Markets

While the industry makes headlines, the market turns

By Steve Spencer

By the time this column gets into the hands of readers, we’ll be getting close to the peak of the production season in southern Australia, in one of the most tumultuous periods in the recent history of the industry.

In the past 18 months, an unprecedented volume of milk has moved between major dairy companies in a short space of time, and most likely has some way to go yet, as the aftershocks of the major step-down in milk prices towards the end of the 2015–16 season continue to reverberate.

There is plenty yet to unfold. We’re just at the beginning of resolving the future of the once-dominant processor, as a number of players (realistically fewer in play than the financial media would have you believe) fathom the available “prize” and work out how to make the shell of MG work in their hands — milk, plants, capabilities and brands.

Still, there is a significant sell-job — beyond anything yet seen from the PR gurus at Freshwater Place to date — to clear the 90 per cent shareholder approval requirement.

The deep downward global market spiral that sparked the local horror story bottomed around the time of the MG and Fonterra step-downs.

Since then we’ve seen a gradual but strong improvement in dairy commodity prices as the market re-tightened — helped by a massive purchase of surplus milk powder by European governments.

While a lot of attention here has been given to the re-allocation of half of MG’s milk amongst its rivals, and whether the season delivers enough to help rebuild farmer confidence and balance sheets, in the background the global dairy market peaked and is weakening again.

Although many who were preoccupied with local industry machinations, the commodity value of milk (in our currency) spent a short period at giddy heights seen rarely in the past. You could be forgiven for not noticing the cycle has made a turn.

Why? Well, once again — inevitably — the issue comes from the supply side as higher prices have done their work.

Milk production is now growing in all major production regions, with both Europe and New Zealand heading for a stronger lift in output compared to a year ago, which will convert into larger supplies of exportable surpluses.

The demand side remains patchy with the Middle East, Russia and South America importing far less, while China’s recent surge seems fragile. Better prospects for oil prices may help demand a little.

At this stage it would seem that the risks of surpluses are mostly in cheese and — unsurprisingly — skim milk powder (SMP), which is, for a while yet, the offal of the dairy industry.

After locking up a major stockpile of SMP last year at a cost of more than €600 million, a tighter European market forced processors to keep their precious cheese markets in a neat balance.

This levered up farmgate prices which have been north of €0.33/litre since late last year. They’re still inching higher and there are few risks of tractors rolling into Brussels.

While the EU Commission is sitting on a mountain of SMP it seems no closer to a solution as to what it will ultimately do with the stocks, and certainly in no hurry to get rid of them.

While the policy has made SMP unattractive to produce, it has turned butter fat into gold. This has made a mess of a lot of the hard work done by the industry to build a broader market in dairy fats, as higher prices have burnt off some demand.

With government buying now closed until next March, SMP prices have slid further. This is because the floor in the market — the government buying price — has been pulled for 5 months. Sounds like the wool industry a while back, and we all remember how well that turned out

The high butter prices should melt with more milk in Europe and NZ arriving in the coming months — but if milk powder gets too ugly for manufacturers, there is also a good argument to say that butter may remain chronically short into the middle of 2018.

Do the EU politicians care about the collateral market damage from their support policy? Nope. The priority is peace in dairy agri-politics — assured for a while given improved milk prices and dairy farm margins.

Speaking of our friends across the ditch, while they are expected to rebound strongly with good milk prices, more bought-in feed and an intact dairy herd, the spring deluge may limit the growth in milk.

It’s dangerous to “call the season” on the first few months — although it may not stop some using that theme to talk up prices.

Unless the predicted warm weather starts to push grass out of the ground a bit faster, the downside risk in the market outlook will be gentler.

But we’re not seeing any clear reason for panic. Things remains fairly balanced in the big picture and a slide rather than tumble in prices lies ahead. Another cycle has come and gone.

• Steve Spencer is a Director of  www.freshagenda.com.au