Federated Farmers: Downturn not severe

At the end of 2014, conditions were already noticeably dry.

The potential extent of this year's drought has been exercising the minds of economists as well as farmers lately.

While the agricultural sector doesn't feature among the largest contributors to New Zealand's GDP, it is certainly one of the biggest sources of volatility. Severe droughts in the past have more often than not been enough to drive the economy as a whole into recession.

We suspect that fate will be avoided this time, though. The drought is likely to knock around 0.5 per cent off GDP for this year, but with strong domestic demand and the Christchurch rebuild in full swing, that won't be enough to drive an outright contraction in the economy.

At the end of 2014, conditions were already noticeably dry, and there was uncertainty as to whether we were about to experience a full-blown El Nino weather pattern for the first time in 17 years.

With the benefit of hindsight, it's clear the dry weather has been a challenge for the agricultural sector, but the impact is not as severe as it could have been.

These past few months have provided another demonstration, if it were needed, that New Zealand is a major player in the global market for dairy products.

In late January, Fonterra announced it expected its full-season milk collection to be down 3.3 per cent on the previous season. Given the strong first half to the season at that point, the forecast implied a steep downturn over the second half.

Fonterra noted the interaction between dry weather and low milk prices could have a particularly potent impact: with prices low, farmers would be less inclined to buy additional feed in order to maintain milk production, instead relying on their own stores of feed and on rainfall to spur grass growth.

The international market responded to this warning accordingly: prices at the next three GlobalDairyTrade auctions rose a combined 22 per cent, admittedly from very low levels.

New Zealand provides about a third of all internationally-traded dairy products, so the prospect of any disruption of supply from here can have a major impact on prices.

However, subsequent milk production data, and the recent rainfall, suggest Fonterra's forecast is now unlikely to be hit. We now estimate Fonterra's milk collection will be down 0.5 per cent for the full season, which means industry-wide collection should be flat to slightly higher.

Buyers have clearly changed their view on the impact of the drought as well, with dairy prices falling back nearly 9 per cent at the latest auction.

We've recently revised down our farmgate milk price forecasts to $4.90/kg for the current season (still higher than Fonterra's indication of $4.70/kg) and an about-average $6.10/kg for next season.

For the dairy sector as a whole, droughts tend to have offsetting effects on revenue, with higher prices offsetting lower volumes.

No such luck for the meat industry, however.

Livestock have been sent to slaughter earlier than usual, which has stretched the capacity of meat processors and forced schedule prices down.

Official statistics up to January show slaughter numbers for lambs and cattle have been elevated, though perhaps not as much as in previous droughts. Thankfully, animal distress doesn't seem to have been a major feature of this drought.

Cattle slaughter numbers were actually running high even before the dry weather set in, as a shortfall in the United State's beef supply was filled by exports from New Zealand and Australia.

Accessing the United States market has been somewhat problematic, due to a long-running ports dispute that has only recently been resolved.

However, with United States beef producers still focused on rebuilding their herds, beef prices have risen sharply over the past year and should remain at relatively high levels for some time.