The Turning Tide of New Zealand Milk Flows
New Zealand has enjoyed a wave of milk production growth across the last two decades. The result of rapid industry expansion saw milk flows increase 4.1% (CAGR) over the past 20 years, with the national herd also increasing steadily, at 2.7% CAGR. This was a time when, until recently, attractive dairy returns—including a record milk cheque in the 2013/14 season—fuelled an increasing appetite for land acquisition and appreciating dairy land values in the quest for milk production gains.
More recently, however, the tide is turning on New Zealand milk production. For the season ended 31 May 2016, output was down by 1.5% and the current season (to 31 May 2017) is very likely to follow a downward trend. In response to a sustained low milk price producers, have needed to cut costs and postpone investment in order to bring down breakeven prices. This has seen a thorough culling of the free riders in the national herd leading into this season.
Now, mixed with very wet, disruptive spring conditions in the North Island, it is likely that national production may fall by as much by 6% this season. As it stands, production is currently tracking 3% behind last season for the five months to October 2016, and collections for October 2016 alone—traditionally the peak milk collection month—have plummeted 5% on last year.
So what is in store for New Zealand milk production beyond the current season? Compared to the surge of New Zealand milk over the past two decades, Rabobank expects the next five years to deliver much slower rates of growth out to 2022, as the tide recedes further on New Zealand milk production.
Although commodity prices have emerged from a severe trough, other constraints will continue to impact the flow of milk, resulting in lower growth across the next five years.
Two seasons of low milk prices have reduced the flood of milk to a trickle. With finances under pressure, the investment in new farm conversions and expansion of existing platforms has trickled virtually to a standstill, kicking off the new era. Dairying as a new land use now requires a higher level of consent and compliance: adding costs to the business system at a time when budgets remain under scrutiny.
Importantly, environmental regulations are tightening and limits imposed on land and nutrient use in key dairying areas will continue to bite moving across through to 2022.
Furthermore, milk production growth will be limited by the sheer availability of resources: land, water and labour. The easy production gains were made at a time when returns in the industry were strong. While Rabobank expectations are for the medium-term prices to be profitable for New Zealand farmers, utilisation of key dairy resources will come at a higher cost to the business going forward.
Finally, there may have been a shift in farmer sentiment for expansion. Battle weary producers, fresh from this downturn and facing growth challenges, appreciate that milk price volatility is here to stay and that production must be at low cost to combat this. Provided this stays front of mind, investment appetite going forward will be more cautious and many will seek to focus on productivity gains rather than production growth.
The bottom line
Milk supply growth has already begun to switch from being primarily found in the addition of more cows, to extracting greater production per cow. This will continue at a greater rate in the years to come, as farmers adapt to constraints.
We are witnessing the beginning of a new era: smaller jumps in milk production slowing the torrent of milk to a trickle. Future incremental milk production growth will come from increased productivity on farm, rather than from increased cow numbers in the national herd, as the industry continues to mature.
Our outlook implies challenges for the existing supply chain. There has been a surge of processing capacity investment in New Zealand over the last ten years to mirror the growth in milk supply, driving an increasingly competitive processing landscape. With a maturing milk pool and further processing capacity coming online, competition is set to become fiercer. The thirst for new inbound strategic investment partnerships with New Zealand will remain, but will come at a higher cost given the competitive local scene. This may mean potential investors will look to acquire milk elsewhere—a trend mirrored by Fonterra’s growth strategy to secure raw milk supplies beyond local shores.