Drought premium gone as world dairy prices fall

Prices for wholemilk powder are down 13.3 per cent to US$2538 a tonne. Photo / File

Dairy prices fell sharply at the latest GlobalDairyTrade (GDT) auction, bringing to an end the so-called "drought premium" built in to prices over February.

The 10.8 per cent price reversal at the GDT auction put downward pressure on Fonterra's $4.70/kg farmgate milk price forecast and raised concerns about next season's likely payout.

Big falls were recorded for the key products of wholemilk powder, down 13.3 per cent to US$2538 a tonne, and skim milk powder, down 9.9 per cent to US$2467/tonne. Wholemilk prices are now just 11 per cent higher than than they were by the end of 2014.

Westpac economists said the fall meant that the drought premium that was embedded in prices in February had been fully unwound.

"This is consistent with our view that the impact of this summer's dry weather has been considerably less than initially feared," it said.

"We now expect milk production for the season ending May 2015 to be around flat, in contrast to Fonterra's estimate of a 2 per cent decline."

ANZ rural economist Con Williams said that with milk powder making up the bulk of New Zealand's product mix, the GDT result suggested a payout of $4.50-4.70/kg this year.

The largest price falls at the auction were generally seen in the longer-dated contracts, up to 6 months out, into the new season.

"While these prices remain higher than those for the end of this season, the curve has flattened, suggesting less price recovery is now anticipated - not boding well for next year's payout," Williams said.

The fall comes as the New Zealand season enters its final phase, with about 80 per cent of production now out of the way.

Most of the price weakness was put down to better-than-expected supply, with the effects of this year's drought being alleviated by rain in many parts of the country.

Fonterra had early in the year revised its production forecast down by 3.3 per cent compared with the previous year, due to the drought, but at last week's interim result the co-op revised that to a 2 per cent reduction.

Analysts said that too might prove to be overly pessimistic, with many expecting production to be flat or just slightly down on last year's.

ASB Bank said it expects production for all New Zealand processors to be steady for the season, and for Fonterra's to fall by about 1 per cent.

"From this perspective, we suspect that the early season pessimism contributed to the subsequent price volatility, particularly once markets realised that the production outlook was simply not that bad," ASB rural economist Nathan Penny said.

ASB has revised its milk price forecasts down by 10c to $4.60/kg for this season and by 30c to $6.20/kg for next season.

Fonterra smooths its payments to cushion the effects of volatility in world commodities markets, so farmers are still benefiting from last year's record payout.

However, economists said the sector can handle one bad season but not two in a row.

Meanwhile, uncertainty abounds on world markets as to how much more milk EU farmers will produce, now that the impediment of quota restrictions has been removed.