There is nothing new about the current high dairy export prices in that the current levels are similar to earlier peak levels in 2007/08 and 2010/11.
The left chart below shows the ANZ dairy commodity price indices measured in NZD terms and world price terms.
The much higher world prices than NZD prices in recent years reflect the negative impact of the high NZD.
In world price terms current prices are well above the levels that existed prior to 2007, with this related to a large extent to increased Chinese demand that was revealed in a Raving that looked at the massive impact China is having on a wide range of NZ commodity exports and tourism. Based on the 7 January Fonterra auction results, dairy product prices in USD terms remained high (right chart).
The surge in dairy product prices last summer shown in the charts above coincided with a serious drought that had a major negative impact on milk production, as shown in the left chart below.
In the first half of last year milk production fell 20% on a seasonally adjusted basis.
Lots of rain and great grass growing conditions resulted in milk production rebounding to peak levels over the second half of last year, again on a seasonally adjusted basis.
For an explanation of why some data are adjusted for seasonal patterns and how to interpret seasonally adjusted data see here.
Part of what drove up dairy product prices in the first half of 2013 was the drought and fall in supply, so it was always going to be interesting to see what happened to prices when production rebounded.
The answer is now available, with prices remaining near peak levels despite the rebound in production.
This means growth in Chinese demand much more than the drought drove the increase in prices.
This isn’t to say prices will remain high indefinitely or head higher; the increase in prices could turn out to be at least partly self-defeating for the reasons discussed below.
What is particularly noteworthy is that the high prices have coincided with high production levels, which isn’t normally the case. The right chart below shows a proxy measure for dairy industry income that is calculated by combining the milk production data from the left chart below with the ANZ NZD dairy commodity price index shown in the left chart above.
In terms of dairy industry incomes the latest boom is something special and this will have a number of consequences.
Local dairy farmers and farmers all around the world will respond to the high prices by increasing milk production via increasing herd numbers, aided in at least NZ’s case by using more supplementary feeds like corn and maize, and by converting non-dairy farmland to dairying.
Converting non-dairy farmland to dairy farms and the associated building of milking sheds plays a significant part in driving the major cycles in farm building consents.
A rush of conversions to dairy farms in response to the surge in dairy product prices in 2007 was largely behind the high levels of farm building consents in 2008 shown in the left chart below.
The spike in farm building consents in October 2013 suggests that the latest surge in dairy export prices and incomes may have started to unleash another wave of dairy conversions.
It is normal for farm building consents to respond to changes in export prices with a lag, as shown in the right chart below. The black line shows the rolling annual average % change in the value of farm building consents. The red line shows the rolling annual average % change in the ANZ NZD dairy commodity price index with it advanced or shifted to the right by six months.
It isn’t a perfect relationship, but in general around six months after an upturn/downturn in dairy commodity prices there has been an upturn/downturn in farm building consents.
Dairy commodity prices are better at explaining or predicting the behaviour of farm building consents than are overall export commodity prices, which reinforces the importance of dairy conversions in driving the major cycles in farm building consents.
Based on the surge in dairy product prices last year a solid upturn in farm building consents should be underway.
But with incomes also boosted by high production levels it is possible a mega-boom in dairy conversions will occur this year.
n NZ’s case at least production per cow can be boosted by supplementing grass with corn kernels and maize. Driving around the Waipu District where we live it is noticeable how much more maize has been planted this year, with a local farmer saying the area planted is 30% higher than last year. I assume the same is happening in other districts, with it probably mainly driven by the high milk prices and partly a response to the drought last summer.
But price is a key consideration (i.e. if the milk price isn’t high enough it isn’t economic to use supplementary feeds).
The milk production numbers shown in the second chart above and more intensive feeding, although weather will continue to have short-term but significant impacts. More intensive feeding should allow farmers to run more cows per hectare, so upside in total milk production will be only partly reliant on dairy conversions. I only have access to milk production data back to 2009, as shown in the chart above that is reproduced below including a linear trend line calculated in excel (left chart below).
Setting aside the impact of droughts, a trend increase in dairy production appears to be underway.
This has been partly achieved on the land currently used for dairy farming via increased production per hectare and per cow. As discussed above, high milk prices mean supplementary feeds can be used to increase production per cow and the number of cows per hectare.
Innovation adds to this by improving herd genetics, grass genetics etc.
But a key driver of the trend increase in milk production is the outperformance of dairy product prices relative to prices for products that compete with dairying for land use.
The right chart below uses the ANZ NZD commodity price indices for dairy products, cattle and sheep products, forest products and horticultural products. The chart clearly shows dairy product prices outperforming other land-based product prices over the last decade with this being a key driver of land use (i.e. land use tends towards the usage that pays the highest returns, subject to some constraints discussed below).
The conversion from sheep farming to dairying in Southland is a good example of this, as is the conversion from forestry to dairying in parts of the central North Island. People familiar with the drive between Taupo and Rotorua will have seen forestry being replaced by dairying.
Helping the switch to dairy is the fiasco of the carbon trading scheme.
The following is an excerpt from an article in the NZ Herald last year: «A survey of large forest owners (with over 10,000ha) by Professor Bruce Manley of Canterbury University has found they intend to deforest 39,000ha between now and 2020, mainly in the central North Island and mainly to switch to dairy farming.»
Stock numbers tell a clear story with the left chart below showing that dairy cattle numbers have increased more than twofold since 1980 while sheep numbers have halved and beef cattle numbers have drifted lower (left hand scale for dairy and beef cattle numbers and right hand scale for sheep numbers, all in millions).
As an aside, deer numbers have fallen in the last decade but remain dramatically above 1980 levels, goat numbers have drifted down following the mega-boom/mega-bust cycle in the 1980s and pig numbers have drifted down since the 1970s (see the right chart below).
The super high dairy farm incomes should also give more impetus to irrigation schemes that can dramatically boost production and make dairy farming viable in areas it wasn’t previously so.
Two large irrigation schemes are in the pipeline, although there may be other smaller ones. The largest is the Canterbury Central Plains Water’s irrigation scheme where 60,000 hectares are planned for irrigation in three stages at a cost of $375m. 100 farms were reported to be in stage one where construction is expected to be completed by September 2015.
The second is the proposed Ruataniwha water storage dam in Hawke’s Bay. The dam is expected to store enough water to irrigate 25,000 hectares and could also produce 6.5 megawatts of power, although it hasn’t been confirmed when or if it will go ahead yet (see the second link below for more info).
The combination of growing Chinese demand for dairy products and NZ’s ability to convert more land to dairying, suggest dairying will continue to grow in importance at the expense of other agricultural or horticultural land-users.
However, there are some constraints to what areas can be converted to dairying (e.g. rainfall, soil types, topography, and effluent and water quality issues).
Another possible constraint is the RBNZ’s desire to breath down banks’ necks scrutinising the level of farm debt.
A bi-product of more land being converted to dairying and Chinese demand for especially infant formula is the building of new dairy factories versus the continued struggle for the meat processing industry because of falling sheep and beef stock numbers.
Examples are the $214m factory in South Canterbury that will create 70 permanent jobs and the $220m infant formula plant at Pokeno south of Auckland that could create 100 jobs.
Dairying is also more labour intensive than sheep and beef farming, so more dairying means more housing for workers will be required in the relevant parts of the country.
So while it is partly a case of dairying usurping other agricultural and horticultural land users, there is a clear net gain in terms of national income, employment and economic activity.
The export volume numbers shown in the charts below tell a similar story to the stock numbers shown above, but with some interesting twists.
The export volume numbers are sourced from Statistics New Zealand and are measures in rolling annual thousands of tonnes of product exported. While sheep numbers have fallen hugely since the 1980s, the volume of mutton and lamb exports has cycled sideways rather than fallen (black line, left chart below).
I assume this reflects increased carcass weights and increased lambing percentages.
By contrast, wool exports have fallen significantly (blue line, right chart below).
Similarly, while beef cattle numbers have fallen significantly in the last 20 years the volume of beef and veal exports has cycled sideways rather than fallen (blue line, left chart). As an aside, fish and crustacean export volumes have cycled sideways (black line, right chart).
In terms of dairy exports, butter and more recently and more significantly milk powder have been the best performers (bottom two charts).
Whenever there is a boom there are always undesirable consequences or side-effects.
From a greenies perspective more dairy cows means more effluent and polluted waterways (dairy farming involving more cows per hectare than beef farming), with water quality a major national issue.
For the dairy industry a key consequence is that the boom will be partly self-defeating. The high prices will result in increased global production, while consumers around the world will respond to the high dairy product prices by cutting consumption.
The demand and supply responses to the latest surge in dairy product prices could mean the increase in prices is partly self-defeating (i.e. may result in lower demand and possibly lower prices at some stage).
But setting aside the tendency for the demand and supply behaviour to create significant short-term cycles in international dairy product prices, there is a major trend increase in Chinese consumption of dairy products that for some time should mean good demand if not also high prices.
The announcement that the one-child policy in China will be dropped has been heralded as a major positive for the NZ dairy industry although even without this boost to demand Chinese consumption of infant milk formula is expected to double by 2017 (see the first link below).
On the other hand, China is moving to increase productivity in the agricultural sector, which should mean increased dairy production.
But water is a major competitive advantage NZ has over China when it comes to dairy production, with this playing a part in driving Chinese investment in NZ dairy production facilities like the Pokeno plant, which some see as a challenge or negative implication (see the second link below).
However, if history has taught us anything it is that booms are never straight-line affairs.
There will be dark spots as well as bright spots along the way.
When we look back on it in 10-20 years it may well be viewed as a revolution more than an evolution, with NZ becoming a farm for China much as it was a farm for the UK in pre-European Union days.
But in addition to the dairy industry having entered a new era that will have a range of consequences, mostly good in terms of national wealth; developments in other industries and especially one could have a significant impact on it.
A left-field event or risk I regularly monitor and report on especially in our client Forex reports is the major oil and gas exploration programme underway in NZ this summer and that could continue for the next few years.
If major oil and gas finds are made they will turn the world upside down for many NZ exporters, including having a significant negative impact on dairy commodity prices in NZ dollar terms. Issues relevant to the NZ and US oil and gas industries have been covered in three previous Ravings (see here, here, and here).
And for non-dairy and non-petroleum exporters, if the white-gold and black-gold industries both fire up over the next several years the exchange rate will probably head to unfathomably painful heights that will offset part but not all of the benefits from the booms in these two industries.
Source: Interest