Global dairy industry faces volatile market conditions

by Keith Nunes
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SYDNEY — The global dairy market has entered a new era with growing world consumption of dairy products combined with reduced growth in supply expected to underpin sustained higher, though volatile, prices into the future, according to "The Global Dairy Industry — Reshaping in a New Market Era," a report by Rabobank’s group in Australia and New Zealand. Despite current short-term challenges facing the market, including a recent moderation in dairy commodity prices, the report’s authors view the medium- to long-term outlook as positive.

"Rabobank remains convinced that the medium-term equilibrium price for dairy products has shifted upwards from its long-term average," the report said. "Economic growth and cultural changes have substantially increased the price the market will pay for milk."

The increased world demand for dairy products — along with constraints on long-term global supply growth — is expected to see prices recover and to continue trading in a higher price band in the future. For New Zealand, this is good news, said report co-author and Rabobank senior analyst Hayley Moynihan, with the country well placed as an exporter to help satisfy growing global demand, at least in the medium term.

Negative market forces have been at play in late 2008 weighing on the previously buoyant dairy industry, the report acknowledged.

"The global dairy market has entered the closing months of 2008 in a bearish mood," Ms. Moynihan said. "Fundamentals on all sides have appeared to be weakening, with retail dairy inflation still building, U.S. milk supply growth only slowing modestly, financial market turmoil and a damaging milk contamination scandal in the Chinese market."

After a boom in global dairy prices in the past two years, which peaked in late 2007, international dairy prices have fallen during most of 2008.

Global dairy demand is likely to remain below average through the first half of 2009 assuming continued weak economic conditions. However, Rabobank expects to see a turnaround later in 2009 on the back of factors including an eventual improvement in the global economy, increased consumer demand due to more competitive pricing and the continuance of demographic and cultural trends favorable to dairy consumption.

Rabobank also expects a moderation of recent supply growth as farmers in many key export regions rein back investment in response to lower milk prices and a step change in the cost of production ushered in by higher input prices.

Production costs to increase

Dairy producers around the world face significantly higher production costs than in recent history.

"The cost of producing milk has significantly increased for all farmers due to the structural increase in the prices of feed grain, fertilizer and fuel," Ms Moynihan said.

In addition, she added, there are constraints on growth in traditional low-cost dairy regions, such as Oceania, due to limited land or natural resource (water) availability.

"This means that for additional export supply, the market will eventually need to turn to regions with higher costs of primary production, less efficient supply chains or greater structural impediments — such as Latin America and the U.S.," she said. "Extreme volatility in the dairy market is likely to remain."

Even with a recovery in prices, the industry must expect significant price swings, the report warned.

"Within this higher trading band, price volatility will be high," the report said. "Global dairy stock levels are low and, in the medium term, we expect to see more frequent shocks to the demand and supply side of the market.

"These are expected to unleash the latent volatility inherent in dairy product markets due to the short-term unresponsiveness of demand and supply to price."

New strategies for key players

The new dairy market era is expected to reshape the sector in the years to come and the report identified the need for all companies in the industry to reconsider their strategies. Even with higher dairy commodity prices, farmers in most regions will not necessarily see margin improvements due to the increased cost of production, while those in export regions must be prepared to manage volatility on all sides of their business.

Domestically-oriented dairy processors also face a battle to restore margins in difficult conditions (with the focus on areas such as input sourcing, product range and brand) while export dairy processors will need to adjust their strategies and develop competencies to suit changed conditions, such as huge increases in export volumes.

Dairy ingredient users also need to reconsider the manner in which they will be able to secure supply and manage the volatility in price, while balancing the costs of reformulation and recipe flexibility with savings from substitution.

And all players, the report said, will need to consider the implication of increased credit risk and capital shortages in the current financial environment.

This article can also be found in the digital edition of Dairy Business News, December 9, 2008, starting on Page 8. Click here to search that archive.

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