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January 17, 2019
Emerging New Zealand dairy export trends and a deep, enduring China connection

Stagnant dairy powder shipments amid booming exports of milk, infant formula and fatty goods –with China deciding which commodity is in fashion.
By Eric J. Brooks

An eFeedLink Hot Topic

After a multi-year, turn of the decade boom, New Zealand's dairy output is closing out the 2010s with five years of roughly flat milk output –but with hope for significantly better prospects ahead.

Originally forecast at 21.9 million tonnes, dry weather kept 2017's fluid milk output at 21.51 million tonnes. On the other hand, a dry start to 2018 gave way to abundant rainfall from late Q2 onwards, resulting in a 1.3% in fluid output, to a USDA estimated 21.75 million tonnes. A 0.6%, 30,000 head reduction in the number of cows in milk (to 4.86 million) was more than offset by improved pastureland conditions.

Market conditions were also on the side of producers: The past two years have seen stable feed costs coincide with a much- needed recovery in farmgate milk prices: During the dairy market crash, the average 2015-16 farmgate prices 35% below their 2008-14 average. Thereafter, with fewer New Zealand dairy goods available for export, the milk solid's price rebounded to the profitable level of NZ$6.10/kg in 2017 before peaking at NZ$6.80/kg last year.

Going forward, the recent slump in Global Dairy Trade dairy commodity indexes implies that average 2019 farmgate milk solid prices will fall approximately 10%. –At slightly over NZ$6.00/kg, 2019's projected average milk solids price is sufficient to encourage the maximum possible production from existing cattle but do not provide much incentive to further expand herds. For now, arid El Nino weather conditions in late 2018 and early 2019 have made for pessimistic forecasts.
The USDA expects output to level out almost unchanged at 21.72 million tonnes. Even so, 2018 and 2019 are seeing New Zealand produce its highest fluid milk volumes since the record 21.84 million tonnes produced in 2014, when the global dairy market peaked and crashed.

Despite the stagnation in milk output, large changes in post-crash dairy commodity price ratios mean that its export mix has continued to evolve –with China driving this evolutionary process. Over the last five years, fluid milk, infant formula and fatty goods such as butter and cheese have performed far better than WMP and SMP, which drove the pre-crash dairy boom.

Hence, while the last five years have seen butter prices hold up significantly better than those of SMP, it was more profitable to process export fluid milk, turn it into infant formula or meet rising Chinese demand for cheese. Thus, WMP's 3% 2018 output increase to 1.42 million tonnes still leaves it 3% below its peak 2014 output of 1.46 million tonnes.

With butter, cheese and infant milk formula offering higher returns than WMP, New Zealand will nominally reduce 2019 WMP output to 1.41 million tonnes and export all of its production. Moreover, diverting a rising proportion of a near-constant milk supply away from WMP and SMP production and making more butter, cheese, fluid milk or infant formula will continue for as long as they continue to provide significantly higher returns.

Interestingly, while WMP exports stay in an undulating plateau within 100,000 tonnes of their 2014 peak value (of 1.43 million tonnes), their export destinations are changing. In 2013, China bought 48% or 622,133 tonnes of New Zealand's WMP exports. Based on preliminary trade figures, China accounted for fewer than 420,000 tonnes or less than a third of New Zealand's 2018 WMP exports.

While China's imports of New Zealand WMP fell by over 200,000 tonnes from 2013 through 2018, from 2013 through 2017, this was offset by export increases to the United Arab Emirates (32,000tonnes), Algeria (63,600 tonnes), Sir Lanka (40,000 tonnes), Bangladesh (37,000 tonnes), Malaysia (21,000 tonnes), Nigeria (16,000 tonnes), Vietnam (13,500 tonnes) and Thailand (11,500 tonnes). In that sense, WMP is anomalous: a formerly China-export driven dairy good is now being sustained by rising demand in Asian and Middle Eastern nations.

With raw milk supplies diverted to the export of infant milk formula, both its production and exports have tripled in five years, from a little under 30,000 tonnes in 2013 to a USDA estimated 75,000 tonnes in 2017, 100,000 tonnes in 2018 and a projected 110,000 tonnes in 2019. Taking full advantage of infant formula's high profitability, 2018 output jumped by 33% at a time when fluid milk output rose an incremental 1.3%. China drove this export growth in more ways than one.

First, New Zealand's direct infant formula exports to China roughly quadrupled in five years, from 11,000 tonnes in 2013 to 42,000 tonnes last year. In value terms, they jumped from US$390 million in 2013 to approximately US$1.3 billion last year. While infant formula is a small part of New Zealand's dairy export trade with China, it makes up over a quarter of export revenue by value. Totalling 51,000 tonnes in 2019, they will account for nearly half of New Zealand's direct infant formula exports.

Second, official infant formula exports to China do not take into account rapid export growth to Hong Kong, which has gone from importing 4,300 tonnes in 2013 to approximately 19,000 tonnes in 2018 –and a large proportion of this volume is subsequently smuggled into China without paying customs duties or being official registered as a Chinese import.

Second, Australian dairy processors are exporting their domestically produced infant formula to China where it fetches a higher price –while bringing lower cost New Zealand imports to supply their domestic market. Oddly, this Australian pursuit of higher value-added exports to China has made New Zealand's infant milk formula exports to Australia grow even more rapidly than its shipments to China. From 3,400 tonnes in 2013, New Zealand's shipments of infant milk formula to Australia skyrocketed 780% in five years, to nearly 30,000 tonnes in 2018.

Hence, Chinese demand is largely responsible for New Zealand combined infant milk formula exports to Australia and China tripling in five years, from 22,000 tonnes in 2013 to approximately 70,000 tonnes in 2018.

This, however, is not to say that New Zealand dominates China's infant formula market: Even if New Zealand's 2019 infant formula exports exceed 50,000 tonnes, they are dwarfed by the collective 218,400 tonnes supplied in 2018 by EU suppliers in the Netherlands (87,900 tonnes), France (43,000 tonnes), Ireland (38,000 tonnes), Germany (28,000 tonnes) and Denmark (20,900 tonnes). While Chinese importers prefer lower cost New Zealand infant milk formula, Europe's large milk surplus and feed-driven elastic production model enable it to supply a lion's share of Chinese demand for this dairy good.

China also drives New Zealand's booming fluid milk exports, which increased 75.6% over five years, from 131,000 tonnes in 2013 to a USDA estimated 230,000 tonnes in 2018, with 4.3% increase to 240,000 tonnes projected in 2019. China's now accounts for an impressive share of its fluid milk trade: New Zealand milk shipments destined for China zoomed up by 620% in five years, from 23,300 tonnes in 2013 to 168,000 tonnes in 2018. Over these five years, the share of fluid milk exports purchased by China has jumped from 18% in 2013 to 73% last year.

A similar story can be seen with butter and cheese. With cheese export prices holding up well, production exceeded their initial USDA forecasts for 2017 and 2018, totalling 378,000 tonnes and 380,000 tonnes respectively. Butter greatly exceeded its initial 476,000 tonne 2017 export forecast. Capitalizing on high prices and demand, actual 2017 exports of 505,000 tonnes motivated 2017 production of 525,000 tonnes. For both 2018 and 2019, the full 530,000 tonnes of butter that can be produced from a constant milk supply will be made.

That was again producers minimizing their production of less profitable WMP to make more cheese amid near-constant milk output. What interesting is that while stagnant fluid milk output constrains their export, the final destination of New Zealand butter and cheese is undergoing a far deeper transformation.

From 2014 through 2018, fluid milk output stayed nearly constant, rising by less than 0.5% over these four years. Over this time, however, led by a 418% increase in shipments to China, infant milk formula exports jumped 267%. An even bigger 427% increase in fluid milk shipments to China boosted their total export volume by 186% during these four years.

With WMP and butter output "sacrificed" to make more cheese, from 2014-18, its output rose 18.1% amid near-constant milk output. That enabled a 20.5% increase in cheese exports over these four years –and this was driven by a 73.6% increase in shipments to China.

Despite so much milk fat being diverted to higher value cheese, butter exports to China defied a 2014-18 production decline of 8.6%. While New Zealand's overall butter exports fell 7.4%, over these same four years its shipments to China increased a healthy 45%.

On the other hand, with China buying 28.4% less WMP and 6.6% SMP in 2018 than in 2014, their export volumes rose by less than 1% in four years.

From all this, we can see what has changed, what has stayed the same, and what New Zealand must do. First, despite the harsher conditions that prevailed after the dairy market crash, New Zealand's dairy exports are holding up well. Second, while flat milk production has constrained output, the proportion of production that goes into higher value exports has been rising.  Third, China has been driving this substitution of higher value dairy exports in place of WMP and SMP, whose trade volumes have been relatively flat by comparison.

Fourth, China would probably love to replace some of its massive EU imports of fluid milk, infant formula, butter and cheese with the same, lower cost products from New Zealand, but can't do so due to the Kiwi dairy industry's flat fluid milk production. Whereas New Zealand's longterm rate of milk production expands at an average 3.4% rate, it has been flat for the last five years.

The good news is that neither dairy market crashes, dry weather or their successive occurrence last forever. As the world dairy market recovers and New Zealand's weather returns to its long-term average, annual fluid milk output growth of 3% should resume. Consequently, so long as New Zealand's weather and farm gate prices make it profitable to expand production, both the total number of high-value dairy exports and the proportion going to China should continue increasing.

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