Fran O'Sullivan and Alexander Speirs: Dairy farmers prepare for worst

The timing of Fonterra's announcement was telling - farmers would not have been expecting to hear an update until the end of this month, write O'Sullivan and Speirs. Photo / File

It was more bad news for dairy farmers over the past week, with Fonterra revising the official farm gate milk forecast for the 2014/15 season down from $4.70 to $4.50 per kilogram of milk solids (kg/MS).

It is the latest setback in what has been a tumultuous 18 months for dairy farmers -- which has seen the price of milk bottom out from a record high of $8.50 kg/MS down to the lowest figure seen in almost a decade.

Wholesale prices took a further tumble at Tuesday's overnight Global Dairy Trade auction, with the overall index dropping 3.5 per cent and whole milk powder falling 1.8 per cent to US$2386 ($3181) per metric tonne.

Overall prices have dropped by more than half since April 2013, as prices threaten to hit the record lows seen during the global financial crisis.

The good news, relatively speaking, is with about 95 per cent of the season's milk already sold at auction Fonterra's $4.50 kg/MS farm gate price is likely to stand -- give or take a few cents.

The timing of Fonterra's announcement was telling - farmers would not have been expecting to hear an update until the end of this month. ASB rural economist Nathan Penny says it is about preparing farmers for the worst, early. "The fact that Fonterra have had to announce early is indication of them wanting to signal to farmers early that things have taken a turn for the worse. I think they were also concerned that they would have to claw back advanced payments made to farmers, so to avoid that they've reduced the forecast early."

A $4.50 per kg/MS payout will equate to a loss for the year for most farmers, well short of the $5.40 per kg/MS average breakeven point estimated by DairyNZ. Practical cost-saving measures are being employed across the country to help meet the shortfall, with reductions to feed and fertiliser costs, and major capital expenditures deferred where possible.

Fortuitously, the poor 2014/15 season follows an especially strong season last year, with balance sheets and overdrafts looking relatively healthy at the start of the season. The bigger issue is if prices fail to pick up and a second consecutive poor season follows this one.

"There's already significant pressure on farmers," Penny says. "We're likely to see those who are highly leveraged or who have just started in the industry recently begin to feel the pinch first. If we see a similar payout next season to this season, financial stress will increase and we'll start to see the impact on land prices and farmers forced to exit."

Fonterra are expected to announce their 2015/16 season forecast following the May 27 board meeting, with Penny saying there is reason for optimism amongst farmers. "At this point we're expecting a rebound, albeit a modest a one.

"There's two keys to achieving that. Firstly, we need to see global milk production continue to slow. We've seen that happen slowly, but it's taken longer than we thought. Domestic production was expected to be even this season, but at this stage it's looking to be about 2 per cent higher.

"The other side of the equation is demand, which out of China in particular has continued to be sluggish for longer than anticipated. We've seen recently Chinese officials move to boost demand -- and the Chinese economy responds quite quickly to stimulus. We do expect that to feed through to dairy, but we haven't seen that rebound yet.

"We need both of those things to deliver for the milk price to rebound to around the $6 mark."

Getting movement on supply and demand will be crucial for the 2015/16 season ahead if dairy farmers' prospects are to improve beyond the breakeven point for next year and firmly back into the black.

Fran O'Sullivan is a business columnist for the NZ Herald, and Alexander Speirs is a business journalist for Herald Business Reports.