Will milk be the next commodity to turn sour?

With a glut in global milk production, Australian farmers are unlikely to see any immediate benefits from the much-touted dairy deal with China.

One of the major focal points for the recently concluded China Australia Free Trade Agreement is the dairy industry. Trade Minister Andrew Robb fought hard for the ‘New Zealand plus’ treatment for Australian farmers and he got it.

Many commentators and analysts have been excited about the prospect for much freer access to one of the world’s largest consumer markets for dairy products. There are many stories of the insatiable demand for baby formula and the jaw-droppingly high prices that Chinese people are willing to pay for air-freighted fresh milk.

However, the reality of Chinese demand and global supply is much more sobering and it doesn’t justify the much-hyped optimism we have seen recently. In fact, there is a lot to worry about when it comes to the future of the dairy industry here in Australia and across the Tasman given the global supply glut and not so bullish demand in China.

In recent days, there has been wide-spread coverage of Chinese farmers dumping fresh milk into fields and turning cows into Big Macs and Quarter Pounders due to depressed milk prices. For example, the purchasing price for fresh milk in Shandong province has been reduced from 4.5 yuan per litre a year ago to about 1.5 yuan per litre at the moment.

The Ministry of Agriculture has urged local governments to support dairy farmers at a time of rapidly falling prices, asking food processors to do whatever they can to buy fresh milk from farmers.

The price of milk powder has also been slashed from about 50,000 yuan a tonne at the beginning of 2014 to less than 20,000 a tonne currently. Globally, milk prices fell 50 per cent in 2014. The dramatic fall in prices is largely due to a glut of global supply as a result of strong international production, high inventory levels in China and Russia’s ban on U.S and European dairy products.

The global over-supply problem could get worse in 2015 once the European Union removes production quotas on milk, allowing farmers to increase production without buying quota rights. South Asia and 25 countries in the EU account for 44 per cent of global milk production, according to the Food and Agriculture Organisation of the United Nations.

The global supply glut is already hurting New Zealand -- the Saudi Arabia of milk production. Export to China boomed following the signing of a free trade agreement in 2008 and export volumes have increased eight-fold. In 2014, New Zealand alone accounted for 85 per cent of total imported fresh milk in China.

For the last decade, the country dramatically scaled up its production and dairy cow numbers increased from 1.5 million to 6.5 million. However, the global oversupply is turning New Zealand’s China boom a bit sour. Fonterra, which buys 90 per cent of New Zealand’s milk production, slashed its forecast payout for the current season to $NZ4.7 per kilo of milk solids in December, from $NZ 8.65 in February 2014.

“There is still considerable volatility in global dairy markets, said John Wilson, Chairman of Fonterra, “falling oil prices, geopolitical uncertainty in Russia and Ukraine, and subdued demand from China as it continues to work through inventory are all contributing to ongoing volatility and weak demand.”

We can see an analogy between falling iron ore and milk prices. The initial China fuelled demand has triggered a global increase in production and the resulting expansion in production is putting pressure on prices. The price squeeze is putting more pressure on small producers who don’t enjoy the benefits of economies of scale.

While the free trade agreement has finally levelled the playing field for Australia, the timing is terrible. Australian dairy farmers have to confront a new reality of falling milk prices, a global supply glut, geopolitical uncertainty as well as subdued demand from China. These market conditions don’t bode well for the sector, which needs farmers to make investment in herds.

The much-promised benefits of the free trade agreement for the dairy sector may not materialise in the short to medium term. Australian dairy farmers don’t have much confidence to invest in herds at the moment in face of failing milk prices and subdued demand from China. 

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