New Zealand's dairy sector is facing an increasingly challenging environment as world milk prices fall. The GlobalDairyTrade price index, based on auction prices, declined by 25% in just two months this summer with the market suffering from excess supply while Chinese demand fell.
The forecast farmgate milk price for New Zealand for the 2015/16 season is expected to be cut from NZ$5.25 a kilogram of milk solids to NZ$3.85 by the country's major dairy cooperative. That is the lowest since 2005/06, although a temporary support payment of 50c per kg was also announced - interest-free for two years and repayable only when prices reach NZ$6.
Around a quarter of the country’s farms had negative cashflow over the 2014/15 season when the farmgate milk price was NZ$4.40, according to the central bank, so a second successive season of low dairy prices will increase the financial strain across the sector. The average cost per kilogram of milk solids of production is estimated at around NZ$5.70.
Fortunately, the agricultural sector’s financial position appeared to be relatively solid going into the season. Debt has grown only slowly and deposits rose by 21% over the year as farmers saved much of their record 2013/14 payout. As a result, the sector's ratio of debt to deposits in 2014 was the lowest since 2008.
There appears to be scope to draw down savings or increase debt to cover this season's shortfall, although financial strain will undoubtedly increase over coming months.
But despite these short-term challenges, we remain optimistic on the outlook for New Zealand’s dairy sector and believe medium-term equilibrium prices will be considerably higher than the current level.
The global dairy market is currently suffering from excess supply as production has increased, particularly in New Zealand and Europe, while demand has been soft.
On the supply side, it is likely that some of the high-cost production drawn into the market over recent years will drop out. That may be painful in the short term but it will support prices over time.
On the demand side, Chinese milk imports have been weak following the extraordinary surge during late 2013 and early 2014 that led to significant stock building. At some point, China will return to the market as a major buyer. And while the days of rapid growth in Chinese demand for hard commodities appear to be over, we should see soft-commodity demand grow as the middle classes expand and consumption becomes a greater economic driver.
In the meantime, though, lower earnings from dairy exports will be a significant drag on New Zealand's national income. But, although momentum in the economy has slowed, we don't expect a sharp slowdown in overall growth. Domestic demand remains firm, the tourism sector is booming and we also expect a further contribution to growth from construction. Currency depreciation and low interest rates should also support growth.
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