Posted 23/06/2016 by Rob Dossor
In April and May 2016, Australia’s two largest dairy processors, Murray Goulburn (MG) and Fonterra retrospectively lowered the price they would pay their suppliers for milk. With effect from 1 July 2015 they would pay between $4.75 and $5.00 per kg of milk solids, down from $5.60 per kg. This has attracted much media attention, focusing on the plight of the affected dairy farmers. Commentators have offered suggestions to support the dairy farmers. Some, incorrectly assuming the current circumstances arise substantially from the $1 a litre ‘milk wars’, suggest a levy on the sale of fresh milk and that consumers buy more branded fresh milk and other dairy products. Others suggest a return to the days of milk regulation. The position is more complicated, however. A better understanding of the factors leading to this predicament has the potential to lead to better targeted responses, if a response is needed.
The Australian dairy industry
The Australian dairy industry is largely centred in Victoria, which produces over 60 per cent of all milk, by value, has 57 per cent of dairy farms and 65 per cent of dairy cattle. MG represents 26.9 per cent of the dairy industry, by market share, followed by Fonterra (14.7 per cent), Parmalat (6.1 per cent), Lion (5.8 per cent), Bega 4.8 per cent and Warrnambool Cheese and Butter (1.8 per cent).
Processors buy raw milk from dairy farmers and produce fresh milk, mostly for domestic consumption, and other dairy products like butter, cheese and powdered milk products, for domestic consumption and export.
Ahead of each financial year, processors forecast the prices they expect to pay for milk for the coming financial year. In practice, these are revised from time to time during the financial year. Reports indicate that there has been only one occasion on which the revised prices had effect retrospectively: in 2009.
The Australian milk price
Australian milk prices are affected by international prices because Australia imports and exports dairy products.
Domestically produced and consumed fresh milk, either branded or unbranded, accounts for only around 25 per cent of all milk produced by dairy farmers. Domestically produced and consumed dairy products, such as butter and cheese use around 30-35 per cent of Australian milk production. Exports—mainly of butter, cheese and powdered milk products, and some fresh milk—account for the remaining 35 to 40 per cent.
In 2014—15, Australia imported $870 million in dairy products, including cheese (such as blue veined and curd, totalling $464 million) and $5 million in fresh milk and cream, mainly from New Zealand.
If Australian milk is expensive, processors can import milk and dairy products, instead of using domestically produced milk. This means that up to 75 per cent of the dairy industry is exposed to world prices and that the bulk of Australian milk must be priced competitively with the world market.
International milk developments
In the last six to eighteen months several international developments have affected the supply and demand of dairy products internationally. In 2015, in the European Union (EU), milk quotas, established in the 1980s in response to structural surpluses of milk and cheese, ceased. The removal of these quotas allowed dairy producers in the EU to ramp up production and meet the then increasing international demand for dairy products.
In August 2014, Russia, the EU’s second largest market for food and drink, banned the importation of various fresh food products, including milk and dairy products from the US, the EU, Australia, Canada and Norway. This was in response to the economic sanctions imposed on Russia for its involvement in the Ukrainian crisis. EU dairy farmers thus had to find alternative markets for their dairy products.
The slowing Chinese market has also impacted the demand for dairy products. China has in recent years been a major market for dairy products.
The increasing international supply of milk has lowered the international price of milk.
The price of whole milk powder, for example, reached a five year high of USD 5,245 per tonne in April 2013, before it began its gradual fall in February 2014. By August 2015 it had reached a five year low of just USD 1,590 per tonne before recovering, albeit briefly, in October 2015. By mid-April 2016 it had improved to USD 2,176.
Source: Global Dairy Trade
The price paid for raw milk by processers in New Zealand has also been declining.
In May 2015, Fonterra, which operates in both Australia and New Zealand, where it is the largest processor, revised the price that it would pay its New Zealand suppliers for the 2014-15 year down to NZD 4.40 per kg of milk solids. It cut its forecast price to NZD 3.85 in August 2015 before lifting it to NZD 4.60 in September 2015.
Australian prices out of step with trends
In Australia, however, forecast prices remained high. In May 2015, Murray Goulburn issued a prospectus for a partial IPO in July 2015 in which it forecast that it would pay its suppliers, on average, $6 per kg of milk solids. Explaining the apparent discrepancy between MG’s forecasts and the prices Fonterra was forecasting in New Zealand, Mr Helou, then Chief executive of MG is said to have justified the higher prices by claiming that MG’s business model is different from Fonterra’s, as it was ‘more exposed to a value-added consumer dairy goods – not only domestically but also internationally, particularly in Asia’.
However, Fonterra in Australia, where it not the largest operator, could not cut its forecast price sooner, as it is obliged under a supply agreement to meet the MG benchmark price.
Adjustment of Australian prices
In Australia, both MG and Fonterra eventually revised their prices down consistent with international trends, including NZ price trends.
MG cut its milk price, retrospectively in April 2016 to between $4.75 and $5.00. Fonterra Australia followed suit in May, dropping its price to $5.00.
The lowering of the milk price by MG and Fonterra was largely a response to a deteriorating international market. The domestic situation, such as the $1 per litre price wars, is likely to have had only a small impact on the price cuts.