Global dairy prices sink another 9.3% ahead of Fonterra's board meeting on Friday to decide the forecast milk price for farmers this season; ANZ now picks price of around $3.50

By David Hargreaves

The freefall of global dairy prices is showing no signs of stopping.

Prices sank another 9.3% on the GlobalDairyTrade auction overnight, reaching the lowest ever on the GDT and settling at levels last seen in the 2002-03 period.

It was the 10th consecutive fall in prices at the auction.

The key whole milk powder price slumped a further 10.3% and is now down a staggering 31.7% across the last three auctions.

At the moment Fonterra is forecasting a milk price for its farmers this season of $5.25 per kilogram of milk solids.

However, the Fonterra board is due to meet on Friday and reconsider that forecast. It was widely expected in the marketplace that the new forecast price would be set at around $4.00 to $4.25, but the further dire auction result overnight must now suggest the forecast may well be under $4.

Economists at the country’s largest dairy farm lender ANZ are now picking a price for the season in the “mid-$3” range. Westpac economists have trimmed their forecast too.

“As bad as this result was, it was just as bad as we were bracing for,” Westpac senior economist Michael Gordon said. “Hence, we can confirm a further downgrade to our forecast of the farmgate milk price this season to $3.70 per kilo of milksolids.” On a slightly brighter note though, Westpac’s released its first prediction of a likely milk price for NEXT season and come up with a figure of $5.20, which would be an improvement, though down on the $5.80 average in the past 10 years.

But back in the present, Fonterra’s forecast payout for the season recently ended was $4.40, which compared with a hefty $8.40 figure just a year ago.

Two seasons of low – and for many farmers, below breakeven – returns are expected to put many under pressure. Farm prices are likely seen as falling.

ANZ senior economist Mark Smith said the latest auction result was “about as bad as it could have been”.

“Since the March 4 auction the cumulative fall in average dairy prices has been a whopping 46%, taking the level of dairy prices below GFC troughs and to around 12 year lows. A look at the components showed broad-based falls, led by anhydrous milk fat (-11.7% to USD 2,253), skim milk powder (-14.4% to USD 1,419 per MT), and with whole milk powder prices (WMP) down 10.3% to USD 1,590 per MT – less than half of March 4 contract prices,” Smith said.

The volumes sold at the auction  were significantly up, with 46,527 metric tonnes sold, the highest since last October, he said.

“Given that the next seven auctions account for a significant chunk of annual (GDT) WMP sales, it doesn’t take a rocket scientist to work out that auction prices of the next two months will weigh heavily on the final milk price outcome for the 2015/16 season.

“The current $5.25/kg MS forecast may have looked reasonable a few months ago, but developments move quickly in commodity markets and we now expect a milk price in the mid 3’s/kg MS. Fonterra is due to provide an update of their milk price forecast this Friday, and signs are not looking good with the likelihood of a second successive season of low dairy incomes looking to be an inevitability.

“Coming on the back of the 3.7% fall in non-dairy commodity prices – revealed in yesterday’s ANZ commodity price index – this suggests a large pending terms of trade hit. Monetary conditions need to be more accommodative and the [Reserve Bank] are likely to follow through with a further rate cut in September. The [New Zealand dollar] is following commodity prices downwards, but the sharp fall in dairy prices suggests more adjustment is needed.”

The Kiwi dollar didn’t have much immediate reaction to the latest auction results but has subsequently started to slide again and is now down about 1 cent in the past 24 hours against the American currency. A short time ago it was worth about US65.4c.

One thing to watch for after the Fonterra board meeting on Friday will be whether the co-operative says anything more about product supply strategies in the face of what is clearly an over-supplied market.  Fonterra signalled to the market last week that it would be putting about 9% less WMP on the GDT auction in the next 12 months.

Fonterra said the key factors that influenced its GDT forecasts were: seasonal changes or weather events impacting its milk supply; production, storage or supply chain constraints; anticipated customer demand from GDT and non-GDT sales channels; and differences in relative returns of products.

“In response to current conditions in the global dairy markets, Fonterra has modified its product mix that will see a volume shift away from whole milk powder and into our other products in the portfolio. In addition, our key customers have responded to global conditions by re-shaping their purchasing profile, altering our forecast off-take profile. On the supply side we have anticipated that our farmers may reduce volumes in response to the current low price signals,” Fonterra said. 

Farmers facing up to the second consecutive season of poor returns will be looking to what Fonterra announces, presumably late on Friday, after its board meeting. Already the dairy co-operative has said it will axe 523 jobs, intended to save it about $55-$60 million a year. But farmers will want to know what Fonterra can do for them right now.

Westpac’s views on next year

In Westpac’s latest Fortnightly Agri Update the Westpac economists lay out their thinking for where dairy prices will go further into the future.

“We’re assuming a price of $5.20/kg, which would be an improvement on current conditions, but still below the average of $5.80/kg over the past ten years. Of course, there’s still a huge degree of uncertainty around how dairy prices perform over the current season, and that goes doubly so for next season,” senior economist Michael Gordon said.

“So what’s the case for expecting an improvement in prices next season? Once again, we return to our checklist of the four factors needed to rebalance the international dairy market: a moderation in milk production, a stabilisation in Chinese demand, a reduction in China’s stockpiles, and an end to Russia’s trade ban.

“All four of these factors are still weighing on prices at the moment, and it’s overly simplistic to pick on just one factor. Nevertheless, in terms of what has changed recently, we would highlight the first of these factors: specifically, European dairy farmers have cranked up their milk production significantly following the removal of the quota system in April. While the intention to do so has been known for some time, the surge in production has come at just the wrong time. It’s well recognised that current milk prices are below production costs for much of Europe, and the latest GDT prices imply that an increasing share of Europe’s milk production will be sold into ‘intervention’, effectively taking it off the international market and perhaps helping to establish a floor for prices elsewhere.

“Notably, overseas industry bodies such as the USDA are forecasting global milk production to grow by only about 1% this year. That implies a strong belief that dairy farmers around the world will respond to price signals and slow down over the second half of this year. If that view is correct, it would go quite some way towards realigning supply with demand. That realignment was in fact already under way, until the recent surge in European production.”