abare.gov.au - Australian commodities – March quarter . volume 16 . number 1 2009

Dairy

Outlook to 2013-14

Peter Berry

Weakening market conditions push world dairy prices lower

World dairy product prices fell sharply in the first half of 2008-09 in the wake of the global economic slowdown, with growth in consumption falling in many regions. While dairy consumption has remained relatively unchanged in some developed countries, growth has declined markedly in many developing countries, especially the emerging markets of Asia and Africa.

Weaker world import demand has contributed to a build up of stocks in some of the major exporting countries, particularly the European Union, New Zealand and the United States. The significant rise in stocks has placed significant downward pressure on world dairy prices.

World dairy prices have also been affected by a moderate increase in dairy production. New Zealand has been the major contributor to this growth in world production as its dairy industry recovered from recent drought and continued to expand. Dairy production has also increased in other major exporting countries, but to a much lesser degree. Smaller increases in production were apparent in the European Union, the United States and Argentina.

In Australia, relatively dry conditions and low irrigation water allocations persist across many dairying regions, resulting in slow growth in herd numbers and milk production. Lower feed prices have provided some relief to dairy farmers, but sharply lower farm-gate milk prices, particularly in the export oriented states of Victoria, South Australia and Tasmania, will reduce profitability in the short term. National milk production is forecast to be up 1.9 per cent in 2008-09, reflecting the slow pace of herd rebuilding. However, increases in average milk yields for the year will be limited by an extended period of extreme summer heat in the south-east of the country, particularly in Victoria.

Outlook for world dairy production, consumption and exports

World milk production continues to grow

In calendar year 2008, the US Department of Agriculture estimated that cow milk production increased in many producing countries. The major contributors were China (up 4 per cent), the United States (up 2 per cent), Brazil (up 8 per cent), India (up 3 per cent) and Argentina (up almost 6 per cent). Among the world’s major dairy exporters, production trends have been mixed.

In New Zealand, the world’s largest dairy exporter, dairy production is projected to increase by 8 per cent in 2008-09 as production recovers from a severe drought in early 2008. In 2009-10, production is forecast to increase by a further 4 per cent. These production increases reflect increasing cow numbers, new investment and conversion of land from other uses (particularly sheep), driven by recent high world dairy prices. In line with growth in production, New Zealand is expected to be the main contributor to growth in global export supplies over the next few years.

The increasingly intensive nature of New Zealand dairy farming is expected to result in improved milk yields and further increases in production in 2009-10 and 2010-11. However, over the remainder of the outlook period, growth in production is forecast to gradually decline, reflecting a lower rate of conversion of land to dairy farming, because of the high cost and competing land uses, and slowing investment in the sector. Other constraints to growth in New Zealand’s dairy output, and consequent growth in exports, will also be important over the latter part of the outlook period. These include concerns over the environmental effects of dairying and lead times in building dairy herds.

In the European Union, in contrast, milk production is projected to increase marginally in 2009-10 as lower farm-gate milk prices affect the profitability of dairying, despite lower feed prices and a 1 per cent increase in EU milk quotas in 2009. In 2008 and early 2009, EU domestic dairy prices fell below set intervention levels although they remain well above world prices. The triggering of the intervention (price support) scheme, in combination with export subsidies, is expected to maintain production higher than consumption as it has in the past.

The volume of tradeable supplies in the European Union has also been influenced by a marked slowing of growth in domestic dairy consumption in response to slower economic growth and recessions in some member states. Slowing domestic demand and reduced export demand, together with a small increase in production, have driven a rise in EU dairy product stocks.

Over the remainder of the outlook period, growth in EU dairy output is forecast to be slow, with milk output constrained by production quotas, although these are scheduled to be progressively eased ahead of their complete removal in 2015. However, exportable dairy product surpluses are expected to continue ahead of the removal of export subsidies which the European Union has scheduled for 2013.

In the United States, growth in milk and dairy product output is expected to slow to around 1 per cent in 2009-10, reflecting lower farm-gate milk prices and relatively high input costs. Economic recession in the United States, and weaker demand from both industrial and final consumers, have resulted in declining consumer spending and lower dairy product prices.

In January 2009, prices for most dairy products in the United States fell below price support levels set by the US Government. This has triggered government buying and resulted in a build up of stocks. With consumer spending forecast to remain weak in the coming year, stocks are expected to rise sharply. The eventual method of disposal of these dairy stocks remains unclear; they can either be used in US domestic feed and food programs, or they can be exported with the aid of subsidies under the Dairy Export Incentive Program (DEIP). The latter scenario is a possibility, given the reintroduction of export subsidies by the European Union. If DEIP is enacted, this would lead to an increase in globally traded supplies and contribute to further downward pressure on world prices.

Over the remainder of the outlook period, milk and dairy product output in the United States is expected to rise slowly, reflecting improved domestic demand as the country recovers from recession and stronger demand for exports. However, growth in US dairy production is expected to be constrained by relatively high feed costs, particularly for grain crops which are also used in the manufacture of biofuels, which will affect the profitability of dairying.
In the second half of the outlook period to 2013-14, most of the increase in global milk production is expected in developing countries, particularly China, India, Argentina and Brazil. These increases will be largely driven by increasing domestic demand and greater investment in production capacity. Much of the expected increase in production in these countries is assumed to be consumed domestically. However, Argentina and Brazil are also expected to increase their exports of dairy products. With a higher proportion of dairy consumption being sourced domestically, import demand in these countries is expected to grow more slowly, or in some cases, decline. In China, in particular, import demand is expected to decline as domestic production increases in response to the return of consumer confidence in the wake of the recent melamine contamination scandal.

Growth in world dairy consumption to slow markedly

World economic growth is forecast to fall sharply in 2009-10. Developed economies will be particularly affected, with a number of these countries already in recession. Developing countries are expected to be affected to a lesser extent with economic growth forecast to remain positive, but well below average.

In many developed countries, milk and dairy products are considered to be staple foods and, as such, demand is relatively price inelastic. This means the economic downturn is not likely to result in any significant fall in total dairy consumption. However, a shift in consumer preference toward less expensive dairy products is expected in the short term. Demand by food processors and manufacturers is also likely to be affected, with the global financial crisis reportedly making it difficult for some major buyers to access credit, and this has affected some food processors’ ability to purchase dairy product inputs.

In many less developed countries, dairy foods are not a traditional part of the diet and are often considered to be luxury goods. These goods are more price elastic and therefore consumption tends to decline sharply when prices rise or incomes fall. However, in light of sharply lower world dairy prices, dairy consumption trends are expected to be mixed. While dairy consumption is expected to grow in countries with stronger income growth, significant income declines in other countries will be partially offset by lower world prices.

Overall, global consumption of dairy products is forecast to slow in 2009-10, with import demand to be relatively unchanged from 2008-09. Over the remainder of the outlook period, strengthening economic growth and rising incomes are expected to result in a recovery in growth in consumption and import demand, particularly in less developed countries where rates of economic growth tend to be higher.

World dairy stocks rise from low levels

World dairy stocks fell to historically low levels over the past few years in the wake of strong growth in global dairy consumption which exceeded growth in production. Most notably, dairy intervention stocks in the European Union, which were the largest in the world, were exhausted in 2007 for the first time in many years. Low stocks reduced supplies available for export and contributed to higher world dairy prices.

However, in 2008 dairy stocks began rising again, largely as a result of slowing growth in exports. The European Union in particular has increasing amounts of dairy products in private storage, while intervention stocks are also set to increase again with the resumption of the Europeans Union’s price support scheme. The resulting increase in EU dairy stocks is likely to be exported by means of a recently announced export subsidy program.

World dairy trade growth to slow

Over the outlook period, growth in world dairy trade will largely be dependent on growth in import demand. While relatively slow growth in production is forecast in the major exporting countries in 2009-10, with the exception of New Zealand, an increase in tradeable supplies is expected. This will largely be in the form of stock accumulations in major exporting countries. Despite this, world import demand in 2009-10, and by extension world trade volumes for dairy products, are expected to remain relatively unchanged from 2008-09.

With an assumed recovery in economic growth over the remainder of the outlook period, trade volumes are expected to grow from 2010-11. However, growth in the overall volume of world trade in dairy products may be limited by lower import demand from some key countries. As mentioned above, China, Mexico and Brazil, are expected to supply more of their dairy consumption needs from domestic production, potentially reducing their demand for imports.

Outlook for dairy product prices

With the bulk of world dairy production consumed in the country of origin, only a relatively small proportion of global production, typically only 8 per cent of all milk produced, is available for trade. As a result, relatively small changes in tradeable supplies can result in disproportionately large swings in prices.

Growth in global production, together with relatively steady import demand are expected to result in downward pressure on world dairy prices in the short term. New Zealand in particular is expected to increase exports as a result of strong growth in production, while moderate growth in production in Australia is expected to be largely exported. In addition, there has been an increase in global dairy stocks available for export, particularly in the European Union and the United States. As a result of these developments, lower average world dairy prices are forecast for 2009-10. After 2009-10, the forecast economic recovery is expected to lead to improved growth in global dairy demand and some rise in prices over the remainder of the outlook period.

Cheese

After falling sharply in the first half of 2008-09, world cheese prices are forecast to decline by a further 20 per cent, to average US$2625 a tonne in 2009-10. The decline is in response to slowing growth in global consumption and the reintroduction of export subsidies by the European Union. Given the European Union accounts for around 30 per cent of world cheese exports, the potential impact of its renewed export subsidies on the world price for cheese could be significant. From 2010-11, cheese prices are forecast to recover over the remainder of the outlook period. After bottoming in 2009-10, cheese prices (in 2008-09 dollars) are projected to rise to US$2819 a tonne by 2013-14.

Growth in global cheese consumption is strongly linked to rising consumer incomes and a trend toward more western style diets, particularly in the major developing countries of Asia, Eastern Europe and in the new member states of the European Union. While the global economic slowdown is expected to limit income growth in many developing countries in 2009-10, cheese consumption (and imports) are expected to improve over the remainder of the outlook period.

The Russian Federation is the world’s largest importer of cheese, with estimated imports of 270 000 tonnes in 2008, which is up 350 per cent since 2000. Similarly, the Republic of Korea and Mexico are increasing their imports of cheese, with imports rising by 73 per cent and 67 per cent respectively over the same period.

Japan, which accounts for around 20 per cent of world cheese imports, or more than
200 000 tonnes a year, is a relatively mature market for cheese, with consumption growing at around 1 per cent a year since 2000. With a declining population, cheese imports by Japan are expected to grow at a slow rate over the medium term, while its relative importance as an importer is expected to gradually decline.

Whole milk powder

After a sharp fall in the first half of 2008-09, world whole milk powder (WMP) prices are forecast to fall by a further 25 per cent to US$1825 a tonne in 2009-10. The assumed strengthening economic outlook is forecast to result in WMP prices recovering over the remainder of the projection period, with world WMP prices (in 2008-09 dollars) projected to rise to US$2251 a tonne by 2013-14.

Growth in import demand for WMP is largely driven by income growth in developing countries where milk powders are easily storable without refrigeration. Among the countries most influencing WMP imports are Algeria and Indonesia, where imports were up 63 and 144 per cent to 179 000 and 44 000 tonnes respectively between 2000 and 2008. Algerian imports are estimated to have accounted for 43 per cent of total world WMP imports in 2008, up from 17 per cent in 2000. In 2008, Indonesia accounted for almost 11 per cent of world WMP imports. However, import demand for WMP in some countries, particularly Brazil and China, has fallen in recent years as rising domestic production increasingly displaces imported product.

Over the next few years, the major source of growth in tradeable supplies of WMP is expected to be from New Zealand, in line with expanding domestic milk and dairy production. With EU milk production expected to grow relatively slowly over the medium term while cheese production increases, growth in EU exports of WMP is expected to be relatively limited over the projection period.

Skim milk powder

Similar to other dairy products, world skim milk powder (SMP) prices have been falling sharply in 2008-09 and are forecast to fall by a further 26 per cent, to average around US$1625 a tonne in 2009-10. Lower world SMP prices are expected to be driven by slower growth in global demand and the resumption of price support and export subsidies in the European Union in 2009. Over the remainder of the outlook period, as economic growth strengthens and import demand expands, world SMP prices are projected to rise, to average around US$2137 a tonne (in 2008-09 dollars) by 2013-14.

Import demand for SMP has been largely driven by rising incomes and increasing per person consumption in developing countries in Asia and Eastern Europe. Consumption has also been growing in the developed countries, for use in food processing and as a protein supplement in animal feeds.

In 2009-10, SMP production and exports are expected to be up in New Zealand, and to a lesser extent in the European Union and Australia. Growth in SMP production has slowed in the United States, and is likely to result in relatively unchanged export volumes over the short term. Global SMP production is forecast to increase as a result of strengthening demand in response to the assumed economic recovery over the remainder of the outlook period.

Butter

World butter prices are forecast to decline by around 29 per cent, to US$1750 a tonne in 2009-10. Falling world butter prices are expected to be driven by increased production in New Zealand, set against slower growth in global demand, and the European Union’s resumption of price support and export subsidies in 2009. Over the remainder of the outlook period, butter prices are projected to recover as a result of an improvement in demand for dairy products. From the forecast low in 2009-10, the world price of butter is projected to increase to around US$2146 a tonne (in 2008-09 dollars) by 2013-14.

In the European Union, a build up of butter stocks and the reintroduction of export subsidies are expected to increase butter exports significantly in 2009-10. In New Zealand, increased milk production is expected to result in increased butter production and exports for the year. However, in the United States, lower world prices, together with an assumed higher US dollar, are expected to result in declining butter exports. For Australia, exports of butter are projected to rise slightly, in line with the forecast modest increase in milk production. Over the latter part of the outlook period, butter exports in most major producing countries are expected to expand as world economic growth improves import demand and drives world prices higher.

EU intervention and export subsidies to put further pressure on world dairy prices

The European Union is the world’s second largest producer of dairy products, and typically accounts for more than one-quarter of total world dairy exports. This large share of world production and exports means developments in the EU dairy industry can have a significant effect on world dairy prices and trade volumes.

The European Union’s Common Agricultural Policy (CAP) has historically protected its domestic dairy industry with import restrictions, while providing high levels of price support and export subsidies. For many years prior to 2007, these policies led to the creation of large dairy product surpluses, although attempts were made to limit surpluses with production quotas. The bulk of these surpluses were exported with the aid of subsidies, and this drove down world dairy prices at the expense of other dairy exporting countries.

However, since mid-2007, strong global demand for dairy products resulted in EU dairy stocks being cleared, while high world dairy prices precluded the need for any price support. At the same time, reforms to the CAP raised expectations these market distortions would continue to be reduced. This changed in January 2009, when the European Commission announced that, as both world and domestic dairy prices had fallen well below set intervention levels, price supports and export subsidies would be reactivated for a period of three to six months.

Under the support scheme, the European Commission (EC) sets a floor price, or intervention price, for butter and skim milk powder. If the domestic market price falls below the intervention price, the EC purchases these products at the set price and the product is either stored or sold on the world market at a subsidised price. However, for the planned period of intervention, three to six months, there is an EU-wide voluntary limit of 30 000 tonnes of butter which can be bought through public intervention, and 109 000 tonnes of skim milk powder. After these limits are exhausted, tenders are accepted by the EC for further sales into intervention stores, which will typically occur at prices which are lower than intervention prices. Intervention is currently not available for cheese or whole milk powder.

The use of a price support typically results in increased production and market surpluses. However, while any increase in total dairy production in the European Union will be limited by milk production quotas, set to grow by 1 per cent a year ahead of their removal in 2015, weaker domestic demand and reduced export demand are set to result in another build-up in stocks.

In response, the European Union has also reintroduced export subsidies for dairy products. These subsidies are equivalent to the difference between existing EU intervention prices and prevailing world prices. The release of subsidised dairy supplies onto the world market is expected to place significant downward pressure on world dairy prices in the coming year. Export subsidies for dairy products are reportedly available for exports to a number of countries including the Russian Federation, China, Japan, Canada and the United States.

Under the WTO agreements, the European Union has annual limits for the amount of dairy product which can be exported with the aid of subsidies. The annual limits are; butter, 411 600 tonnes; cheese, 331 700 tonnes; skim milk powder, 323 400 tonnes; and whole milk powder, 232 345 tonnes. Typically, EU butter and SMP export volumes are well within these limits, while total EU exports of cheese and WMP exceeded subsidy limits by 35 per cent and 42 per cent respectively in 2008.

While EU price support and export subsidies are intended to be of limited duration, according to official announcements, there is the possibility any prolonged period of low world prices could be met with an extension of these intervention policies. In addition, the European Union’s reintroduction of export subsidies could potentially encourage other countries to resume or introduce export subsidies in retaliation.

Prospects for Australian dairy

Australian farm-gate milk prices to fall

to sharply reduce milk prices mid-season, Australian farm-gate milk prices are projected to fall by more than 19 per cent to average around 40c a litre in 2008-09.

In 2009-10, further forecast declines in world dairy prices are expected to result in average farm-gate milk prices falling by a further 14 per cent to 34.5c a litre. Farm-gate prices are expected to be highly variable across the country, with larger declines projected for regions which are more exposed to export markets. Dairies in Victoria, Tasmania and South Australia will be most affected, given the high proportion of those states’ milk production which goes to the manufacture of dairy products, much of which is subsequently exported.

After bottoming at around 29c a litre (in 2008-09 dollars) in 2010-11, average farm-gate prices are projected to recover slightly, rising to the end of the outlook period, to around 31c a litre (in 2008-09 dollars) by 2013-14. The forecast modest rise reflects some recovery in global demand and a resulting improvement in world dairy product prices.

Australian milk production to recover slowly

Reflecting a moderate increase in the dairy herd, the first in seven years, and a steady increase in yield per cow, Australian milk production is estimated to increase by 1.9 per cent to around 9.4 billion litres in 2008-09. In 2009-10, Australian milk production is forecast to increase by 1.6 per cent to 9.55 billion litres.

A number of factors are likely to result in a slow recovery in Australian milk production. Sharply lower farm-gate prices on offer in 2008-09 are expected to reduce the profitability of many dairy farms, despite the availability of cheaper feed and fodder. Irrigation water allocations will remain a major issue for many dairy farms over the outlook period, particularly those in northern Victoria and southern New South Wales, where dairy farms are more reliant on irrigation. The availability of irrigation water will be a major factor affecting the speed of recovery in the Australian dairy herd and total milk production.

Over the remainder of the outlook period, growth in world dairy consumption is projected to strengthen relative to production. This is forecast to result in improved world prices for dairy products and some improvement in Australian farm-gate milk prices. As a consequence, Australian milk production is forecast to increase from 2007-08 lows, to around 10.6 billion litres by 2013-14. Australia’s dairy herd is projected to increase by around 10 per cent and milk yields to rise by around 5 per cent over the outlook period.

Over the outlook period, changes in Australia’s dairy product mix and total output will be driven by changes in relative returns from the various manufactured products. For example, prices for higher-value products such as cheese are projected to be somewhat stronger than prices of other dairy products. As a result, cheese is likely to account for an increased proportion of manufactured dairy product output and Australian dairy exports over the outlook period.

Australian export returns to fall

As a result of a forecast fall in world dairy product prices outweighing the effect of increased export volumes and a lower exchange rate, the total value of Australian dairy product exports is forecast to fall by 19 per cent to $2.13 billion in 2009-10.

For the year, the value of skim milk powder exports is forecast to be down by 22 per cent, to $337 million and whole milk powder export earnings down by 21 per cent to $315 million. The value of butter exports is forecast to be down by 25 per cent to $154 million, while export earnings from casein and cheese are expected to be down by 20 per cent and 16 per cent, to $89 million and $835 million respectively.

After falling to less than $2 billion (in 2008-09 dollars) in 2010-11, the total value of dairy exports is projected to recover, reaching around $2.2 billion (in 2008-09 dollars) by 2013-14.