March 21, 2017

A battered but changing world dairy market

An eFeedLink Hot Topic
  • Dairy market trade flows are being changed by a variety of factors including EU liberalization, Russia's embargo and Chinese investment in non-traditional Australian and New Zealand dairy lines
  • Oceana producers are seizing market share in China, Russia while the EU takes market share in Southeast Asia
  • The world market is in truth half recovered: Traditional fatty products like butter, AMF are back to near pre-crash levels but once fashionable dairy powder lines continue to drag down the entire market
  • Volumes have equaled or exceeded pre-crash levels but with excess supply depressing prices, returns are poor
Today's beleaguered world dairy market is not as depressed as it is misunderstood. Dairy volumes are recovering but despite repeated attempts, the market's volume fails to do so. Moreover, the type of dairy commodity, its origin and export destination are all undergoing large changes.
Superficially, after rising by 55% from July to December 2015 (from a very low base), the Global Dairy Trade Index recently turned sharply lower, falling nearly 10% from mid-February and mid-March. It was the second time in two years that the industry has seen a 55% rally from very low price levels crash and fall. –And even before prices turned down, the index remained approximately 25% below its 2013-14 levels and 36% below its all-time peak established in 2007.
That's because the now-defunct rally was based on solid fundamentals –but not on solid returns. According to Dairy Australia, total world dairy export volumes increased 7% in the twelve months ending in October 2016. In particular, shipments to Greater China (including Hong Kong and Taiwan) rose 13% from the previous year, while those to Southeast Asia increased 7%. Collectively, the many nations that make up Africa also took advantage of the low prices to boost imports 300,000 tonnes or by 11%, to over 2 million tonnes for the very first time.
Among markets that import a million or more tonnes of dairy products, only the oil crash deflated Middle East saw volumes stay flat, falling an immaterial 1%. In a similar vein, Russian dairy imports increased 15% but at 146,000 tonnes, they were a far cry from the 500,000 tonnes pre-boycott volumes. Similarly, China last year finally imported more dairy products than before the crash. However, with much of the new demand made up by fluid milk, infant formula and cheese, Chinese demand for market trend-setting dairy powders remained slack.
In all, of the additional 500,000+ tonnes of dairy products purchased on the world market, 441,000 tonnes were accounted for by either China or Southeast Asia. The latter, despite having only half of China's population, has overtaken it in dairy import demand. This is driven by fast growing dairy import demand in Vietnam (+21%), Indonesia (+10%), Philippines (+9%) and Thailand (+7%). Vietnam's food industry saw it ramp up SMP import volumes by 28% in one year. However, with SMP volumes falling everywhere else, the returns on this once lucrative dairy line continue to be the poorest.
The problem is that while the aggregate volume of exports has recovered, their value remains much lower and their product profile is shifting. For example, the 7% rise in the volume of Southeast Asian imports coincided with a 17% drop in their value, from US$5.60 billion to US$4.65 billion. This was due to the impact of SMP price crash. It created a situation where ASEAN SMP import shipments increased 4% even as revenues from them fell 24%.
In China, returns were better but still disappointing: A 13% export volume increase pushed the value of dairy goods exported up a tiny US$100 million or 1.4%, to US$7.2 billion. However, unlike the past when Chinese dairy demand was accounted for mostly by WMP or SMP, infant formula is now the single largest export category, accounting for US$2.5 billion and over a third of earnings. Fluid milk also did its part to chip to destroy the one-time powder duopoly over dairy exports to China. Fluid milk shipments to China rose by 36% from 500,000 to 680,000 tonnes while revenues were up by nearly a third.
The dairy powder lines found themselves going in opposite directions. After running down the previous year's bloated inventories, China's imports WMP rebounded 14.7%. Rising from 393,000 to 450,000 tonnes, they are now mid-way between their peak volume of 640,000 tonnes and their 2015 lows.  SMP by comparison, SMP import volumes fell another 8% and at 200,000 tonnes, stand 25% below their peak volume.
The origin of Chinese dairy imports also changed. Reflecting recent huge investments in Australian and New Zealand UHT milk and infant formula facilities, Chinese imports of Australian products rose by 29% on-year while those from New Zealand rose 20%. It also gave a 16% boost to its European dairy imports, while those from America fell by 9%. This Chinese thirst for fresh milk also reflected in Australian (+25%), EU (+29%) and New Zealand (+42%) fluid milk exports, all of which jumped sharply.

If southern hemisphere suppliers are taking the market lead in China, in Southeast Asia, it is European influence which is growing. EU exports to ASEAN increased 17%, roughly double the pace of Australian (+8%) and New Zealand (+5%) shipments.
On one hand, the EU shifted several hundred thousand tonnes of SMP, whey and casein once bound for Russia to nations like Vietnam, Indonesia, Philippines and Thailand. On the other hand, counterbalancing the 17% EU surge into Southeast Asia was New Zealand's 20% increase in its exports to China and Australia's even larger 30% sure in shipments to the Middle Kingdome. Moreover, with the EU and America blocked from the Russian market, New Zealand took advantage of this situation to boost its exports the latter by 156%.
The only country to lose volume in last year's dairy trade was the United States. Hampered by a high US dollar and growing domestic demand leaving less available for trade, US export growth of 6% to Mexico could not counterbalance a 10% drop in larger volume shipments to China and 2% fall in sales to Southeast Asia. In both markets, it found itself being squeezed by new competition from the EU.
Finally, importer shifts in commodity preferences are being reflected in wildly diverging world dairy prices and submarkets.
Highly fatty butter and AMF are actually back at their 2014 market peak price levels. In particular, AMF, the fattiest of these heavier dairy commodities is now selling a few percentage points above its early 2014 market peak high. Slightly less fatty butter is selling at roughly the same price it was during its market top.

This is especially true of commodity milk powders WMP and SMP, which had led the sector's growth during its export-driven years from the late 1990s to mid-2010s.
Lower in fat than either AMF or butter, cheese is below market peak levels but almost at the same price it was in early 2013, when it was strongly profitable. By comparison, rennet-casein, which is used to make cheese, remains 36% below its 2013 peak. Even so, it fares well relative to non-traditional dairy powders.
SMP, by comparison, is selling nearly 60% below its peak 2013-14 price points, while slightly fattier WMP is nearly 50% below the levels of that time. 
This can also be seen in the reversal of a dairy market metric: The price difference between near 100% fat butter and SMP, which is completely fat free. During the world dairy market boom decade, SMP usually had a price premium of several hundred dollars a tonne over butter. This relationship however, reversed itself after the 2014 market crash.
From late 2014 through mid-2016, butter sold at a premium usually ranging from US$600/tonne to US$1,200/tonne. Then, from the time of the last dairy market bear rally in mid-2016 to the rally's end in the late Q1 2017, butter's price premium over SMP more than doubled, fluctuating near a whopping US$2,000/tonne at the time of this article's publication.
This is an interesting market reversal of sorts. During the dairy boom, powders were all the rage while fattier dairy commodities were considered slower growing and old-fashioned. But even though dairy powders did far better than fats or fluid milk, we did not have a situation where the prices of different dairy commodities diverged this greatly. At this point, the global dairy price index makes less sense than before because it does not capture the very different, highly opposite stories going on in different parts of the world dairy sector.
Hence, we really have a two-track dairy market: Buoyed by constant demand in the west and growing processed food and quick service restaurant sectors in Asia, traditional fatty dairy products have recovered reasonably well. Soaring Chinese demand for fluid milk and infant formula have also made these lines into new, important revenue lines, particularly for Australian and New Zealand exporters.
Going forward, while early 2017's new dairy market slump is real, it does not reflect all past or current factors. Over the short term, some products are garnering far better returns than others. For the medium term, an 8% drop in this year's Australian fluid milk output should be felt later this year. 
While the depressed state of dairy powders will keep the market from taking off, prices will stabilize in the second quarter and recover, probably to 10% higher levels than their February peak in H2 2017. Until oil prices recover, the 2 million collective tonnes of import demand accounted for by the Middle East and Russia cannot will have at most a limited recovery, as will the world dairy market.
Over the longer term however, important changes are underway. Southeast Asia is taking over from China as the world dairy market driver. This will particularly be the case for dairy powders, for which China's appetite will only slowly recover.
Within China itself, consumers have made an unofficial (but very strong decision) to leave domestic milk supplies to their food processors, while they and their infants consciously choose to consumer foreign milk. Thus, while China is conceding its control of the dairy powder market to ASEAN, it is making UHT milk and infant formula into commodity lines that will command much more statistical attention in the future.
Finally, while it is impossible to make high fat dairy products (eg. butter) without creating low fat mirror-image products (eg. SMP), there is an ongoing shift in market signals and value-added pricing away from low fat powders and towards fattier products like AMF and cheese. The flexibility and ingenuity with which suppliers adjust to these new realities will determine their success in the 2020s.

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