Sharp drop in forecast farmgate price slashes farmers’ income by $4.3b versus last season.
A sharp reduction in Fonterra's milk price will put the squeeze on the industry and rural communities will feel the brunt of the economic impact, says Federated Farmers dairy chairman Andrew Hoggard.
The dairy co-operative yesterday reduced its forecast farmgate milk price for the 2014/15 season from $7 to $6 a kg of milk solids, saying the drop reflected continuing volatility in international dairy prices, with the GlobalDairyTrade auction index declining 16 per cent since the beginning of the season on June 1.
The forecast price reduction represents a total drop in payments to farmers of nearly $1.6 billion from Fonterra's earlier forecast or a cut in farmers' collective income by roughly $4.3 billion compared with last season's record pay-out, according to Westpac.
A drop in the milk price from a record $8.40 last season to $6 this season will amount to a reduction of 1.9 per cent in gross domestic product, said Westpac chief economist Dominick Stephens.
Fonterra estimated a dividend range of 20c to 25c a share, amounting to a forecast total cash payout of $6.20 to $6.25 for the season.
Hoggard said the extent of the milk price decrease came as "a bit of a surprise" to farmers yesterday.
"The industry stats we've got show that around 20 per cent of farmers have cost of production over $5 per kilo of milk solids," he said. "If you add on the average debt servicing of a dollar per kilo of milk solids that puts, potentially, 20 per cent of farmers at risk of making a loss and everybody else makes reduced profits or they break even."
Hoggard, who farms 560 cows near Feilding, said the economic impact would be felt in rural towns.
"There will just be reduced spending in those towns on farm supplies and less improvements on farm. It won't just be the hit on farm, it will be the hit on rural communities as well."
See the result of recent dairy auctions here:
Rabobank senior analyst Hayley Moynihan said the economic impact of a milk price drop would be more significant next year.
"At the moment farmers are still receiving retrospective payments from the high milk price last year," Moynihan said. "This lower price will have a bigger impact next year when those retrospective payments will be significantly lower."
She said Rabobank expected the current "trough" in dairy prices - a result of increased global supply - to last until early 2015.
"Through the first half of 2014 there was around seven billion litres of additional milk on the market compared to the first half of 2013," Moynihan said. "That literally is a wave of milk." She said the European Union, New Zealand and the United States were the biggest contributors to the increased global supply.
BNZ economist Doug Steel said the decreased milk price was not unexpected, given the falling dairy prices combined with the continued strength in the New Zealand dollar.
Fonterra's announcement saw the kiwi fall to US85.14c at 6pm last night from US85.46c at 8am.
Hoggard said farmers would be financially cushioned, to some extent, by last year's record season.
"You will still have people getting caught out," he said.
"It's the nature of farming at the moment - it's very volatile."
Hoggard said there was a risk the forecast milk price could be reduced further.
"It just depends on where that international market is heading," he said. "My guess would be that the Fonterra board have erred on the side of caution."
Fonterra chief financial officer Lukas Paravicini said global dairy prices were expected to increase, but there was a chance they could decline further.
"This [the forecast] is our best estimate at this time," Paravicini said.
"We have given advice to our farmers to be cautious when they do their budget."
Fonterra chairman John Wilson said there had also been a build-up of inventory in China and falling demand in some emerging markets in response to high dairy prices.
Fonterra chief executive Theo Spierings said improved returns on its value-added and branded products were expected, given volume increases and lower input costs. Units in the Fonterra Shareholders' Fund closed up 1.2 per cent at $6.07 last night.