Australia dairy farmers are at the very end of a value chain that stretches around the world and back again.
While more and more of the industry’s milk is sold domestically, the international market continues to heavily influence farmgate prices — particularly in southern Australia.
This is because around 90 per cent products from this part of the industry — whether sold at home or abroad — are competing in a global market.
In our business we developed a continuous forward-looking product that tracks the fundamental value of the major dairy commodities, based on a rolling analysis of global supply and demand balance.
We sell this product globally — to major dairy companies, ingredient buyers and traders in Europe, the US, Asia and in Australia.
These heavy hitters have identified the need to have a comprehensive view on what could develop in the future, that they can track and respond to over time.
In a market as volatile as dairy, small changes can make a big impact to the bottom line.
It’s not just major corporates that understand this. Dairy farming is also a game of inches, even small changes in input costs, a turn in the weather, or an unexpected drop in farmgate price can have a huge impact on profitability — even viability.
Farmers receive an annual opening price, and perhaps some step ups through the current season, but little information in between on how next year might be shaping up.
With very little forward-looking market information out there that relates directly back to farm, we continue to share our analysis of the commodity value of milk (CMV) — based on our global work — in these pages.
When things shift materially, we also share an outlook on southern farmgate price — which is composed of the projected CMV and the likely value capture above commodity returns, see Chart 1 below:
It’s an indicative figure, but allows farmers to understand how expected market conditions might affect farmgate price once exchange rates and product mix implications are considered.
This doesn’t always make us popular — especially when the market for milk is weakening!
In October we released an updated farmgate price outlook, based on our latest quarterly analysis of global market conditions.
For the current season, the CMV has improved from our June outlook — as butter prices have remained higher for longer.
However, offsetting that has been the continued retail discounting of block cheese on the domestic market, which has eroded value capture.
The net effect is a forecast fall of $0.10/kg MS in the midpoint of our range for the 2017–18 season — which now sits between $5.70 and $5.90/kg MS.
This assumes an average exchange rate of US$0.78.
Chart 2, below, breaks down contributions to the change in underlying CMV between 2016–17 and the current season — which on average accounts for 80 to 90 per cent of farmgate price.
There is clearly a significant contribution from butter, more than offsetting low returns from SMP.
Improvements in cheese prices have been steady if not spectacular but the contribution to commodity value reflects the importance of cheese in the industry’s product and export mix.
The biggest change is in the outlook for the 2018–19 southern farmgate price — although there are still many things that can change between now and next season.
We have revised the midpoint of our range down $0.35/kg MS to which is now projected to be between $5.05 and $5.45 kgMS — a wider range to account for the greater uncertainty and potential for change between now and then.
This time it’s the underlying commodity milk value that is responsible for the change.
As global markets move into an oversupply situation in 2018 — largely due to the recovery in EU milk production — commodity prices are expected to fall.
Critical to this outlook is the strength of the northern hemisphere spring, but with favourable farm margins in place — this is likely to add significantly to export availability.
Large EU intervention stocks of SMP continue to weigh on powder values, and recent comments from EU Commissioner Phil Hogan aimed at discouraging further purchases in 2018 have added to uncertainty and significantly weakened market sentiment.
To quote American economist Edgar Fielder: “If you have to forecast, forecast often”.
That’s why our analysis is monitored and updated monthly, and our outlook is updated when things shift substantially.
The purpose of a forecast is not to pretend the future is certain and set. It’s to help plan for a future farmgate price scenario that might have serious implications for your business, something that you might want to discuss with those around your business on whom you rely — family members, financiers, consultants, suppliers, and workers.
These discussions are not so easily had when the bombshell has hit — plans can be reactionary and short-sighted as a result.
But testing the resilience of plans against forward looking-information on income and input costs could allow adjustments to be made that help mitigate risk and develop contingencies that will keep businesses in shape for the long haul.
We’ve taken some heat for flagging a likely decline in farmgate prices next year — that we’re talking the market down or even giving dairy companies the excuse for paying less!
Well these views are objective; they’re our own (without first checking with dairy companies); and are based on anything but guesswork.
If we have learned anything from the last couple of years in this industry, it’s that denying market realities only gets you so far, and without prior warning the wake-up call can be devastating.
• Jo Bills is a Director of www.freshagenda.com.au.