White gold not so golden

10/09/2008

A fall in world prices for dairy products is making potential investors increasingly shy about putting their money into the sector.

With whole milk powder prices retreating significantly in the past couple of months, market participants are saying demand for rural land suitable for dairy is lessening and linking it to new production investment.

Global Dairy Network director John Shaskey said the latest price being paid for whole milk powder was about US$3000 a metric tonne, a significant retreat from recent peaks.

One set of University of Wisconsin data showed whole milk prices peaking at more than US$5800 about a year ago.

“In the last two months they’ve dropped by about US$1500 … Demand has really softened in key markets, in developing markets,” Mr Shaskey said.

There were also now expectations of “a pretty normal supply year” from Oceania markets, including Australia and New Zealand, where Fonterra was expecting about 10 per cent more production compared with last year’s drought-ravaged supply.

Mr Shaskey, whose company trades and exports on behalf of New Zealand and overseas producers, said the Kiwi dollar would need to retreat even further from its existing levels of US66c-US68c to support Fonterra’s payout plans.

Another industry insider said the price falls had created uncertainty in terms of investment in land and the development of infrastructure for processing milk. “This will have an impact on the payout price by Fonterra- the banks are talking somewhere between $5.50 and $5.80 [a kilo of milk solids].”

In spite of the encouraging propsects of increased demand and diminishing supplies, I knew that the milk payout wasn’t going to keep going up. I didn’t however, expect it to come back down so soon and so far.

The concern is that while the payout has gone up so too have costs and they won’t come down as far or as fast as returns do. That will mean taking a more conservative view on budgets for established farmers and even more serious re-budgeting for new entrants who have paid an inflated price for land based on higher returns than will now be achievable.

In May, Fonterra increased the farmer payout to a record $7.90 for the 2007-08 season, and announced an initial forecast for 2008-09 of $7 a kilo. “This is certainly affecting the economics of people who are looking to enter the dairy industry, and those who have bought land at high prices with an expectation that the high payout prices will continue,” the industry insider said.

Financial players who knew the dairy sector well and knew that demand would continue were now in a wait-and-watch mode, the insider said.

Mr Shaskey said that in the longer term there could be a significant realignment of high land prices, given retreating commodity prices and the probability of more overseas supply coming into the market.

But the creation of new processing facilities and land conversion would probably continue, given prices were above historic levels.

“People need to be cautious around their numbers, and not budget on $7 [a kilo] plus payouts … because they’re not the norm.”

Another view in the market was that a US dairy herd expansion had driven up supply but that now some of those farmers were leaving the business – a positive for New Zealand producers.

Conversion to bio-fuels has led to an increase in the costs for US dairy farms which use grain to feed their cows. It’s possible some of those farmers will find more lucrative uses for their land than dairying which will provide a gap in the market for us.

But the short term outlook isn’t nearly as good as it was and if the Emissions Trading Scheme passes its third reading then more of the shine will go off our white gold.


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