Drop to $7 a kg of milksolids could punch $2.6b hole in dairy farm revenue: economist

Dairy farmers can expect to see a drop in the milk price to around $7 a kg of milk solids from the current season's record price of $8.65 a kg when Fonterra releases its 2014/15 forecasts next Wednesday, say economists.

Ongoing weakness in international dairy prices and a stubbornly high New Zealand dollar might also weigh on the payout for the current season - which ends on May 31 - by 20c to 30c a kg, they said. If a $7 milk price came to pass in the 2014/15 season, then it could punch a $2.6 billion hole in dairy farm revenue, assuming 3 per cent volume growth, Bank of New Zealand economist Doug Steel estimated.

A reduction of that order across the sector would equate to 1.2 per cent of New Zealand's nominal GDP over calendar 2013.

The dairy sector accounts for more than 30 per cent of merchandise exports and has been a key driver of New Zealand's improved economic performance over the past year or so.


At this week's GlobalDairyTrade auction, a 1.8 per cent decline to an average winning price of US$3783 a tonne took the cumulative US dollar fall to 25 per cent since early February, or 28 per cent in New Zealand dollar terms. The auction was the last before the farmer-owned co-operative announces its first pick for next season on Wednesday next week.

"We expect Fonterra to shave $0.20-0.35/kg off the current milk price forecast of $8.65/kg for 2013/14, with risks of a larger cut," ANZ said in a commentary.

The bank said next season's milk price was likely to be around the low-to-mid $7 mark, which would still be firm by historical standards.

BNZ's Steel said it was possible Fonterra could choose to trim its forecast for the current season to $8.50 and that $7 was a possibility for 2014/15. He said the auction results and a stubbornly high New Zealand dollar would weigh heavily on the forecast for next year.

"In the bigger picture, while it is a sharp drop from the current record, $7 or thereabouts would still be pretty favourable compared with previous averages," Steel said.

The key drivers of lower international prices have been a highly productive season locally - domestic production looks like being 11 per cent higher than in the previous drought-affected season, plus increased production in Europe and the US.

"It's a lot of milk for the international market to absorb," Steel said. "I think that we are just coming down from a good, old-fashioned commodities cycle."

The dairy sector is closely watched by the Reserve Bank because it carries about 65 per cent of all agricultural debt.

Dairy sector debt is also highly concentrated - about 50 per cent of all dairy debt is held by around 10 per cent of farmers.

Westpac economist Anne Boniface said 2013/14 had been an outstanding season for farmers, both in terms of price and production.

"However, we don't think such outstanding conditions can persist indefinitely," Boniface said.

Boniface expected the 2014/15 payout to be significantly lower.

"What's more, interest rates are rising. And with 70 per cent of dairy debt on floating mortgage rates one of the most significant costs for many dairy farmers is rising," she said.

But Boniface said that farmers, for the most part, appeared to be treading carefully and taking a relatively cautious approach by opting to use the additional cash flow to reduce debt.

ASB Bank rural economist Nathan Penny said that, viewed together, the 2014 and 2015 seasons meant the dairy sector was in good heart, particularly when coupled with the strong 2014 production performance.

"Also, while down on the stellar 2014 milk price, the 2015 season is still shaping up well."

On the currency markets, the weaker GDT auction put downward pressure on the kiwi, but the currency remained firm by historical standards, trading at US85.6c late yesterday.

White gold

• Fonterra will update forecasts on Wednesday next week.

• Current farmgate forecast for 2013/14 is $8.65 per kg of milk solids.

• Market expects 20-30c downward revision for 2013/14 and a drop as low as $7 per kg for 2014/15.

• Key drivers are increased production and a high NZ dollar.