A deep cut in Fonterra’s milk price forecast will wipe $5 billion off the country’s GDP and most dairy farmers will make significant losses this year, according to a leading agri-economist.
It will also impede the ability of New Zealand’s exports to pay for imports and put a dent in the Government’s tax take.
Veteran rural economist Phil Journeaux said that, even before Friday’s sharp reduction of $1/kg of milksolids in the mid-point of Fonterra’s forecast price range for the current season – from $8/kg to $7/kg – modelling had shown that the downturn in global milk prices and soaring cost increases meant the average Waikato-Bay of Plenty farmer stood to make a loss of $54,000.
For Fonterra farmers that loss was offset by the Fonterra share dividend and a scheduled capital return from the company. But Friday’s announcement had turned the loss into $80,000, Journeaux said.
To break even under today’s economic pressures, the average dairy farmer needs $8/kg, according to modelling.
“As of today (Friday) with a $7/kg payout, the model farm makes a $190,000 loss, which is not offset (by the dividend and capital return) making the loss $80,000 in round figures,” Journeaux said.
The cut in the mid-point forecast was expected to wipe $1b off dairy farmers’ earnings.
“So for the wider economy that’s at least $5b off our GDP,” Journeaux said.
Dairying and dairy exports are a cornerstone of the economy, with the annual milk payment to farmers having a multiplying effect in the rural and wider financial communities.
Fonterra’s reduced forecast follows a string of weaker results in the Global Dairy Trade auction and weaker than anticipated demand from China, which is New Zealand’s main dairy product market. A reduction was expected but not as severe as the midpoint $1/kg.
Fonterra is scheduled to return a total of $800m to its farmer-shareholders later this month. How much each farmer gets depends on how many shares they own.
Flow-on effects
The expected farm losses from the reduced payout will have a ripple effect.
“In terms of absorbing that loss they will certainly defer any debt repayment and cut back on things like fertiliser and there will be no capital purchases,” Journeaux said.
He noted that sharemilkers and non-Fonterra farmers, those who supply independent companies such as Open Country Dairy and Westland Milk Products, are “going to wear it all” because they won’t be getting a dividend or a capital repayment. Suppliers of milk to independent processors don’t have to buy shares, as Fonterra farmers do.
BNZ economist Doug Steel said the lower milk price would put further pressure on the country’s terms of trade.
Using a rule of thumb, one tonne of milk powder on average, over time, had been able to buy 46 barrels of oil, Steel said.
Under the new, lower, price one tonne of powder would buy 34 barrels of oil.
“From what our exports buy in terms of imports, we are talking about a quarter of decline relative to that average,” he said.
“We are talking more than a $1b loss of cash flow or revenue to Fonterra farmers.
“Assuming that is indicative of the wider dairy sector – which it is – it is likely to be more than that.
“It’s bad for the economy and it is a clear income hit.”
Steel noted that most of the export base – dairy, meat and logs – had seen weaker prices due to subdued post-Covid demand from China.
“At the same, time we are seeing increases in the likes of oil prices, so that is a net negative for New Zealand’s terms of trade.
“It is an outright loss of purchasing power for the country, so that can manifest in many ways, domestically.
“Whether that is lower business investment or lower consumption as the tightness comes through various channels.”
All of that would be a drag on GDP.
“When you get such a substantial hit to nominal income, it will slow the place down.”
On the plus side, Fonterra had increased the advance rate it paid to farmers upfront, which was helpful, Steel said.
Then there was the 50c a kg capital return, due in September. Along with what is expected to be a strong dividend, that would reduce the pain somewhat.
“But there is no doubt that the current market dynamics are weak, and that is coming through in the milk price, which is by far the main driver of farm revenue.”
Farmers under pressure
Journeaux likened the latest slump to the 2015 dairying downturn when the farmgate milk price slumped to $3.90.
He agreed some dairy farmers might not be able to stay in business with such losses, rising interest rates and a 24 per cent increase in farm costs in the past two years.
“A big factor in farmers getting through will be how the banks react.”
The dairy industry was worth about $22b to the national economy last year.
While farmers who supplied independent processors might retain the 5c-10c premium they’re offered over Fonterra’s benchmark farmgate milk price, “in the overall scheme of things it’s not going to make much difference”, Journeaux said.
Fonterra’s farmgate milk price becomes the industry norm due to its market dominance. The co-operative collects about 78 per cent of the country’s raw milk.
Less tax for the Government
The Government’s tax take will be hit by the forecast price drop.
“Most farmers paid bugger-all tax last year and they’re going to pay none this year. The tax take from farming will be well down,” Journeaux said.
Sheep and beef farmers were in a similar boat. “Not quite as dramatic, but most will run at a loss because of the drop in the lamb price.”
Some Fonterra farmers would be questioning how they were going fund their businesses after today’s announcement, said Fonterra Co-operative Council chair John Stevenson.
The head of the Fonterra farmer watchdog said a cut was not unexpected given the global market downturn, but the size of it was “significant and will cause a lot of pain”.
His phone had been ringing hot since the morning announcement, with some farmers wondering aloud how they were going to continue to operate.
The council could only hope banks would work with farmers, he said.
The council would be closely questioning Fonterra on the drivers of the reduction.
Federated Farmers president Wayne Langford said the big drop would put “a lot of pressure on dairy farmers’ break-even point”.
The Golden Bay dairy farmer and Fonterra milk supplier said the depth of the cut was a surprise, though it wasn’t exactly a shock that Fonterra had reduced its milk price range forecast.
About 70 per cent of a dairy farmer’s on-farm expenditure was coming up in the next six months so Fonterra’s pro-active timing of the announcement was appreciated, Langford said.
Farmers would now budget accordingly. The reduction would have a “significant” impact on farmers’ ability to meet rising interest rates and inflation. They would be “locking up their chequebooks”, he said.
Fonterra, the world’s sixth largest dairy company, collected milk from 8435 farmer-shareholders last year, and its tankers visited the farms of 222 non-shareholding suppliers.
Last year it accounted for about 3.1 per cent of GDP and 35 per cent of all merchandise exports. The co-operative contributed about $12b to the economy in 2022.
Challenging time ahead
With a forecast of $7 to $7.25/kg, ASB economists have long been at the bottom of the range.
“If we do wind up with a milk price around the level we’ve long been predicting – and remember, it is still quite early in the season – we won’t relish being correct,” ASB economist Nathaniel Keall said.
“A milk price around the $7/kg mark will be below break-even for many farmers at a time when the climate indicators imply there could be a challenging latter half to the season as El Nino sets in,” he said in a commentary.
While some key farm costs have started to come down, others – such as average interest expense – have probably yet to peak.
Other expenses – such as fuel and grain prices – have bounced back a bit after recent geopolitical developments.
“Given the size of the dairy sector as a proportion of the New Zealand economy – between a quarter and a third of total New Zealand exports on their own – the subdued outlook for the season is a substantial headwind not just for the sector, but the wider New Zealand economy in aggregate,” Keall said.
ANZ agriculture economist Susan Kilsby said the degree of decline was a surprise.
“I think it’s about Fonterra trying to be as honest as it can be about what this current situation is.
“It’s getting the message out this early in the season before all the farm expenditure gets locked in, so that farmers can manage their cash as best they can.”
Fonterra chief executive Miles Hurrell said the revised forecast range reflected ongoing reduced import demand for whole milk powder from China.
“When we announced our opening 2023-24 season forecast farmgate milk price in May, we noted it reflected an expectation that China’s import demand for whole milk powder would lift over the medium term.
“Since then, overall Global Dairy Trade (GDT) whole milk powder prices have fallen by 12 per cent, and China’s share of whole milk powder volumes on Global Dairy Trade events has tracked below average levels.”
This reflected a current surplus of fresh milk in China, resulting in elevated levels of local production of whole milk powder, and reducing near-term whole milk powder import requirements.
Today’s move follows a string of poor GDT auctions.
At the last sale this week prices fell sharply. The GDT price index for the twice-monthly auction dropped 4.3 per cent – its biggest fall since April.
Whole milk powder prices – which have a big bearing on Fonterra’s farmgate milk price – were down 8 per cent to an average US$2864 a tonne.
In May the co-op lifted its forecast normalised earnings to 65-80c a share from 55c-75c and said it was on track for a strong full-year dividend.
Andrea Fox joined the Herald as a senior business journalist in 2018 and specialises in writing about the dairy industry, agribusiness, exporting and the logistics sector and supply chains. Jamie Gray is an Auckland-based journalist, covering the financial markets and the primary sector. He joined the Herald in 2011.
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