No-one plays God on milk supply

The world is awash with milk; supply chains are clogged with milk powder in the sheds of big producers in New Zealand, Europe and the US, and in buyer warehouses in the big markets.  

We could blame these woes on a retreat by Chinese buyers and the closure of Russian markets to cheese and butter supplies from the West.  Both developments took hold at roughly the same time when farmgate prices were strong and production was gearing up.  The strong growth in milk output is the now biggest issue ahead.

Such are the workings of the dairy supply chain that it takes time for big changes in markets to translate into product prices achieved by dairy manufacturers and, in turn, milk returns to farmers.  Then comes more delay before the milk supply slows – usually something to affect cashflows onfarm such as drought and/or higher bought-in feed costs. 

Once milk producers have set up their production systems – cows in place, and abundant and cheap feed -- the buyers of milk brace themselves for the gush of milk. The juggernaut can’t be quickly stopped once set and running, regardless of what milk prices are doing. 

When the market is clearly going pear-shaped you will rarely, if ever, see a concerted effort, a ‘God call’ for farmers to slow production. It’s every man and woman for themselves in the farm sector, to optimise their farm enterprise as they see fit. The supply chain deals with the consequences and sends the messages slowly back in the mail.

We’re in a classic, deep market cycle. The theory goes that the best cure for low prices in such a cycle will be low prices – farmgate prices eventually falling enough to dry up milk supply and rebalance the market, driving product prices back up.  A change in market dynamics has to come from a slowdown in Europe, the US and/or NZ. With only 7% of global trade Australia is smallfry.

So, given international prices for commodities have been sliding for 16 months, how’s the milk supply response going? Not well so far, in fact, hardly at all.  By our reckoning, the big export producers will collectively add nearly 4 billion L of milk in 2015, two-thirds in the second half of this year.

Can this milk output be slowed? 

Farmgate milk prices adjust to market realities in a wide range of timeframes given their different exposures to world markets and the prevailing production, political and corporate environments. NZ exports 95% of its milk, and we’ve seen the bluntness of the message passed to Kiwi farmers.  Despite this savage cut in prices, any NZ supply response in 2015-16 it will be driven by weather and cashflows rather than the season’s milk price. 

But for those with large, stable domestic or home markets, the effects of a weak world market are shandied.

Europe sells 13% of total milk output on export markets, but that varies widely across that region. Internal wholesale prices in Europe are affected when world prices change, as trade affects product availability in milk powders, fats and commodity cheese.

EU milk prices have been cut: most are now in a range of 27-30 euro cents/L, one third lower than last year. Local analysts reckon a further 10-15% cut will be needed to cause a slowing of output, given the good production conditions prevailing.  

There has been no unilateral call for a curbing of post-quota enthusiasm.  French, Belgian and British farmers may be jostling politicians with their tractors, and more protests are planned, but Europe’s milk flow is rising.  Politicians will react with band-aid cash but the underlying behaviour and market denial won’t change.

The US seems immune to this global cycle, even though weaker export demand has cut milk values. 

The US also sells 13% of its milk on export markets, and some regions, e.g. the southwest, are exposed to commodity markets.  US farmgate prices have slumped in 2015, but this is cushioned by a stronger domestic market boosted by a recovering economy.  

Also buffering the farm sector is the prevalence of co-ops, reciting their mantra to protect their owners from the ravages of the marketplace and take any milk produced. 
Co-ops collect most of the milk in the big producing countries of Europe and the US; they have mastered the art of the cross-subsidy within their pricing policies, allowing stable domestic markets to cushion producers, and putting a base under all prices. You’ll search hard to
find any co-op newsletter that says producers should take opportunities to slow or cut their output.

Given these settings, for faster change in this cycle we should be looking for the next drought, because that’s what it will take.  As long as it happens to someone else, right?

• Steve Spencer is a director of Victoria-based consultants, FreshAgenda.