Dairy payout achievable, but more work needed

Fonterra's forecast $4.05/kg milksolids payout for this season may prove "challenging" as global demand and supply conditions become less favourable, bank economists say.

"To maintain the expected $4.07/kg milksolids final payout from the season just past into next, it appears further value-added gains will be required," Westpac economists said today in their Agribiz newsletter.

"Fonterra's 2006/07 payout forecast of $4.05/kg milksolids is a challenging, but achievable, one".

Fonterra's forecast $4.07 for the just completed 2005/06 season -- to be finalised at Fonterra's board meeting in July -- was for record production record of more than 14 billion litres of milk, equivalent to 1.21 billion kilograms of milksolids. This was up 4.3 per cent up on the previous season's production, and 0.6 per cent ahead of the previous 2003/2004 season record.

The Westpac economists have also forecast a payout of $4.05/kg for the 2007/08 season as further falls in the average currency conversion rate offset declines in world product prices.

They said NZ milk production had increased an average of 4.5 per cent for each year of the past decade but would slow as rising costs for fuel, electricity, labour and fertiliser squeezed profitability and cashflows, "putting a short- term dampener on the expansion and intensification process".

Noting that up to 95 per cent of NZ milk was exported, the economists said prices were heavily dependent on the global economy, and that was in turn dependent on the US economy. The US was doubly important because it was the NZ dairy industry's single biggest customer, taking 13 per cent of exports last year.

Dairy product prices over the past two years had been even higher than could be supported by buoyant world economic growth because of low world stocks and limited expansion in tradable milk.

Though only about 7 per cent of the world's milk was traded, New Zealand and Australia account for over 40 per cent of that and prices were helped by a poor 2004/05 season in New Zealand and slow recovery from drought across the Tasman. There was also little increase in European and North American production.

But now there was more milk coming out of the northern hemisphere, and international prices were falling: "We anticipate falls in the order of 10 per cent across the season just started with a further fall of similar magnitude in the following season.

The degree to which these projected falls actually lowered farmgate payouts would depend largely on what happened to the exchange rate for the NZ dollar.

"We forecast the NZ dollar to fall further over the coming year, heading to the low US50c (levels) ... by the middle of 2007, before settling a little higher by the end of 2007".

Lacklustre NZ economic growth and a gaping current account deficit would do nothing to support the dollar's value, and NZ interest rates would remain stable as overseas interest lifted.

The NZ dollar was expected to have an average value of US57c in this 2006/07 season and US56c next season. Fonterra's forex hedging -- for 15 months ahead with forward exchange contracts and options -- were likely to have an average conversion rate of around US62c for this season, down from the reported US66c for the season just finished. "This would not be sufficient to offset the expected declines in world prices".

- NZPA