "Through 2009 we saw a remarkable price recovery in whole, skim milk and whey powders. Butterfat prices jumped by 80-120 per cent, the biggest jump we have seen in history apart from the one 18 months prior to that.

"Why did this happen? Buyers starting returning to the market in numbers. The global economy had started improving. Industrial production was contracting at 20 per cent in early 2009, but by late in the year we were back in positive territory, and it was the same with merchandise exports.

"The retail price of milk products had dropped considerably. So consumption started picking up and the impact in wholesale markets was amplified. They started buying more because they were selling more, but also to refill their inventories which had been pretty low, because they thought the market could completely collapse."

Another key factor was Chinese buying. In 2009 WMP imports by China increased by 150 per cent. In January this year they thought they would import 40,000 tonnes of WMP, four times what they were importing pre- crisis. After the melamine scare consumers did not trust locally produced product, and imported product was much cheaper.

When buyers returned to the market they found there was not a lot of product for sale globally because the EU and US spring surplus had been sold into government intervention and shut up in warehouses.

New milk production was falling in every major export region by September 2009, as farmers responded to unprofitable milk prices.

Current situation: "There is plenty of stock around.

"The end use of dairy will expand through 2010, but relatively slowly.

"The global economy is returning to growth but it's uneven. China and India expected 10 per cent this year, whereas for the US and Europe it's more like 1-2 per cent.

"We are closely watching China. Early this year the government there announced it had found more melamine tainted product still in the system, made 12 months ago. So consumers are being reminded that the supply chain quality is not great.

"For the 2010 calendar year we don't expect less than 5 per cent growth in milk production from the big eight export regions: Argentina, Australia, Brazil, EU, NZ, US, Uruguay, Ukraine.

"We expect processors such as Fonterra to announce good opening prices for the start of the 2010-11 season; we have a strong expectation this will be a profitable year."

Encouragingly, in China McDonalds was planning to open 500 new stores in the next three years, a faster rate than in the three years up to the financial crisis.

Rabobank's expectation is the global demand for dairy in milk equivalent terms which peaked around 3 per cent and came down to below 1 per cent in 2008, will pick up through 2010 by 2.5 per cent moving into 2011-13.

"It's not spectacular, but solid. That's because of population stagnancy in developed countries and concerns about obesity. Hence consumption levels are just as likely to fall as rise in places like the US and Europe.

"We think half of this growth will occur in China and India, and even after satisfying most of that themselves, it still leaves a fair amount of growth for exports. And those countries which are not big dairy producers and are import-reliant, we reckon they will need 2-3 billion litres per year, which is not a lot of milk.

"Milk supply is capable of keeping up but only at the right price. There are several countries still producing milk at a relatively low cost, including NZ, Argentina, South Australia and Brazil. But they can't produce 2-3 billion more litres on their own.

"The US can do it easily and the EU to some extent. The US produces twice as much milk as is traded on international markets, the EU three times as much. So it doesn't take much additional growth out of their supply base to fill this kind of market."

Further out: "In 3-4 years we think there will be a return to higher grain and fertiliser prices and we think this will push international prices beyond traditional levels.

"In this scenario NZ sits very nicely as a profitable opportunity over the medium term."

He supported this contention with a table of Rabobank's estimates of the comparative costs of producing milk (in USD) in 2008. The range was 55c/litre in France, Argentina mid-20c; California sits in the middle at about 42c and NZ is at the lower end around 35c.

"The export price paid to major producing countries - California, Ireland, Germany - is going to be well above your cost of production and that's the nub of why we think there's a good future for dairying in this part of the world."

But even in this scenario he does not envisage prices sitting at a high average level and the New Zealand dairy industry making good profits every year going forward. The past four years had been the most volatile in the history of the industry.

Agriculture pricing would increasingly be linked to energy pricing; climatic disruption was expected to be increasingly frequent; the market will be tight with low stock back-up and any disruption will knock prices out of kilter. While not claiming to be able to perfectly predict the future he believes the bottom line for NZ farmers over the next five years will be:

High average price outlook.

Low cost of production.

Limits on growth elsewhere.

These represented profitable opportunities. But volatility would remain and even with the most positive price outlook, excessive land prices can eliminate profits. "Even with things looking positive for New Zealand, farm businesses still have to be resilient to withstand what could be some pretty sharp downturns in the next five years," Mr Hunt concluded.

- © Fairfax NZ News