The change has only just begun: Rabo

Buckle up. That’s the message threaded right through a report on Australia’s dairy supply chain by Rabobank‘s Michael Harvey released today.

While so many of us are aching for some stability, for things to just settle down a bit, the report crystallizes fears that change has only just begun.

Michael’s report cites three causes for continuing change:

  1. Down by 800 million litres in southern Australia, milk production is at its lowest in two decades
  2. Australia’s largest processor, MG, has “stumbled and remains under pressure”
  3. The lower price farmers are paid for milk has triggered a boom in stainless steel investment and aggressive recruitment

The scale of the shake up is huge


p. 2, Harvey M., (2017), The Australian Dairy Supply Chain

While Rabobank’s chart illustrates just how much milk MG has hemorrhaged, it also shows that MG continues to be a critical player in the whole industry’s fortunes. As does Fonterra, now more than ever.

Fonterra is abandoning the Bonlac Supply Agreement, which used the MG price as a guaranteed baseline, for something yet to be announced.

MG, the Rabobank report concludes, has suffered “structural damage” that will, if it can recover, take years to repair before the co-op can resume the role of price setter.

So, here is the kicker in Michael Harvey’s own words:

“The reality is that the old system of price discovery for raw milk has broken down and a new method of price discovery will need to emerge, meaning that, in the future, dairy farm operators will be operating in a more commercially oriented and flexible market for their milk.”
– p. 4, Harvey M., (2017), The Australian Dairy Supply Chain

Is it a warning? Perhaps. Change is often difficult but it brings fresh opportunities, too.

Competition will drive farmgate milk prices for a while
Rabobank notes that while milk supply has fallen by 800 million litres, enough new stainless steel is coming on line this year to process another 700 million litres, with more expansion planned. It expects competition to drive milk prices in the medium term.

Milk flowing beyond borders
According to the report, there is an increasing appetite for milk processors to spread supply risk beyond their traditional collection areas.

We’ve seen this locally, with Warrnambool Cheese & Butter, for example, recruiting milk in Gippsland.

A rethink of the current price system
Michael Harvey devotes a significant portion of the report considering the impact of the production decline on Australia’s status as a preferred supplier. “Alarm bells are ringing for international customers,” he writes.

In this context, Mr Harvey also discusses the tension between the need for flat milk supply versus the lowest cost of milk production – on one hand processors can’t manage a very “peaky” supply and, on the other, the discounting of Spring milk has forced up the cost of production for farmers, stifling growth.

Let’s just hope that out of this crisis comes a fresh start.

Do we care whether Australia makes less milk?

Could Australia be running out of milk? Dairy identity Darryl Cardona told the senate inquiry that we could be importing milk in two years. according to media reports. Wondering if this really could be possible and what difference it would make, I turned to Rabobank senior dairy analyst, Michael Harvey, for insight and am really grateful for his guest post below. Thanks Michael!


Michael Harvey, Rabobank

The Australian dairy industry is staring down the barrel of one of its largest annual falls in milk production and would follow a 2% decline last season. This season has begun with three consecutive months of double-digit falls and is forecast by commentators (including Rabobank) to finish the season down between 7-10%. One of the country’s worst droughts in history was the catalyst for a contraction in supply of 8% back in 2002/03 – a clear indication of how difficult it is right now.

The collapse in milk production is not surprising given the challenges being endured on-farm. Some producers are exiting the industry and the producers who remain are making strategic decision to quickly bring down their breakeven levels through reducing herds and cutting costs. Just to make matters worse, seasonal conditions present challenges for the second consecutive season (but for complete opposite reasons). Some dairying regions are faring better with seasonal conditions and less global market impact on milk prices – the steepest declines in production are from across the southern export regions.

Losing supply is risky for processors
So, what are the implications for the industry beyond the farmgate when facing a collapse in milk supply? For processors, losing a large volume of milk supply is risky business.

A loss of milk can have a material impact on profitability. This is through reduced efficiencies and higher overhead costs associated with running processing plants at less-than-optimal rates. The financial impact will depending on how much milk is lost, where from, and what the manufacturing footprint is to be able to spread the impact.

As has been well publicised, there is active recruiting of milk supply across southern Australia leaving Murray Goulburn the most exposed processor. For a processor the size of Murray Goulburn, a short-term loss of milk supply can be managed. However, losing a large quantity of milk in a rising price environment is not ideal. Furthermore, a more permanent loss of milk supply may require a review and resize of its manufacturing footprint (existing and planned) to meet the new supply realities.

Will Australia remain self-sufficient for milk?
Looking more widely, given the scope of the reduction this season, concerns are being raised at the ability of Australia to remain self-sufficient in milk and dairy. Entering this season, Australia was a net exporter of dairy and sold around 3.5 billion litres of milk (in liquid milk equivalents) into the global market.

But Australia is actively engaged in global trade and is an open economy. In the same year, Australia imported over 1 billion litres (in liquid milk equivalent) of dairy products and ingredients. A large portion of this was either cheese or butter for a use across retail, industrial and foodservice. Australia also imports ingredients that are in short supply locally. Examples include whey, casein and lactose for production of nutritional powders.

For most dairy processors, a drop in supply will mean an immediate reduction in exports because the domestic market delivers higher and more stable returns and supply is tied to contracts.  If Australia’s milk supply falls 10% this season that would equate to a loss of over 1 billion litres in just two seasons – a worrying trend for the entire industry.

Long-term a continued fall would trigger a spike in imports of more cheese, butter and ingredients to meet shortfalls and cover the loss of milk as processors focus on utilising local milk in the most profitable streams. But Australia would need to lose a lot more milk before needing to import liquid milk from New Zealand to meet the local consumer market for fresh dairy products.

What the future holds
So what can we expect moving forward? Firstly, better seasonal conditions over the remainder of the season would help to stem the loss of milk. Secondly, there are positive signs in global markets which have seen some improvement in farm-gate returns. Rabobank is confident of a sustained price recovery which will flow back to the farm gate. While it might be too late to have a more material impact of farmer margins this season, 2017/18 is shaping up well and should see a return to profitability on-farm. This would go a long way in stopping further bleeding of milk supply.

There is a risk for the whole of industry that Australia’s milk pool will remain stagnant or shrink further. Collectively the industry needs to re-ignite profitable milk supply growth. Australia needs at least 1% growth in milk production each year just to meet growing, albeit modestly, domestic market requirements.

Incentivising milk supply long-term to maximise help existing and planned processing capacity is more demanding. Restoring confidence and appetite for investment at the farm gate, which history shows for Australia, is an element difficult to attain and will require a sustained period of farmer profitability.

Without more milk supply, Australia will become less export focused, reducing its commitment to fast-growing global dairy markets, and potentially importing more ‘milk’.

Will the storm clouds clear?

With this week’s east coast low, the drought may be over but a new milk price drought seems set to linger, with some analysts even calling the downturn a “long term significant reset of dairy economics across the globe“.

I asked Rabobank senior analyst Michael Harvey for the bank’s take on what has caused prices to fall and what it will take to restore farmer fortunes. I’m grateful for his explanation below.


Uncertainties have surfaced about the true shape of the global market and its medium-term proposition. Are there factors at play that will continue to plague the market and do we need to reset our interpretation?

This is where Rabobank can provide some independent insights. There have been some changes to the market which I will explore and this commodity crunch is what Rabobank defines as a super-cyclical caused by a number of events leading to a perfect storm:

•    The ‘floor’ price in the global market is weaker, and lower
•    The EU has removed a structural handbrake on milk supply – the rate of growth in Europe has surprised even us, and was the main reason we missed our original expectations for a price recovery!
•    There is a downshift in the speed of growth in the Chinese economy (and with it the world economy)
•    The slowdown of Chinese dairy demand growth (this occurred before the crash in prices)
•    The reduction in the prices of key commodities (and expectation that they will probably be lower in the medium term that we expected) which impacts feed prices
•    The end of the Chinese corn price support scheme
•    The failure of states in the Middle East

Political impacts on pricing
When gauging the global price floor, you need to look at intervention pricing systems.  A few years ago the United States industry removed its intervention system and replaced it with a margin protection program. The floor is already weaker because of this.

The EU still operates a public intervention system and its wholesale market is weak enough right now that product is moving into intervention stores quickly. The price in Europe is set in Euro per tonne. Shifts in currencies have seen the intervention fall US$500/tonne when converted to US dollars which means the global floor price is not only weaker but lower.

A removal of a 30-year milk quota system is no doubt structural adjustment. It was always going to lead to an uncomfortable period for the global market. However, global markets have simply been overwhelmed by the sheer volumes. A slowdown in Europe milk supply will be the biggest factor to help correct the ship.

In the first year without quotas, the EU produced 153 billion litres of milk in total. This was just shy of 4% more than the same corresponding period (or in other terms 5.5 billion litres). That’s a lot of extra milk.

The growth in milk supply growth across Europe has not been uniform. Twelve of the 28 EU members had 2% or less growth and the Dutch and Irish sectors have been responsible for 45% of the growth.

But the signs of a slowdown in overall EU milk production growth are emerging. It will take a few more months yet but, by late 2016, this growth should grind to a halt. Rapidly falling milk prices and poor weather will be key to supply correction.

Other factors will also be at play. For example, in the Netherlands the introduction of ‘phosphate rights’ will force Dutch dairy farmers to reduce herds. The pressure won’t kick in until next year when new rules are enforced but there will be a need to reduce herds.

The good news
Rabobank is confident the global market will turn around and this is within sight. There will be other supporting factors helping to rebalance the global market including:

•    Global supply growth outside of Europe – major exporters of dairy (Australia included) have seen lower farmgate prices and milk supply growth slow. But stocks do exist and need to be run down
•    Sluggish dairy demand – macro headwinds and weak consumer confidence linger in many economies; but are now being offset by retail price relief and increased dairy promotion
•    China’s well-documented ‘rebalance’ – China buyers have mostly worked through excess stocks and are likely to increase import volumes over the course of 2016
•    Oil prices – a recent rally signals the end of the global surplus. Oil prices will increase again – but remember this is a good thing (for dairy importers) and bad thing for dairy (production costs)
•    The cost of production for many dairy producers is lower right now due to cheap feed costs and a period of low fertilizer and interest rates

What about Russia – one of world’s largest importers of dairy? Russia’s trade ban is coming up for a two-year anniversary with no immediate end in sight. But Russia will eventually end the embargo.

Questions remain as to Russia’s long-term role in global markets. European cheese exporters may be cautious in rushing back in to this market. Meanwhile, Russia continues to build alternative supply chains – the success of this strategy is yet to be proven successful. Also, the collapse of the Russian economy means dairy demand and consumer purchasing power is weak irrespective of the trade ban.

Global pricing will get substantially better in the medium term
In Rabobank’s opinion there has not been any major shift in the medium-term fundamentals. The global market will present good opportunities to deliver profitable returns for Australia’s dairy sector – with the right export strategies. Here is our logic:

•    Demand growth is still expanding the quickest across the developing world, including Asia
•    These economies are net importers of dairy; and self-sufficiency will continue to be challenging going forward
•    The cost of producing in many of these regions is expensive. The case in point resides in China where the cost of producing good quality milk can be as high twice as expensive as in Australia. So there is an incentive to buy imported milk
•    Consumers in these markets also trust and prefer imported products which strengthens the trade opportunities
•    Australia and New Zealand will simply not supply all the milk these market needs. This means the global market needs more milk from Europe and the US in the medium term
•    Dairy producers in Europe and the US are structurally higher cost producers of milk than Australia.
•    Current global prices are not sustainable for any dairy producers anywhere in the world and simply need to improve.

Better times do still lay ahead. Weak global market conditions are at the core of the current problem but by early 2017 the global market will be in better balance. However, the market will remain volatile and under current pricing models dairy producers will continue to absorb this risk.

Hopefully trust along the supply chain can be restored, as the viability and sustainability of the sector remains healthy beyond the current crisis.