Market braces for low milk price forecast

Rabobank suggests farmers should budget on a $5.50/kg milk price. Photo / Mark Mitchell

Farm cashflow likely to be under severe pressure well into 2017, say economists.

Fonterra will late this month release its milk price forecast for 2015/16 and indications are that it will be towards the lower end of market expectations.

The Reserve Bank will be mindful of the increasing fragility in the dairy sector, which has influenced economists to start to factor in one or two interest rate cuts in the official cash rate this year.

In addition, the central bank is likely to single out the issue of low payouts and high dairy industry debt in tomorrow's financial stability report.

"On the dairy sector, the Reserve Bank will be particularly mindful of what the current weakness in incomes could mean for the broader economy and financial sector," said ANZ economists. "What we feel is not widely appreciated is that even with the modest recovery forecast in the 2015/16 payout, farm cashflow will likely be under severe pressure well into 2017."

The ANZ added that it was already detecting increased stress in the rural regions.

"Elevated rural land values look particularly vulnerable."

Fonterra is expected to release its forecast after its next board meeting on May 27 and uncertainty abounds around oversupply, Russia's dairy import ban, increased production from the European Union, and slack demand by China.

"Current spot prices on GobalDairyTrade are somewhere around the low $4/kg of milk solids at present, so it would seem a stretch that the opening price will be pitched around the mid-$5/kg MS - current market expectations," said ANZ rural economist Con Williams. "To us a more prudent forecast in the current environment would be $5-$5.25/kg."

Rabobank said farmers should prudently look to a 2015-16 milk price of about $5.50/kg for budgeting purposes, but also understand their financial position at $5/kg.

As farmers get ready to consign the current season to the scrapheap, attention is turning to Fonterra's system of deferred payments, which is used by the co-operative to smooth out farmers' incomes. The so-called out of season "retro" payments will be substantially lower this year compared with last year's.

The farmgate price for the current season, which ends on May 31, of $4.50/kg would hit farmer cashflow and profitability across this season and next, but Rabobank said a turnaround in global dairy markets was starting to emerge.

"What we are seeing reflected in the dairy prices now is the result of global dairy import demand softening in early 2014 due to high retail dairy prices impacting consumers, combined with lower income growth in many emerging markets and a sharp increase in global production during 2014 and 2015," said Hayley Moynihan, Rabobank's director of dairy research for NZ and Asia.

Import growth returned in late 2014 and early 2015 and many import buyers, such those in Southeast Asia and the Middle East, had been taking the opportunity to replenish their inventories at the lower prices, Moynihan said.

"The dairy market in China is also still rebalancing, with higher domestic production and as it works through inventories from 2014 and generally adjusts to lower rates of demand growth."

Expectations that dairy commodity prices would firm late this year and early next year were likely to support an increase in the milk price for the 2015/16 season, she said.

"That said, farmer cashflows are unlikely to benefit from this until 2016 and more fully in 2017."

Rabobank's NZ chief executive, Ben Russell, said the bank had always considered that the current trough in global dairy prices would be prolonged.

"As with so much in agriculture, it's necessary to take a longer-term view of these periods and we've been working through cashflows with our clients at a lower milk price over the past six months and we will continue to do so."

Rabobank said growth in import demand through to 2020 - combined with supply growth constraints and cost pressures in key dairy export supply regions - would result in whole milk power prices averaging more than US$3500 a tonne over the next three to five years.