‘Cure of low prices is low prices’

Everyone got that wrong – economists, food companies, dairy exporters and analysts – but especially the Chinese government that has been caught out by the massive loss of confidence in its industrial demand, currency and stock market.  Even the world’s biggest dairy exporter, with a long association and deep investments in the market, couldn’t see the building stockpiles and flattening demand.

With acute 20/20 hindsight, the Chinese dairy boom and bust may go down as one of the biggest bubbles in the history of dairy trade, but leaves us with staggering numbers.  Chinese import growth exploded from 2012 to 2013 to consume an additional three billion litres in a single year, with expectation the growth would keep going. This surge very cutely equalled the expansion in NZ output over three years to 2014 as it geared up to supply the surging demand. Imports slid in 2014 and again over 2015, and many now think China’s future norm will be back at 2012 import levels.

Add that to Vlad Putin’s hissy fit with the West, and the subsequent closure of Russia’s cheese market which put a further 2.3 billion litres of market demand in doubt. This came at a time when net export availability (after domestic demand) from the big three exporters grew nearly four billion litres. 

Hence the demand disruptions coupled with extra supply meant an extra nine billion litres –Australia’s total annual output – was without a home over the past year. Low prices encouraged some keen buying in several markets – South East Asia, Middle East and North Africa, Mexico and South America – to soak up about 40% of that volume. The world is now still left with a large problem – literally a powder mountain – to work through before ‘balance’ is restored. 

But what does balance actually mean? It isn’t some calm derived from a neat meeting of minds of buyers and sellers for mutual benefit.  Simply, it’s the average prices at which trade has been done over the long term (since 2007 when the world changed) – milk powders at about US$3500/t and cheddar around US$4000/t.  In 2012-13 at these prices, when the $A traded at around parity with the $US, average southern milk prices were close to $5/kgMS.  With the dollar at or around US70c, those prices will pay well above $6.50/kgMS. So, you’d like to see them back, right?

The world will adjust, the market will recover, but what will the new norm look like beyond that?  

Sorry, but this is another phase of the extreme volatility that has plagued dairy markets since 2006.  Dairy is not the only sector going through this, given close relationships between grains, meat proteins, and oilseeds, and the greater fragility of the world’s weather, not to mention China’s influence and geo-political upheavals.

The history of spot prices for cheddar and SMP shows the contrast over time. 

Either side of a period of relative calm from early 2010 to mid-2013, markets have experienced lengthy phases of extreme volatility. Up to 2009, a global food shortage then the global financial crisis had large impacts on trade. Since mid-2013, a more complex mix of influences have impacted the sector. 

Can we come out of this deep plunge? The adage ‘the best cure for low prices is low prices’ is now at work to slow down milk supply, but it will take time. 

Supply responses always work faster when the market is low – as long as it takes to put cows on a truck bound for burger heaven, or to hang-up on the feed merchant. On the way up, the response is far slower: high product prices in 2013 and 2014 induced a positive, gradual milk supply response which has lasted well into 2015, spurred by the removal of EU production quotas. 

A slowing in milk output is underway in New Zealand, and will accelerate as its season unfolds. A gradual slowing has also started in a number of EU states more exposed to commodity exports. The slowdown may take longer as new found freedom post-quota has created its own monster, and exports are a small portion of milk use.  

There is much more to unravel from the current market situation, as this extremely volatile cycle quickly built large stockpiles. Chinese processors will take time to work through milk powder inventories, but buyers in other regions such as SE Asia and MENA are also well-stocked. 

All up, we will be very lucky to see the balance restored to prices in the next year. Most likely this will take longer to arrive, certainly in actual prices paid to exporters, as opposed to the emotion captured in spot prices. Poor weather may change that.

Will the dairy world learn from these inevitable impacts? Possibly not a lot.

China as a single large market is a black hole because its data in most areas can’t be believed. Creating a better system of information on consumer demand and product in stockpiles in China and other critical countries might be a dream but it won’t be developed without a benefit to players who have to share. 

• Steve Spencer is a director of FreshAgenda, a consultancy company based in Victoria, Australia.