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The Dairy Industry - an update


The dairy industry continues to feature prominently in the media with the ABC’s Four Corners program a recent example. The focus has largely been on the conduct of the major milk processors, Murray Goulburn (MG—a dairy cooperative) and Fonterra (a New Zealand dairy cooperative), which retrospectively lowered the prices paid to dairy farmers, imposing additional debt on farmers, many of whom were already troubled by declining milk prices. The focus on the processors tells only part of the story, however, with the dairy market affected by low prices worldwide brought on by over-supply.  A recent Parliamentary Library flagpost provides some background to the topic.

Dairy industry situation

The dairy industry differs from other livestock industries in some respects. Dairy properties tend to be smaller in size, typically carry fewer livestock and are relatively capital intensive compared to, say, beef cattle properties. They require high value plant like a milking shed, milking machinery, milk storage and refrigeration equipment. Due in large part to this, dairy farmers tend to be heavily indebted with average debts close to $1 million. Profits of dairy farmers are suffering too, due to this and the other developments. This is illustrated in this table which presents data published in August 2016 by Australian Bureau of Agricultural and Resources Economics and Science.

Region Forecast profit 2014-15 $ Forecast profit 2015-16 $ Percentage change Debt 30 June 2015 $ Debt 30 June 2016 $ Percentage change
Murray 56,400 -33,000 -158.5% 666,700 780,000 17.0%
Tasmania 112,700 -14,000 -112.4% 1,728,600 1,851,000 7.1%
South Australia -9,000 -50,000 -455.5% 1,146,800 1,045,000 -8.9%
Gippsland 18,700 -24,000 -228.3% 942,800 848,000 -10.1%
Western Victoria 134,500 -2,000 -101.5% 853,100 881,000 3.3%
Australia 64,400 -14,000 -121.7% 888,200 914,000 2.9%

Source: Australian Bureau of Agricultural and Resources Economics and Science, Australian Dairy: Financial Performance of Dairy Farms, 2013–14 to 2015–16, August 2016.

Developments

Collectively MG and Fonterra make up almost 50 per cent of the Australian dairy processing industry. In April 2015 MG retrospectively lowered the price it would pay its dairy suppliers for the 2015–16 season from $5.60 to between $4.75 and $5.00 per kg of milk solids. The following month, Fonterra retrospectively lowered its price for that season to $5.00 from $5.60.

The retrospective drop in prices caused many dairy farmers to incur significant debts to MG and Fonterra. To alleviate this, MG implemented a payment plan, allowing affected farmers to repay the debt gradually. Fonterra, on the other hand, offered an interest free loan equivalent to the difference between the original price and the reduced price. The loan is repayable from the 2017-18 financial year and allowed Fonterra farmers to continue to receive the higher $5.60 price for the remainder of the 2015–16 season.

The plight of farmers attracted media attention, with commentators offering their thoughts on ways to address farmer’s difficulties. These included a suggestion that there be a 50 cent per litre levy on fresh milk sales. As the Parliamentary Library’s earlier flagpost explains, these solutions mostly reflected a misunderstanding of the causes of the situation.

In late July 2016, MG announced an price of $4.80 per kg of milk solids for the 2016–17 season. When taking into account the MG payment plan, the average becomes $4.31 per kg. Fonterra then announced a price of $4.75 per kg for the 2016–17 season. According to David Basham, acting president of Australian Dairy Farmers, the average cost of production for Victorian, South Australian and southern NSW farmers is $5.00 per kg.

Industry adjustment

As debt repayments bite, and milk prices remain below the claimed cost of production, dairy farmers are selling increasingly large numbers of dairy cattle for slaughter. According to Dairy Australia (DA the national services body for the dairy industry) slaughtering of dairy cattle is up by 37 per cent from March 2015 and is 38 per cent higher than the five year average. Other farmers are simply quitting the industry, and the farm, as the sunk costs involved with dairying are so significant that it is difficult to diversify.

Those farms with sufficient equity levels and a flexible production system are more likely to be able to weather the storm.  According to Mr Basham it is mostly young farmers under heavy financial stress and those near retirement who would be ‘considering’ leaving the industry.

With a structural over-supply worldwide, it is likely that, in the short to medium term, there will be a reduction in number of dairy farms and dairy cattle in Australia, reducing production capacity, particularly in the southern regions.  This will be because, already, farms are reducing their herds and other farms will be sold, or partially or fully diversify.

The prospects for the sector over the longer term will depend to some extent on the conditions in the world market. Russia’s ban on milk imports from certain countries, the removal of quotas in the EU and growing milk production in the US have contributed to the current oversupply and low prices. If world milk prices adjust to sustainable levels it will take time for Australia’s industry to adjust its capacity to take advantage of better prices.

International experience

The adjustment being experienced in Australia is not unique. Low world dairy prices are leading many dairy farmers to exit the industry around the world, particularly in Europe. Despite this, however, world production continues to increase, led by Europe and the US. While international demand for dairy is also growing, so are inventories (especially in Europe) as the demand fails to match the increasing supply.

Outlook for 2016–17

DA forecasts that a global turnaround remains some time off. As up to 75 per cent of the Australian dairy industry is exposed to world prices, the Australian dairy industry is unlikely to turn around until world prices improve. DA claims that the Australian domestic market remains stable and is mitigating to some degree the impacts of low world prices. Despite this Rabobank states that the 2016–17 season will be financially challenging with milk prices for export-oriented producers likely to remain below breakeven.

Tags: Agriculture