Despite a recent rally in dairy commodity prices, up from January lows, Rabobank’s Q1 2015 report on the dairy industry finds that suppliers are not out of the woods yet. Rabobank Group provides wholesale and retail banking and other services.
“We have passed through the worst for dairy market fundamentals, but things aren’t likely to be as tight through mid-year as the market is currently factoring,” said Rabobank global dairy strategist Tim Hunt.
Released in mid-March, the quarterly analysis found that global prices remained “lifeless” through the first half of Q1, before a surprisingly “vigorous bounce” in mid-February. By mid-March, whole milk powder prices were up 42% over mid-December levels, with butter and skim milk powder up 20%. Cheese remained largely unmoved.
Rabobank noted that the strength of the recent rally is hard to justify based on current fundamentals. New Zealand experienced a dry period in February/March, while tighter margins and penalties for exceeding quotas have brought an end to a wave of milk supply growth in the EU. But the supply tap remains on in the U.S., there is little improvement in demand in key surplus regions, and China and Russia are leading the first demand-driven contraction in international trade since the 2009 financial crisis, according to Rabobank.
“In the nearer term, we consider some loss of pricing entirely possible,” Hunt said. “Unfortunately for suppliers, the market is likely to want to deliver the signal to restrain production growth as we progress through the middle of the year.”
As 2015 progresses, Rabobank analysts expect supply growth will continue to slow, lower prices will unlock better consumption growth and stronger buying elsewhere will help offset the weakness of China and Russia.
“We continue to look for a gradual tightening to occur in this market, leading to modest upward price pressure in the second half of 2015,” Hunt said. “By Q4 2015, we expect to be back in positive margin territory for most dairy farmers in key export regions of the world, but it will take time – producers are not out of the woods yet.”
“Low prices were required to help clear a market still dealing with exceptionally strong supply growth, a rising U.S. dollar, a weak economic environment, and reduced buying from China and Russia,” he said.
EU quotas are gone
In a separate report issued in March, Rabobank said that with the removal of EU milk quotas on April 1, production will become further concentrated in the key milk-producing regions of Northern and Western Europe.
Rabobank said it foresees farmers in these areas using the spare capacity developed through investment and technology gains over the last 30 years. However, with an expansion of over 12 million metric tons already achieved between the announcement of milk quota removal in 2006 and 2014, a large proportion of this additional capacity has already been used. Once this available capacity of the land is used, a step change in raw milk prices will be required to incentivize further expansion in production through investment in land and capacity.
In addition, actions will be required to ensure European milk remains competitive in global markets.
“Despite Europe continuing to have a conducive climate, continued effort will be required to ensure Europe is competitive at prices set by international markets,” said Rabobank Analyst Kevin Bellamy.
Extra processing capacity
In preparation for milk quotas being removed, milk processors have taken steps to invest in extra capacity, with most of the investment taking place in Northern and Western Europe. The opportunity created by the expansion of global demand for dairy products has been a key driver towards expansion and has led most dairies to respond to the opportunity by expanding capacity rather than seeking to limit future supplies. As a result, new drivers for demand are emerging. At the same time, while the removal of milk quotas is a significant step towards a deregulated market, many support/regulatory mechanisms of the Common Agricultural Policy will remain in place.
Regardless of occasional depressed market conditions caused by volatility, Rabobank believes that medium-term global demand in the global dairy market will increase at a compound annual growth rate of above 2% from 2014 to 2020. This increase will be driven by continuing population growth, urbanization, globalization and increasing disposable incomes. However, despite the increasing demand, the picture is not all positive, and price volatility is likely to be a key issue. As a result, extreme price variations will continue to impact dairy supply chains.
Furthermore, EU milk production will begin to face new challenges as the land capacity is reached and the high cost of milk production compared with other global supply regions will limit margins. Farmers in many EU regions will have to compete with lower-priced milk from other production regions where farm consolidation and efficiency has progressed more quickly.
Thus, while Europe will continue to have a conducive climate — together with the good infrastructure needed for dairy production — and will always supply the needs of the local markets, further efforts in investment in entrepreneurial farmers, intensification of farming systems, making available capital to fund continued production consolidation and efficiency and a supportive government and regulatory environment will be required to ensure Europe remains competitive at prices set by international markets.