The biggest immediate beneficiary of the China free trade deal is the dairy industry, which now has the potential to double over the next five years.
The milk price for farmers is set to rise substantially over this period, but the free trade agreement is just the starting point. To achieve any gains, the major players will have to make big capital decisions. The industry will almost certainly require superannuation capital and the self-managed superannuation funds are probably best placed to provide these funds.
Currently, the Australian dairy industry produces about nine billion litres of milk a year. New Zealand, which already has a free trade with China, produces about 20bn litres. If we make the industry changes, our milk production should be able to match that of New Zealand within five years. If these changes are not made, we will lose the China opportunity.
The first and obvious change is that we need to double the size of the herds. Even if we made a flying start today it would still take three years, because, unlike grains, it takes time to build up herds. Unfortunately our farmers are in deep debt and the majority doesn’t have the capital required to lift output.
It will require good banking. NAB is the largest banker and chief executive Andrew Thorburn will have to decide whether to go in deeper or to play a different role. Many farms need an injection of equity capital.
Many will just sell to Chinese investors, but in the last few years a number of big dairy groups like Murray Goulburn have introduced schemes whereby Australian superannuation funds buy farms and lease them to people who operate the farms. It requires very long-term capital. At the moment the schemes do not allow the $500,000 entry points that would enable larger self-managed funds to join. When that happens, substantial Australia superannuation money will be available.
The second change required is just as profound. Australia currently exports most of its dairy products to China (and Asia) on the basis that the Chinese should eat the same dairy products that we produce for the Australia domestic market -- exports are viewed as being an add on.
Unfortunately, that’s not what the Chinese and other Asian communities want to eat. China wants processed cheeses that do not smell, long life milk and differently flavoured milk.
We need to produce these products with the most modern, labour-efficient plants that are available. The old inefficient plants must close.
Our largest milk processor, Murray Goulburn, is planning to invest $500 million in plants that will produce for the export market. All the other major milk processing companies will need to make similar decisions if they are to take advantage of access to the Chinese market. If they are not prepared to modernise and expand, they should sell out.
Thirdly, because major investment in herd development is required from farmers, we do not want international groups like Saputo coming to Australia and immediately reducing the milk price they pay to farmers.
Saputo will argue that they will adjust the milk price in time, but their current actions leaves the impression that farmers are being asked to pay for the high entry price the Canadians paid when the company purchased Warrnambool Cheese and Butter.
Distribution will be very important. Australia has not developed extensive selling operations in China that link with the right distribution points. If we are not careful, the benefit of the tariff reductions will go to Chinese distribution people. Given the fact that it will take years to build up the herds, we have time to set up the best possible Chinese distribution systems.
The milk price is currently being depressed because Russia has banned cheese and other dairy product imports from Europe and Australia in reprisal for the sanctions the West has imposed over Ukraine. The prices of many milk products have fallen 40 per cent (Putin's dairy war is hurting our farmers, October 14).
The combination of low current returns and the need to modernise may cause a number of big dairy processors in Australia to exit.