Fran O'Sullivan: Time for serious rethink on dairy

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Perfect storm which hit global industry is not moving away
New Zealand is the runner-up to the European Union  in terms of the value of dairy exports to China. Photo / Getty Images
New Zealand is the runner-up to the European Union in terms of the value of dairy exports to China. Photo / Getty Images

Judging by results, you wouldn't hire John Key as a dairy futures trader.

Sure the Prime Minister made a tonne of cash back in the day when his forte was trading foreign exchange.

I doubt many, if any, dairy farmers invested on the back of Key's assurance in late 2014 that the dairy market would "bottom out pretty soon and start going back the other way ... I don't think it's based on hope it's fundamentally based on what is a massive consumer demand."

But the brutal reality is this has not occurred.

Prime Minister John Key. Photo / Mark Mitchell
Prime Minister John Key. Photo / Mark Mitchell

Key - along with many industry players who accepted the received wisdom - could usefully be coming up with a strategic response to the lengthening price slump.

Surely, it is time for the industry and the politicians to take off their rose-tinted glasses, do some hard-thinking about our major goods export industry and the international environment it operates in and take steps to become future fit.

DairyNZ says 49 per cent of Kiwi dairy farmers made a loss in 2015. This year it predicts 85 per cent will do so. The banks are scrutinising credit exposures. Some farmers will be sold up.

Key - like dairy industry leaders, bank commentators and politicians who made similar calls in 2014 - believed the perfect storm which had hit the international dairy industry would be temporary.

The "fantastic growing conditions" would diminish. China would stop building up its inventory and use up its stockpiles of dairy powder. European and US farmers would cut production to meet the market. The Russian trade ban would be temporary.

This has not occurred.

People I talked with in the dairy sector over the past week are still saying that "we've been here before" ... "dairy farmers are resilient" ... the "automatic market stabilisers will ultimately click in".

But there is no concrete evidence to suggest this is yet the case.

To its credit Fonterra has been through a strategic rethink and restructured itself.

But it has also had to again lower its payout forecasts to its farmer shareholders.

Here's a few factors to take on board: While New Zealand remains the top supplier by volume to China which is Fonterra's biggest market, the value of the EU dairy exports to China is higher.

A Beijing-based consultancy - which is widely scrutinised by other international dairy players as a source of intelligence about the Chinese market - notes that from January to November, China imported 1,197,604.26 tonnes of dry dairy products, 397,526.30 tonnes pure milk and 8,968.44 tonnes yoghurt.

The value of imports from the EU hit US$2.35 billion, but imports from NZ were only US$1.77 billion.

NZ was still the biggest source of import by volume and on a "raw milk equivalent" remained the largest supplier.

But Europe was making more money as a large proportion of its exports to China were infant formula - accounting for 76.76 per cent of the total infant formula imported from offshore.

The principal dairy exports from NZ were raw powder, accounting for 82.3 per cent of the total milk powder imported into China.

The upshot is Europe's concentration on higher value exports meant it made more money off lower volumes.

Both the import price for raw material powder and import quantity from NZ fell in 2015, hence NZ was the runner up in China's dairy import value.

Second, China has tightened its infant formula market. A recent post on the World Trade Organisation website recorded that enterprises (including those outside of China) would be restricted to selling just three brands (or series) of infant formula within China. This would impact on the OEM manufacturers which make products for other companies to market under their own brands. Fonterra has in the past had a tidy business in this field. We have a free trade agreement with China - it's time for NZ to hold its ground here.

A third factor to absorb.

A major bank is mounting an interesting counter-factual by challenging the accepted wisdom that Beijing's decision to dump the one child policy will spark more births. And with it boost the demand for infant formula.

It suggests the birth rate which is now running at 16 million a year could fall to 12 million by 2020.

Credit Suisse reckons that as countries get richer the middle class birth rates decline.

Chinese friends have suggested another factor may be at play. Many young Chinese adults were "little emperors".

They may not necessarily want to share their growing prosperity with more than one child.

Food for thought in a much needed rethink.

Debate on this article is now closed.

- NZ Herald

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Head of Business for NZME

Fran O'Sullivan has written a weekly column for the Business Herald since its inception in April 1997. In her early journalistic career she was a political journalist in Wellington and subsequently an investigative journalist who broke many major business stories including the first articles that led to the Winebox Inquiry in both NBR and the Sydney Morning Herald. She has specific expertise in relation to China where she has been a frequent visitor since the late 1990s. She is a former Editor of the National Business Review; has twice been awarded Qantas Journalist of the Year and is a multiple winner of the Westpac Financial Journalism Supreme Award.

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