April 28, 2015
China's dairy market goes back to the future
As it returns to its pre-2008 growth path, foreign participation in the China's dairy industry is shifting away from dairy powder imports and back to capital investment.
By Donald XU, Business Director - Dairy, BIOMIN China
An eFeedLink Hot Topic
Over the past year, China's dairy industry has re-taken its place as this country's fastest growing livestock line. Five years of stagnation caused by 2008's melamine contamination crisis are now over. In this new era, China now stands as the third largest fluid milk producer after India and the United States. Moreover, as the world's largest dairy importer, it makes or breaks the world market for such products.
Production and consumption
From the start of its modern era, China's dairy industry's growth eclipsed that of other sectors. From 2000 to 2008, the USDA estimates that fluid milk output expanded at annual rates ranging from 10% to 32%. After the melamine scandal, output fell 18% in two years, then stagnated another two before finally exceeding its 2008 volume in the past year.
Demand however, kept growing at nearly the same pace as before, resulting in a large supply-demand gap bridged by exceptionally rapid growth in the volume of imported milk powders.
According to the USDA, from 103,000 tonnes of total imports of fluid milk, skim milk powder and whole milk powder in 2007, China's imported volume of these products jumped to 668,000 tonnes in 2012 and 1.31 million tonnes in 2014.
There will however, be one side effect to China's rising domestic fluid milk output: While the world pays attention to China's rising dairy import volume, its skyrocketing dependence on foreign dairy inputs receives far less attention. From a mere 2,088 tonnes of alfalfa hay mainly from the US in 2007, its import volume increased to 900,000 tonnes in 2014. These can be expected to continue rising at a rapid rate in years to come.
Going forward however, import volumes will continue growing but nowhere near the rapid, near exponential rates seen after 2008: A recent report by the China Statistics Bureau estimates that milk production will reach 59 and 76 million tonnes by 2020 and 2030 respectively. This implies that annual fluid milk output of 8% over the next five years. Even if the country falls short of this optimistic supply-side forecast, there is no doubt that fluid milk output will equal exceed consumption growth, limiting the potential for further import penetration.
However, while fluid milk supplies are finally keeping pace with demand, the industry still suffers from a productivity deficit. According to Chinese government figures, a Chinese dairy cow's average milk yield of 5,500 kg/cow/year is half of that of cows in America and Europe.
Fortunately, there remains decades of pent-up demand to fuel large, sustained increases in both output and productivity: Average annual urban per capita consumption of dairy products in 2013 was 28.6 kg -with far lower consumption rates in rural areas, which hold 40% of the country's population. Urban per capita consumption is only 26% of the global average consumption level of 109 kg, and is very low compared with per capita dairy consumption levels of Australia (412kg), the EU (302.3kg), America (289.5kg), Japan (59.8kg) or South Korea (43.2kg).Hence, while rising production will limit opportunities for dairy powder exporters, the closing of this productivity gap represents a great opportunity for suppliers of dairy farming capital.
Industry location and structure
Geographically speaking, China's dairy industry is concentrated in China's cooler, more temperate northern regions, which account for 83% of its cattle herds, of which 50% are dairy cows. The rest of the country's cattle are to be found in central China (11%), and eastern (5%) and southern China (1%).There are three dairy farming models in China. Backyard farms have up to 20 cows and mostly use compound feeds bought from feed mills. Due to poor farm management, their fluid milk output of 10-15 kg/cow/day is up to a third below the overall average for the country. Similarly, the price they receive is normally US$0.25/kg lower than that of commercial ones.
By comparison, cooperatives vary in scale anywhere from a few hundred to a thousand farms for each cooperative. On average, each cooperative has about 15 individual farmers on average and they usually own from 10 to 50 dairy cattle. All cows at are milked at the cooperative's central milk collection unit and then sold to local dairy processors.
Relying on concentrates and compound feeds supplied by mills, cooperatives' dairy productivity averages around 15-20 kg/cow/day. Although their productivity is slightly higher than the national average, it is still 33% to 50% below that of commercial farms. Milk prices are also about US$0.15/kg lower.
Except for being substantially larger than their backyard competitors, commercial dairy farms show considerable diversity in their size, scale and operational methods. Commercial farms with fewer than 500 dairy cows are usually considered small; those with 500 to 1,000 head are medium, while integrators with over 1,000 animal are considered large. According to the China Dairy Yearbook 2013, there are about 60 farms with over 10,000 cows on a single farm. The 33 largest dairy integrators have 340 farms holding 800,000 dairy cows, while the top 100 dairy processors own about 240 dairy farms each.
Government, competition, drives consolidation
All dairy farms have benefitted from government policies but in an uneven manner. This is because since 2008, tax incentives and subsidies have been used to encourage consolidation. In 2013, the central government allocated a budget of US$161.3 million for dairy farm construction, US$42 million for genetic improvement, US$6.12 million for dairy herd improvement, and US$85 million for alfalfa production respectively.
By far however, the greatest beneficiaries of these policies were large dairy enterprises. They are favoured due to their lower unit costs, strong capital base and because their compliance with new, strict food safety laws can be more easily monitored. On the other hand, the past two years saw many smaller producers take advantage of high beef and cattle prices to exit the industry.
According to the ministry of agriculture, farms and cooperatives with over 100 cows accounted for 37% of the total cow population in 2013 compared with that of 19.54% in 2008. This percentage increased to 40% at the end of 2014 and will double over the next decade.
The future
From these intersecting trends, several things become clear. First, after several years of stagnation, the industry has regained much of its pre-2008 growth momentum. Second, with supply keeping pace –but never overtaking demand– dairy import powder import growth will decelerate and this lead to more moderate world dairy prices.
Third, the industry's recovery is being achieved via the consolidation and exit of smaller, less productive farms.
Fourth, the future of China's dairy industry is also its past. Before 2008, with production rising rapidly, foreign agribusiness giants were investing in domestic operations. Then for five years, dairy powder imports grew more rapidly than production or foreign investment holdings. Going forward, we are returning to a dairy industry model where the vast majority of China's dairy production will be produced domestically, but with large, ongoing infusions of foreign capital and technology.
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