Dairy markets

Dairy markets

After news of so much misery it is easy to forget that profitability is so dependent on the producer’s contract and in the long-term UK dairying has the potential to be highly profitable. Global downwards pressure has not dissipated and it is worth thinking about long term strategies.

 

Not out of the Lake

A number of factors have kept down milk prices but if supply had been short relative to consumption, there can be little doubt that most of the other influences on price would have been seen as irritations rather than real cause for alarm.

 
Graph 1: UK Daily Milk Production 2014/15 as % of 2013/14

There are not many mature industries that can withstand a 20% increase in production as seen last spring without a price penalty. However, it appears that supply is now back at 2013/14 levels in the UK. While EU production never reached the same level of oversupply as the UK, supply at the start of the quota year was also high at about 8% over the previous year but is now also close to last year’s production levels. However, the US, New Zealand and Australia as recently as this January were still producing more than they had 12 months earlier, although the percentage increase was relatively small.

The Fonterra milk auction price (used as an International benchmark) had been rising since the start of the year until falling back in the auction on 17 March 2015. The fall in price was despite a halving in the volume offered compared with March 2014. Furthermore, although the global benchmark auction prices have risen since the start of the year, they have averaged only a little over 60% of those 12 months earlier.

Demand is increasing and excess supply will be mopped up eventually but there is a warning. Since global production has been higher than now, if prices rose it is much easier to put existing plant back into production, than build additional capacity, so the production response to a rise in prices is likely to be rapid. Therefore slowing the rate of  price growth.

Price change and volatility

Dairying has actually been relatively stable compared with arable farming as illustrated below showing the annual percentage change in price compared with the previous year for milk and wheat. Milk price is less volatile than wheat.

Incidentally, measured as a percentage price change, cereal prices are no more volatile now than they were 100 years ago but inflation, and thus higher prices, have resulted in a higher absolute price change making the apparent swing greater.

 
Graph 2: % Annual Change from previous year: UK Milk and Wheat

Equally of interest is the relative price increase as shown below.

 
Graph 3: Price of UK Farm gate milk and wheat as % of the 1970-2015* average

Changing subsidy basis slightly slews the figures since an area payment for cereals was introduced in 1993 but not introduced for dairying until 2004 (and into the single payment scheme in 2005). At the same time as the area payment was introduced support for output prices fell. Perhaps of equal importance is that grain is a cost for dairy production, both directly as feed but also indirectly since in some areas it drives up the rental values for land. The most significant impact of the end of the Milk Marketing Board (MMB) monopoly was that the contract price differential between farmers increased.

The five-year profit averaging introduced in the March budget, while complicating the preparation of accounts, is a sound, straightforward measure to help manage price volatility. While not a panacea there are also good arguments to introduce an effective futures market with processors in mind, to allow some of the additional price risk to be managed. CME Group provide a futures market for cheese but more work is needed to establish the relationship with physical prices. It would also make it easier to operate a sensible dual pricing regime where milk supplied under contract could be priced well ahead allowing farmers to invest and plan, while over contract milk would reflect the spot global or national price.
increase as shown below.

 
 

Key contacts

Ashley Lilley

Ashley Lilley

Director
Food & Farming

Savills Cheltenham

+44 (0) 1242 548 012

+44 (0) 1242 548 012