3 November 2008

13 minute read

Executive Summary

After steadily expanding at a rate of 4% per annum since 1990, milk production in New Zealand fell 3% in marketing year MY 2008 (June/May year). The decline is attributable to the drought that engulfed most of New Zealand during January to April 2008. Milk production is forecast to rebound in MY 2009 by 8% reaching a record 16.3 million tons. The upturn is primarily attributable to an estimated increase of 200,000 cows over the past two years. While there is potential for the continued expansion of milk production in New Zealand, there are also a number of factors tempering future production increases including the high price of land, environmental constraints, and increasing on-farm costs.

The drought and resulting downturn in production led to a 13% drop in dairy product exports (excluding liquid milk exports which actually increased by 21%). Whole milk powder exports were off 7.3% while cheese, butter and nonfat dry milk were down 8.4%, 16.5% and 23%, respectively. Dairy exports are forecast to rebound in MY 2009, with cheese and whole milk powder exports expanding by an estimated 15% and whole milk powder 13%.

Soaring food prices made front page news in New Zealand earlier this year and there is growing concern regarding the affordability of food. Food prices, which rose 8.2% in the year to June, joined forces with soaring oil prices to push inflation up to 5%. However, according to Statistics New Zealand, dairy product prices were up even more. Milk was up 22%, cheddar cheese 62%, and butter 87%.

In August 2008, New Zealand's Trade Minister Phil Goff announced that a "substantive conclusion" was reached at the negotiations between ASEAN, New Zealand and Australia for a Free Trade Agreement (AANZFTA). The accord is expected to be signed at the ASEAN leaders' summit in Bangkok in December 2008 and is expected to be "comprehensive" (i.e., dealing with all market sectors including dairy).

Production

Summary

After expanding at a rate of 4% per year since 1990, milk production in New Zealand fell 3% in marketing year MY 2008 (June/May year). The decline is attributable to the drought that engulfed most of New Zealand during January to April 2008. However, milk production is expected to rebound in MY 2009 by a forecast 8%. The upturn is attributable to an increase in cow numbers and an additional 330 new dairy farms coming on stream. While there is still room for expansion of milk production in New Zealand, there are also a number of factors tempering future production increases including the high price of land, environmental constraints, and increasing on-farm costs.

Drought Conditions Result in Lower Production in MY 2008

Drought conditions covered most of the North Island and parts of the South Island from January through April of 2008, including the Waikato region, which is the main dairy producing region accounting for approximately 40% of total production.

Two regions - the west coast of the South Island and the dairy areas north of Auckland on the North Island - were largely spared from the drought. In fact, Westland Cooperative, which is located on the west coast of the South Island, reported increased milk production over last year.

Dairy Payouts Reach Record Levels in MY 2008

Fonterra, the largest milk cooperative in New Zealand with a 94% share of domestic milk production, recently finalized the MY 2007/08 season payout confirming shareholder suppliers would be paid NZ$ 7.90/kg (US $5.37) of milk solids (MS). This is the highest price ever paid out to Fonterra shareholders and is a direct result of the run up in world dairy prices. Fonterra’s payout to farmer shareholders includes NZ$ 0.31/kg MS (USD 0.21) for the value-added component of the business and NZ$ 7.59/kg MS (USD 5.16) for raw milk. The Fonterra Board retained NZ$ 0.24/kg MS (USD 0.16), which means suppliers received a net of NZ$ 7.66/kg MS (USD 5.21). The Board cited the need to strengthen its balance sheet in the face of the global credit squeeze as a main reason for the retention. By way of comparison, Westland announced a payout of NZ$ 8.22/kg MS and Tatua NZ$ 8.00/kg MS. These cooperatives also announced retentions from their respective payouts.

In September 2008, Fonterra announced that its MY 2008/09 forecast payout would be $6.60/kg milk solids (US$ 4.49). Some industry sources predict that the actual payout will be on the order of NZ $6-6.50/kg MS over the next two years. While the declining NZ dollar will help insulate producers from the downturn in world dairy prices, on-farm operating costs are likely to increase by 20 to 30 cents/kg MS.

Production Forecast to Rebound in MY 2009

Milk production is forecast to increase 8% in MY 2009, due largely to the 5% increase in cow numbers over the last two years. This increase includes an additional 165,000 head on 330 new dairy farms coming on stream in late 2008.

This forecast also takes into consideration ongoing productivity gains from better feeding, improved genetics, larger economies of scale and other factors. Productivity has been increasing at an average annual rate of 8.3 kg of MS, or 2.4%, according to the Livestock Improvement Corporation. While these gains were masked last year because of the drought and lack of feed, post anticipates that they will be above average in MY 2009.

The National Institute for Water and Atmospheric Research (NIWA) is predicting average rainfall and average to slightly above average temperatures throughout New Zealand with only the far north of the North Island and perhaps the southern end of the South Island receiving less rainfall or having slightly lower soil moisture levels. Because the rainfall over the winter in most areas has been average or above average, aquifers and water tables are relatively high, especially in Canterbury.

Increased Production Capacity and Foreign Investment

There is a fairly significant increase in production capacity of milk powder coming on stream in New Zealand. As can be seen from the chart below, much of the new production capacity is owned by newcomers, some of which is funded by offshore investment. According to industry sources, once all of this new capacity is up and running, Fonterra’s share of milk production will drop from 94% to approximately 90%.

Conversions to Dairying Continue but Support Services are Stretched Thin

According to industry contacts, approximately 330 farms will be converted to dairy production in MY 2009. Most of the farms are on the South Island, particularly Southland, which is the southernmost province. There have been reports that, because contractors are stretched so thin, some of the conversions didn’t have their milking sheds finished before calving season started. An additional 200 farms are expected to be converted in MY 2010.

In the future, the recent improvement in lamb prices might temper the rate of conversions from sheep and beef farms to dairy production. Additional factors that will potentially temper conversions include the cost of credit, increases in on-farm operating costs, and the falling payout price, which will likely squeeze profitability.

On-Farm Operating Cost Continue to Increase

As can be seen from the charts below, on-farm operating costs jumped 0.67 cents/kg MS in MY 2008, which is a 25% jump from the previous year. While part of this increase was due to the drought, this level of increase year-on-year is not sustainable over time , especially when the forecast payout is trending downward.

Environmental Concerns Over Dairying Continue to Grow

One issue receiving significant attention in New Zealand is the environmental impact of dairy production. While only 7% of New Zealand’s total land area is occupied by dairy farms, there is concern that the increasing intensity of dairy farming (e.g. a steady increase in the stocking rate and production per hectare) is causing a buildup of nitrates in the soil, which are leaching into the waterways and potentially harming water quality. In addition, there is some evidence that soil quality is being adversely affected with the loss of organic matter, compaction, and loss of micro flora and fauna.

New Zealand dairy farmers must comply with environmental regulations promulgated and administered by Regional Councils under the auspices of the Resource Management Act. While Council requirements vary by region, compliance costs associated with meeting the requirements have steadily increased over the past several years. Some industry observers believe that the growing compliance costs associated with environmental regulations will potentially diminish profitability and temper how much the New Zealand dairy industry can expand in the future.

Consumption

Consumption in MY 2008 Adjusted Downward

Post adjusted the figure for MY 2008 domestic consumption of fluid milk, butter and cheese downward, due largely to significant domestic price increases for dairy products. Soaring food prices made front page news in New Zealand earlier this year and there is growing concern regarding the affordability of food. Food prices rose 8.2% in the year to June, joining forces with soaring oil prices to push inflation up to 5%. However, according to Statistics New Zealand, milk was up 22%, cheddar cheese 62%, and butter 87%. The Commerce Commission announced in May 2008 that it is making preliminary inquiries to determine whether or not to investigate the spike in domestic dairy prices.

Consumption Forecast to Continue Downward Trend in MY 2009

In response to higher prices, consumers are reportedly buying fewer dairy products or smaller sizes and are looking at low priced alternatives such as milk powder. According to press reports, the demand for butter during the March 2008 quarter was down 12% from a year ago. Demand for cheese products is reportedly showing a similar trend. Post has adjusted the MY 2009 forecasts for consumption of fluid milk, butter and cheese to reflect this trend.

Trade

Summary

New Zealand, a major dairy exporter, accounts for a significant percentage of global trade in dairy products. Whole milk powder (WMP) is the leading dairy export accounting for just over one-third of total exports followed by butter, cheese, and non fat dry milk (NFDM). While other cooperatives do export dairy products, Fonterra, with a 94% share of domestic milk production, accounts for nearly all of New Zealand’s dairy exports.

Since 2000, New Zealand’s total dairy exports (other than liquid milk) have grown at a rate of 3.75%. However, the drought during the summer (January to April) of 2008 resulted in a 3% decline in milk production and a 13% drop in dairy product exports (excluding liquid milk exports which actually increased by 21%). WMP exports were off 7.3% while cheese, butter and NFDM were down 8.4%, 16.5% and 23%, respectively.

Dairy exports are forecast to rebound in MY 2009, with Cheese and Non-fat Dried Milk exports expanding by an estimated 15%, Whole Milk Powder 13%, and Butter and Anhydrous Milkfat by 4%. Since 1992, Powder and cheese exports have increased more rapidly than butter. During MY 2009, relative pricing illustrated by the charts below suggests that production of WMP and cheese will increase more than that of NFDM and butter so the long term trend are likely to be reinforced with the exception of NFDM.

As dairy prices peaked at the beginning of CY 2008 it is estimated there has been some rebuilding of stocks.

Cheese Exports Fall 8.4% in MY 2008

While there has been a steady upward trend in New Zealand cheese exports over time, exports fell 26,000 tons, or 8.4%, in MY 2008, due largely to the production limitations imposed by the drought. Cheese exports are forecast to increase by 42,000 tons, or 15%, in MY 2009 reaching 325,000 tons.

In terms of cheese export destinations, the United States has fallen to fourth place in value terms behind Japan, Australia, and South Korea. As can be seen from the chart below, over the last several years, New Zealand exports to the United States have fallen steadily from 32,453 tons in MY 2005 to 18,744 tons in MY 2008.

Butter and Anhydrous Milk Fat Exports Fall 16.5% in MY2008

Butter and Anhydrous Milkfat (AMF) exports fell 72,000 tons, or 16.5%, in MY 2008. (Note: AMF export tonnages are multiplied by 1.22 to standardize them with butter tonnages for the PSD tables). Again, a major factor accounting for the decline is the drought induced drop in milk production. In addition, the relative pricing of butter and other commodities, as shown in the NZD FOB pricing graph above, appeared to encourage WMP and cheese production.

In MY 2009, butter and AMF exports are forecast to increase by 15,000 tons, or 4%, to 382,000 tons. In keeping with past history, the bulk of this increase will largely be AMF. While New Zealand has valuable butter quotas, over time the increase in New Zealand’s butter exports has been less than 1% per annum while AMF exports have grown 9.5% annually since 1996.

Whole Milk Powder Exports Fall 7.3% in MY 2008

New Zealand’s whole milk powder (WMP) exports came off their high of 670,000 tons in MY 2007 falling to 621,000 tons in MY 2008, a decrease of 7.3%. As in the case of cheese, butter and AMF, the decline is largely attributable to the drought along with some rebuilding of inventory. WMP exports are forecast to jump 13% in MY 2009 reaching a record 700,000 tons.

Venezuela has become the leading export destination by volume for WMP followed by Sri Lanka, Malaysia and Saudi Arabia. WMP exports to China have dropped off fairly significantly in the last two years.

Nonfat Dry Milk Exports Fall 23% in MY 2008

Total exports of nonfat dry milk (NFDM) fell to 251,000 tons in MY 2008, a decrease of 23% compared with MY 2007. As with the other commodities, the decline is attributable to the drought that swept the country in the summer of 2008. NFDM exports are forecast to rebound in MY 2009 to 288,000 tons, a 15% increase from the previous year.

Ice Cream, Whey, Casein and Other Products

All of the other product groups recorded double digit percentage decreases in export volumes in MY 2008 with the exception of liquid milk and whey products, which increased by 21% and 23% respectively. Casein products fell from 91,644 tons in MY 2007 to 78,467 tons in MY 2008, a 14% decrease. The United States is the top export destination taking 42,417 tons in MY 2008. Milk Protein Concentrate (MPC) exports fell to 78,667 tons in MY 2008, a decline of 26% from MY 2007. The United States continues to be the largest export market but New Zealand exports fell to 44,767 tons in MY 2008, down from 53,585 tons the previous year.

Policy Issues

New Zealand Government Conducts Review of DIRA

In response to longstanding concerns on the part of industry players, the New Zealand Government (NZG) announced in August 2007 that it would review the Dairy Industry Restructuring Act (DIRA), which provided for the restructuring of the New Zealand dairy industry in 2001. This legislation facilitated the merger of New Zealand’s two largest dairy manufacturing companies – New Zealand Dairy Group and Kiwi Cooperative Dairies Limited – and the assets of the New Zealand Dairy Board to form Fonterra Cooperative Dairy Company Limited (Fonterra). Two companies - Tatua and Westland - opted not to join Fonterra.

Access to Dairy Quota Markets

Among other things, DIRA brought to an end the former New Zealand Dairy Board monopoly over exports of dairy products. The DIRA also provided, on a transitional basis, for the establishment of eleven regulated dairy markets and provided Fonterra with exclusive access for a fixed period of time. These fixed periods started to expire in mid-2007 and will completely expire in 2010.

These regulated markets were reviewed by the NZG in 2007 and the DIRA provisions relating to them were amended by the parliament in December 2007. Provision was made to deregulate two of the regulated markets, one in 2008 and one in 2010. For the remaining markets, the Ministry of Agriculture and Forestry (MAF) now allocates export licenses annually among eligible dairy processors on the basis of the percentage of milk solids that a processor collects directly from New Zealand dairy farmers. On the basis of a Ministerial decision, MAF issues export licenses to eligible processors for one quota year at a time and allows them to be transferred under certain conditions. From 2010, all of the remaining regulated markets will be allocated annually.

Further Reading

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November 2008