As of now, Rabobank is forecasting that the drought will result in about a 3% decline in New Zealand’s milk production, Bailey told Dairy Foods.

“Five years ago, that would have caused the market to be very concerned,” he noted. “Today, this decline in supply is more than offset by the additional milk coming in from the EU. But we may see some regional premiums develop for New Zealand product.”

In reality, New Zealand’s supply needs to be down about 10% to begin to balance the global surplus of milk, Bailey said.

As for the abundant EU skim milk stocks, Rabobank forecasts continued discounting of aged stock as “very old inventory” is pushed out. Although the EU will likely “slowly reign in supply through 2018,” Bailey said, production is expected to be up about 1% for the full year.

“That’s going to weigh down the entire protein side,” Bailey said. “That’s ultimately going to weigh down milk prices in general for dairy farmers around the world. But we will still see some premiums for fresher product remaining.”

Because dairy commodities are generally interconnected, as skim milk prices face pressure, so will whey prices, he noted.

“The whey price is going to affect the cheese stream and so on. So even though it’s a two-tiered skim market — fresh and aged — it’s still going to have a broader effect on the dairy commodities,” Bailey said.

Reasons for optimism

The good news? Rabobank believes there will be an uptick in global demand driven by market expansion and the return of some buyers that pulled back a bit in the falling market. But milk production also needs to slow to give the market a chance to get back into equilibrium, he said.

“Our internal financial economists are very optimistic, probably the most optimistic I’ve heard them be in the nearly five years I’ve been here,” Bailey said. “Some of the leading indicators … are pointing to solid expansion in 2018, and that’s going to translate into dairy demand.”

In the meantime, dairy processors can take a number of steps to mitigate the current market challenges. If they haven’t put risk management strategies into place already, they may want to consider such strategies, he noted. And they should be as transparent as possible in their relationships with producers in terms of commodity price movements and what it means for milk prices.

“Your milk price is reflective of the current market dynamics,” Bailey noted. “The more transparent you can be on that, the more credibility you have with your business partners.”

Looking longer term — especially in light of the current uncertainty in relation to the North American Free Trade Agreement (NAFTA) — U.S. dairy processors also will want to look beyond Mexico and Canada for export opportunities.

“If we do pull out of NAFTA, it’s going to be very tough for U.S. prices,” Bailey said. “Southeast Asia is a sizeable market we should be looking at to gain more trade agreements. You don’t necessarily have to have an agreement in place to be competitive. It helps, but if clearing product is your concern, as it could be if we pull out of NAFTA, having a relationship in those markets is important.”