June 10, 2016
 
Australia's dairy sector: Doing the best it can, within nature's straitjacket
 
By ERIC J. BROOKS
 
An eFeedLink Hot Topic 
 
  • An El Niño-induced drought has made milk output fall below projections for a second straight year
  • With pastureland parched, over reliance on feed and temporary water supplies has jacked up production costs even as farmgate milk prices fall, forcing many to cull herds
  • Longterm drought continues to keep milk output 10% to 15% below turn of the century peak levels
    Despite the difficult economic conditions, bad weather and low world market prices, exports of most dairy products increased
  • For new investments in production intensification, new technologies and new UHT milk facilities to pay off,  several years of above average rainfall is required
Economics and the weather took turns to make it a challenging year for Australia's dairy sector. While exports held up better than expected, dairy export prices are down by more than third. With over 60% of fluid milk output consumed domestically, neither farmgate prices nor earnings have not fallen as drastically as in New Zealand, where 90% of output is exported.

Nevertheless, from near A$7.00/kg at their peak, farmgate milk prices fell to A$6.00/kg in 2015, were adjusted down to A$5.50/kg this April, and are expected to bottom out around A$5.00/kg at the start of the next marketing year. and nature is now impacting supplies too.
 
Last year's El Niño resulted in predictably dry pastureland conditions. The arid conditions also had a detrimental impact on dairy cow productivity, particularly in the last quarter of 2015 and first quarter of this year.
 
During November and December when output usually peaks, milk volumes were approximately 5% lower than in the same months a year earlier. The impact was felt most strongly in southeastern Australia's Victoria state, which accounts for 66% of the country's dairy production.
 
According to the USDA, "Adverse seasonal conditions have led to shortages of feed for dairy farmers in Victoria and Tasmania", noting that, "In response, many dairy farmers have been forced to buy additional feed and water." It estimates that feed risen from its traditional 10% to 15% share of Australian milk production costs into the 20% to 33% range. The cost of temporary water required to get through the drought was also 50% higher than a year earlier.
 
Forced reliance on feed and procured water inflated production costs at a time when low farmgate milk prices had already tipped many dairy farms into a net loss margin position. The combination of low farmgate milk prices, bloated feed costs and high beef export prices motivated farms to cull their older or least productive cows.
 
According to Matt Watt, Australian national milk supply manager for Fonterra, the arid conditions forced farmers to begin relying on feed a month earlier than usual. Watt stated that once their dairy feed inventories were exhausted earlier than anticipated, farmers had, "to make some tough decisions around culling cows as culled cow prices remain reasonable and that clearly impacts production."
 
Consequently, the USDA estimates that Australia's 2016's overall cattle numbers to fall by 5% for a second consecutive year, though dairy cattle herds will fall by only a fraction of this amount. Even so, it is enough to transform this year's anticipated milk production gain into a decline.
 
Initially, the USDA saw Australian fluid milk output rising from 2014's 9.7 billion litres to above 10.0 billion litres in both 2015 and 2016. Unfortunately, late 2015's dry conditions carried over into straight through into April of this year. Although precipitation increased significantly in May, with pastureland past its growing season and entering winter months, the current wet spell will provide much less support to milk output than if it had occurred six months earlier.
 
Furthermore, because Victoria and Tasmania's soil moisture levels are now very low, their pastureland needs an extended period of high rainfall just recover its traditional productivity level. Even over the short term, there is no certainty that May and early June's wet weather will extend into the critical late third and fourth quarters, when milk output usually peaks.
 
Consequently, the drought has caused 2015 estimates to be revised down to 9.5 billion litres, down 2.1% from the previous year. With 2016's first two, higher production months also impacted by sparse rainfall, most analysts have cut initial milk production estimates of approximately 10 billion litres back to 9.7 billion litres.

Though this decline is nominal, it will have a disproportionate impact on Australian dairy exports. Victoria, which accounts for the overwhelming proportion of falling milk output, traditionally uses 10% for human consumption and converts the other 90% into dairy products, most of which are exported. In other regions however, only half the milk produced undergoes further processing into dairy commodities. With Australia's most export-driven dairy region hit, its ability to supply international markets is also impacted.
 
Although milk output remains flat, foreign demand for Australian dairy commodities, particularly high fat or high protein lines, remains strong despite the lowest export prices in years. Partly due to strong Southeast Asian demand, partly due to a high US dollar inducing a partial retreat of US dairy exports, Australia is producing more SMP and cheese today than when the dairy market peaked three years ago.
 
For example, with its above average returns, cheese has defied the past two years of falling fluid milk output. Its 2015 production rose 1.2% from 320,000 in both 2013 and 2014 (when the market peaked) to 324,000 tonnes in 2015. This year, cheese output and is expected to jump another 4.9% this year to 340,000 tonnes. Moreover, 19,000 tonnes of this two year, 20,000 tonne rise in cheese output is being exported, as outbound shipments rose from 151,000 tonnes in 2014 to total 170,000 tonnes both in 2015 and this year.
 
Similarly, at first, the dairy market crash made SMP production fall nearly 5%, from 215,000 tonnes in 2013 to 205,000 in 2014, when the market downturn commenced. In 2015 however, SMP production jumped a whopping 30%, to 266,000 tonnes. This year, despite nominally lower milk output, SMP output will rise another 1.5%, to 270,000 tonnes.
 
Though SMP output increased in part due to its being a by-product of high demand fatty commodities like cheese, Asian buyers eager to restock inventories cheaply absorbed 75% of this two-year, 61,000 tonne output increase, as exports rose 28%, from 164,000 tonnes in 2014 to an estimated 210,000 tonnes this year.
 
Only WMP (due to the downturn in Chinese buying) saw its production fall 22% and 13.5% respectively over the past two years, as the downturn in Chinese buying could not be fully counterbalanced by higher exports elsewhere.
 
Similarly, with Russia's economic boycott closing a market that absorbed 29% or 14,000 tonnes of Australia's 48,000 tonne butter exports in 2013, it could not maintain either its production nor exports of butter, which is estimated to have fallen by 25% and 32% respectively from 2014 through 2016 inclusive. Export growth in Malaysia, China and Taiwan could simply not outweigh the loss of Russia's market.
 
Ultimately however, Australian dairy's fortunes are very much at the mercy of nature. A decade long drought followed by last year's unusually strong El Niño leaves Australia in a bad position. In fact, while
both Australian and New Zealand dairy production costs have risen relative to their American competitors over time, they have done so for very different reasons.
 
New Zealand's rainfall has been relatively reliable but skyrocketing Chinese dairy demand is forcing it to achieve record output by outgrowing the industry's pastureland base. The resulting higher rates of feed inclusion jacks up production costs.
 
This however, is not the case in Australia. Unlike New Zealand, even though world dairy exports nearly doubled over the last 15 years, 2016's milk output remains 16.5% below the 11.61 billion tonne peak achieved in 2002. In any given year, Australian milk production languishes 10% to 15% below its 2002 record volume.
 
As the accompanying graphs show, Australia's output of dairy products closely tracks what percent of its peak fluid milk output any given year's production is –and its exports track the fluid milk supply even more closely than their production. Hence, despite the industry's sizable expenditures in production intensification, new processing technologies, larger scale facilities and new UHT milk-for-export facilities, several years of consistently above average precipitation are needed before these investments bear fruit.
 


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