New era for global dairy market: industry report

13 November 2008

Two years after the commencement of an unprecedented boom in dairy export prices, the international dairy market finds itself amidst a global economic crisis that is unwinding much of the recent gains. But a recently-released industry report suggests that despite a bearish near-term outlook for international prices, the years ahead will see prices return to a higher trading range.

The Global Dairy Industry – Reshaping in a New Market Era, a report by leading agribusiness lender Rabobank, says inflated prices, volatile markets and shifting trade patterns will continue to characterise a new market era for dairy – in which all players must reconsider their strategic positions.

Short-term price downturn

After the phenomenal peaks of late 2007, international dairy prices have softened through 2008.

While supply has improved, demand weakness has been the key driver, as strong retail price inflation, substitution and an economic downturn have conspired to pull back the rate of dairy demand growth, explains report co-author Rabobank senior analyst Tim Hunt.

“A rising US dollar has also played an important role in pushing down US dollar denominated prices,” he says.

The report outlines Rabobank’s expectation that negative forces will continue to weigh heavily on the near-term prospects for dairy export pricing.

“The global dairy market has entered the closing months of 2008 in a bearish mood. Demand has been heavily impacted by the combination of high retail dairy prices, poor income growth and substitution at ingredient level. While supply growth is slowing in the US and EU, that is being offset for now by increased contributions from Southern Hemisphere suppliers. As a result, supply growth will struggle to slow quick enough to create any price tension in coming months given weak demand conditions,” Mr Hunt says.

“In Australia, declining US dollar prices are being offset to a significant extent by the collapse of the local currency. However, forward selling and the near-impossible task of hedging amidst extreme gyrations in currency markets will almost certainly mean that few exporters will fully benefit this season from the recent collapse of the currency.”

Expected turnaround

Global dairy demand is likely to remain below trend level through the first half of 2009 assuming continued weak economic conditions. However, Rabobank expects to see signs of a turnaround later in the year on the back of factors including an eventual improvement in the global economy, increased consumer demand due to more competitive pricing and the continuance of demographic and cultural trends favourable to dairy consumption.

The bank also expects a moderation of recent supply growth as farmers in many key export regions rein back investment in response to lower milk prices and a step change in the cost of production ushered in by higher input prices.

Medium term return to high prices

As we move into the medium term, we expect a return to strong growth in global dairy consumption, Mr Hunt says.

“Global demand for milk at any price point has shifted upwards. Essentially income growth and favourable demographic and cultural trends have increased the number of people that are aware of dairy, have access to dairy, want to consume it and can afford to do so,” he says.

The world’s dairy producers can match this demand growth, but only at the right price.

In coming years dairy producers across the world are likely to face significantly higher production costs than in most of recent history, the report warns.

“While the prices of feed grain, fertiliser and fuel are coming down at present, we expect them to again be expensive in future, significantly increasing the cost of production for all farmers,” Mr Hunt says.

In addition, he says, there are constraints on growth in low-cost dairy regions, such as Oceania, Argentina and Brazil, due to factors varying from limited land or natural resource (water) availability, poor supply chains or unfavourable government policy settings.

“This means that to meet demand in future, additional supply will be required from regions with higher costs of primary production, less efficient supply chains or greater structural impediments – such as the EU, Latin America or the US,” Mr Hunt says. Alternatively, the market will need to encourage pasture-based producers to increase supplementary feeding.

“Either way, the world will need to pay higher milk prices to ensure that supply growth is forthcoming, and that will push global commodity prices back into a higher trading range,” he says.

Volatility

Even with a recovery in prices, the industry must expect significant prices swings, the Rabobank report warns.

“Within this higher trading band, price volatility will be high,” the report says. “In the medium-term, we expect to see more frequent shocks to the demand and supply side of the market, given more volatile costs of grain and fertiliser, climate change and the more prominent role played by less stable import and export regions like China and Brazil.

“These shocks are expected to unleash the latent volatility inherent in dairy product markets due to the short-term unresponsiveness of demand and supply to price.”

New strategies for key players in Australia

The new dairy market era is expected to significantly reshape the sector in the years to come and heralds the need for all players involved in the industry to reconsider their strategies, the Rabobank report finds.

“As the global dairy industry contemplates life in this new market era, players all along the supply chain will need to re-evaluate their strategies,” it says.

“Those who adjust best will be well placed to reap the benefits that market change will bring.”

In Australia, farmers in export regions will need to be prepared to manage enhanced volatility of all sides of their business, says Mr Hunt. “While milk prices are expected to trade in a higher range in the medium term than we have seen in recent decades, farmers will have to manage higher cost base to ensure margins are not eaten away,” he says.

At corporate level, domestically-oriented dairy processors face a short term battle of restoring margins in difficult conditions (with the focus on areas such as input sourcing, product range and brand) and an ongoing challenge to balance commodity costs and retail pricing.

Export dairy processors will need to continue to strive to maximise value from what is expected to be a slow growth milk pool, and stay ahead of new exporters.

Dairy ingredient users also need to reconsider the manner in which they will be able to secure supply and manage the volatility in price, while balancing the costs of reformulation and recipe flexibility with savings from substitution.

And all players, the report says, will need to consider the implication of increased credit risk and capital shortages in the current financial environment.

Rabobank Australia is a part of the international Rabobank Group, the world’s leading specialist in food and agribusiness banking. Rabobank has more than 100 years’ experience providing customised banking and finance solutions to businesses involved in all aspects of food and agribusiness. Rabobank has a AAA credit rating and is ranked as one of the world’s safest bank by Global Finance magazine. Rabobank operates in 42 countries, servicing the needs of more than nine million clients worldwide through a network of more than 1500 offices and branches. Rabobank Australia is one of Australia’s leading rural lenders and a significant provider of business and corporate banking and financial services to the Australian food and agribusiness sector. The bank has 50 locations throughout Australia.

Contact

For further information please contact
Denise Shaw, Public Relations Manager
ph: (02) 8115-2744 or 0439 603 525
email: denise.shaw@rabobank.com
or
Elise MacDonald, Public Relations Consultant
ph: (02) 8115 4861
email: elise.macdonald@rabobank.com

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