October 5, 2015
Australian beef: Kind markets, cruel nature and a dairy driven bump in output
A dairy market downturn is giving Australia's beef trade a temporary boost but to take full advantage of growing Asian demand,it needs a return to rainy conditions.
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Nature is showing no mercy to Australian beef cattle. Long standing dry conditions intensified in 2014. Northern Australia which accounts for 62% of beef cattle and 50% of beef production, saw up to 40% less rainfall. 75% of Queensland, the major northern producing state, has been in drought since 2012, with 60% of its beef cattle ranches within the affected areas.

With years of below average rainfall and dry conditions in all but southern coastal areas, grazing land has not been given a chance to recover. Moreover, because of the current El Nino event, 2015's rainfall was below average in an even higher proportion of the country. Dry conditions are now forecast to intensify and possibly spread to the southern and eastern coasts of Victoria and New South Wales, where much beef cattle for export are raised.
While arid conditions make it difficult to economically maintain herds, high cattle prices encourage mass culling. This is especially true in Australia, as the lack of a deep, US-style feed crop base makes profitability as dependent on pastureland conditions as it does on beef cattle prices.
At the same time, with US and Chinese demand pulling up world prices, the benchmark Eastern Young Cattle Indicator index rose from A$3.30/kg (US$2.92/kg) in late 2014 and repeatedly set new price records in a the A$5.00/kg to A$5.60/kg range (US$3.58/kg to US$4.00/kg) throughout the third quarter. [Note: Due to fluctuating currency exchange rates, US dollar equivalents are not always proportionate to Australian price changes] Going forward, the USDA expects prices to exceed A$6.00/kg [US$4.23/kg] in early 2016.
Record cattle price + drought = high culling rate
This combination of unsustainable pastureland conditions and two years of exceptionally high cattle prices motivated a mass cattle culling, resulting in a temporary, two year bump in beef production and exports. The USDA initially estimated that 2014's 2.6 million tonnes of output would fall to 2.28 million. With high prices and persistent drought encouraging culling, 2015's beef output is now expected to total 2.5 million tonnes, just 3.9% less than the previous year's record high.
Exceptionally dry conditions in Australia's north also encouraged exports of live cattle to China, Indonesia and Vietnam. In fact, live cattle exports were initially projected to fall from 2014's 1.3 million head to 900,000. Instead, with Vietnam's unexpectedly high beef cattle demand offsetting China's 90% reduction in dairy cow imports, the number of live cattle exported will total 1.2 million, only 7.7% than in 2014, rather than the 39% fall initially expected.
Moreover, two years of low dairy prices mean that a high proportion of this temporary, upwards bump in cattle culling and beef output comes from the pairing down of dairy herds. On one hand, from 29.29 million head in 2014, total beef and non-beef cattle numbers fell to 5.8% to 27.6 million at the start of this year. They are projected to enter 2016 at 26.3 million head, down another 4.9% from the start of this year and 10.2% in two years.
On the other hand, the beef cattle herd fell 6.5% from 13.9 million in early 2014 to 13.0 million at the start of 2015. With beef prices high and dairy prices low, beef cattle retention is encouraged while that of dairy cows is discouraged. Thus beef cattle are expected to enter 2016 at the same 13.0 million head inventory level that they started the previous year.
With dairy cattle culling driving production increases, beef output jumped 9.6% in 2013, from a USDA estimated 2.15 million in 2012 to 2.35 million that year. 2014's dairy market losses, booming Chinese demand\ and America's need for ground beef imports then boosted 2014 output by 10% to a record high 2.6 million tonnes. With the past 24 months of high culling rates tapering off in the second half of this year, 2015 output will fall 3.9%, to 2.5 million tonnes.
As drought and high prices coincided with booming Chinese demand and faltering US beef production, shipments to those countries powered a beef export boom. Exports jumped 13.2% from 1.41 million tonnes in 2012 to 1.59 million in 2013. Last year saw even bigger gains, with exports rising a whopping 16.2%, to a record 1.85 million tonnes. This year, with the culling rate falling to more sustainable levels, exports will retreat 5.5%, to 1.75 million tonnes, the second highest volume on record.
Falling cattle numbers, missed export opportunities
Going forward however, two years of culling excess dairy cattle and the need to rebuild the beef herd will limit both Australia's beef production and its trade performance. Assuming wetter conditions resume and high beef prices persist after El Nino dissipates in early 2016, the need to rebuild the beef herd makes it impossible for their slaughter volumes to counterweight a dwindling number of dairy cattle eligible for culling.
With domestic consumption staying constant, beef output will drop by 4% or 100,000 tonnes to 2.4 million. Given high world beef demand however, exports will drop by a smaller 2.9% or 50,000 tonnes to 1.7 million, with a beef inventory run down making up the difference.
Behind these quantitative changes to Australia's beef export picture are more qualitative transformations. America remains its most important trade destination, taking in a USDA estimated 400,000 tonnes of beef exports and garnering A$2.4 billion (US$2.12 billion). Reflecting America's own coincidence of record low cattle herds and strong beef demand, exports to the US were up 90% from 2013's 210,000 tonnes.
300,000 tonnes of 2014's 400,000 tonne of shipments to the US are accounted for by ground beef but there is also growth in a high-end segment: Grass-fed beef cuts such as steak jumped 90% by volume, from 31,500 tonnes in 2013 to 60,000 tonnes in 2014 and up to 70,000 tonnes this year.
For 2015, exports to America are expected to jump another healthy 12.7%, to 451,000 tonnes. You may note that this exceeds its 2015 US tariff free import quota of 418,000 tonnes (imports above the quota volume face a 21% tariff).
Australia can however, exported less than its allowed tariff free volume in 2013 and prior years. It is now using this to offset its over-quota amount for this year. Going forward, Australia's tariff free US import volume is gradually rising to 448,000 tonnes in 2023 and becoming unlimited thereafter.
Hence, while imports may have to level out or fall nominally in 2016, given Australia's limited export capacity during 2016 and 2017, US import barriers will not be much of an issue thereafter. What is more interesting is whether Australia can maintain the export momentum of its high-end segments to America, which has traditionally relied on it for ground beef.
While the United States remains its largest market, demand for Australian beef is growing more rapidly in China than in any other market. They multiplied 15-fold and jumped 953% in three years, from 10,000 tonnes in 2010 to 153,000 tonnes in 2013, before falling back to 128,000 tonnes last year, as it faced competition from lower end Indian beef re-exported from Vietnam into China.
That caused its share of Chinese beef imports to fall from the 37% to 31%, though it still has a greater share than any other supplying country. Unlike its shipments to the US however, exports to China are dominated by high-end lines such as steaks or wagyu beef, which are sold in high-end restaurants and supermarkets.
This year, with the smuggling trade being cracked down upon, beef exports to China are expected to rebound to the 150,000+ level seen two years ago in 2016 and rise significantly higher thereafter. With a free trade agreement with China coming into effect, 12% to 25% tariffs on beef exports to China will gradually fall over the next nine years.
Going forward, Australia is expected to maintain its one-third share of China's beef import market, which looks poised to grow by at least 5% annually and possibly significantly more –if more plants can be approved for export to China. Either way, China looks set to overtake South Korea as its number three beef export destination after America and Japan.
Even so, there is much potential to expand its exports to mature Asian markets too. It recently signed free trade agreements with Japan and South Korea. Under the Korea-Australian FTA's terms, the latter's 40% tariff on Australian exports of beef and offal and 72% tariff on ground beef are being lowered over the next 15 years.
Similarly under an FTA recently signed with Japan, the existing 38.5% tariffs on frozen and chilled beef will be reduced to 19.5% and 23.5% respectively by. In addition, the exiting tariff on live cattle imports from Australia will be reduced by 20% and feature no volume restrictions.
These trade liberalizations will, at the very least, enable Australia to gain back some of the market share it lost to America, which signed an FTA with South Korea several years ago and regained market much of its Japanese market share after being allowed back into the country in the late 2000s.
Moreover, with the Australian currency's 30% fall against the US dollar over the past year has led to a considerable improvement to its beef's terms of trade within Asia. In fact, its exports to China, Japan and South Korea would rise to significantly higher levels in 2016 and 2017 it not for the restrictive impact of its falling, constrained cattle herd numbers. 
At this point, much depends on Mother Nature. Although Australia has much greater scope for boosting beef exports than the United States, the break in America's years long drought is allowing that country to boost its cattle inventory for the first time in decades.
Will cattle prices stay high and rainfall return in a way that would let Australia take advantage of the world beef market's export opportunities? Only time will tell.

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