4 April 2010

12 minute read

Summary

• International dairy commodity prices slipped in the opening two months of 2010, before stabilising in March.
• Prices appear to have corrected from what had begun to resemble a substantial price overshoot in late 2009, given only modestly supportive fundamentals and the inevitable end to buyer restocking.
• Current price levels appear far more sustainable, with stagnant milk supply and patchy but real improvements in demand likely to keep the market firm, despite high stocks in some regions.
• Pricing is expected to remain in touch with current levels as we progress through Q2 2010, though the potential for a large EU surplus remains a prominent downside risk.

Prices

The opening quarter of 2010 saw some steam blown off the international dairy market. USD prices of key commodities fell 10 per cent to 15 per cent in the first two months of the year, before stabilising in the first half of March. With the US dollar itself largely unchanged on a broad index basis over the same period, recent shifts in international dairy pricing have been driven primarily by market fundamentals rather than currency factors.

Figure 1: Dairy Commodity Prices fob Oceania

The slide in dairy prices evident in January and February almost certainly reflected a correction of what had begun to resemble a substantial price overshoot in late 2009.

The global economy is still improving, but progress is slow in most regions. And with retail dairy prices now on the rise again, there is evidence that end-consumption growth is slowing rather than accelerating in some markets. Anecdotal evidence suggests wholesale buying has also slowed as buyers contemplate full inventories, high prices and the upcoming Northern Hemisphere spring flush.

The more recent signs of price stabilisation in March also appear surprisingly logical, given the recent track record of overshoots and undershoots in the global market.

While a price correction was warranted, there would appear to be enough support in the market to avoid a more substantial near-term price slump.

Supply-side constraints are still compelling. In recent months, the US, the EU, Australia and Argentina reported milk supply still at or below previous-year levels. And while the milk/input cost equation has shifted at least back to neutral for most farmers around the world, short-term supply growth prospects are limited.

Meanwhile, with the world economy continuing to tiptoe around the most obvious recent pitfalls, enough buyers remain active to sustain hope of a decent period for demand growth—with buying from China still particularly vigorous. Still, the demand outlook remains somewhat tempered by rising retail prices and pressure from cheaper substitutes.

Current pricing is probably being set on low trade volumes as the market drifts through the lull between a weak Southern Hemisphere season and the upcoming peak in the Northern Hemisphere spring.

The coming months will provide a sterner test for demand as the traditional surpluses generated by the EU flush hit the market.

Supply side

EU

EU milk production fell 1.2 per cent in 4Q 2009 year-on-year (YOY) as low mid-year milk prices and increased culling took effect.

Despite some improvement in milk prices by early 2010, preliminary data showed another 1.1 per cent YOY contraction in milk supply in January. Poor weather impacted milk collection in a number of countries, and some farmers eased back in the lead up to the end of the quota year to avoid super levy payment.

EU dairy consumption remains weak. High unemployment and low consumer confidence continue to impact spending despite more benign retail pricing trends than in many regions.

Restricted local demand ensured plenty of product available for export during the closing months of 2009, despite falling milk supply. Exports rose 12 per cent in milk equivalent YOY terms during Q4 2009, led in particular by SMP and butter shipments.

A more balanced market ensured limited interest in government assistance programmes early in 2010. Only small amounts of butter have entered PSA to date, no sales to intervention have occurred and early bids for SMP export refunds have been rejected.

Rabobank expects EU milk supply to trail previous-year levels as the region passes through the crucial spring flush in the coming months. The EU dairy herd started 2010 2.2 per cent smaller than 12 months prior. Reduced use of concentrate last year is also impacting fertility rates. Milk prices are considerably above last year—e.g., FrieslandCampina’s guaranteed March milk price is at EUR 28/100 kg (including seasonal adjustments)—but still only around breakeven levels in much of the EU. And extreme cold and heavy, late snow have ensured a weak start to the flush.

While EU intervention stocks carried over from the previous season remain considerable, most of the butter and a quarter of the SMP will be sold under the EU food aid for deprived persons programme from May, with the balance unlikely to be sold during 1H 2010.

More generally, the slow improvement in global demand for dairy and restrictions on supply from other locations are expected to result in buoyant EU exports through Q2 2010. This should help compensate for stagnant local demand conditions over the same period.

Weak supply, firm exports and limited destocking should keep commodity prices generally above intervention levels, with, at worst, small quantities likely to be purchased in Q2 2010.

US

US milk production continued to contract in YOY terms in the three months to February 2010, with improved yields more than offset by herd reductions following extreme financial pressure on farms through most of 2009.

Consumption of cheese and milk continued to expand in Q4 2009, but the rate of growth slowed once more (to 1.3 per cent YOY milk equivalent) as rising retail prices and ongoing concerns regarding the economy continued to bite.

Q4 exports rose nine per cent on the depleted levels of Q4 2008.

Reduced milk supply, improving local consumption and rising exports tightened up the US market somewhat, with the All Milk price up 37 per cent on previous-year levels in February. Further slippage in corn prices has contributed to marginal profitability.

Milk production looks likely to stabilise sooner than was expected three months ago, with potential for suppliers to improve feed rates and benefit from full heifer pipelines in response to improved returns to milk production. January data showed the first herd expansion in 13 months, followed by a further small increase in February.

The market is unlikely to require YOY growth in US milk production through Q2 2010.

Product inventories remain substantial—with cheese stocks 13 per cent above previous-year levels in January 2010 and CCC stocks still to be placed back into the system.

While economic recovery is underway, the prospects of meaningful reductions in unemployment look bleak, tempering the outlook for consumer spending. Rising retail prices are also impacting dairy consumption. Disconcertingly, fluid milk sales fell in January in YOY terms.

Export markets will continue to take reasonable volumes of US product in coming months but are unlikely to offer enough upside to provide a rapid solution to ample supply availability in the domestic market.

Rabobank expects that the rebalancing of the US dairy market is likely to be a slow process, with limited significant upside for suppliers in coming months.

New Zealand
Seasonal conditions have turned in favour of New Zealand’s dairy farmers in recent months. Following a dry summer in some parts, a warm, wet and productive February was seen in most areas, with much the same weather evident in March.

A falling exchange rate offset to some extent the decline in international prices evident in early 2010.

Fonterra’s milk price forecast for 2009/10 remains unchanged since November at NZD 5.70/kg MS. The co-op did increase its forecast distributable profit in late February, though this increase is earmarked for retention.

Good pasture availability, positive margins for supplementary feeding and the positive impact of recent farm conversions in the South Island pushed national milk supply ahead of previous-year levels in February, with wider YOY gains expected in March.

After an inconsistent run, New Zealand thus looks set for a strong finish to the 2009/10 season (ending May).

Belying the weak earlier peak in the NZ production season, exports were up 21 per cent in milk equivalent terms in the three months to January on the financial crisis -impacted volumes of the previous year. Milk powder has led the way, supported by the sustained boom in shipments to China.

A strong end to the current season should help sustain reasonably solid export volumes through the coming months.

Australia

For Australian farmers early 2010 brought further milk price gains, lower feed costs, improved water availability and, in early March, a deluge of rain that has all but ensured a great start to the autumn for most. Farmer confidence is much improved.

But hopes are diminishing that improved conditions and a return to profitability for most might ensure a strong tail to the season. January milk supply still fell nine per cent below previous-year levels, emphasising the difficulty of turning around a season that started in such a difficult environment.

The gap between current and previous-year production may narrow somewhat in the closing months of the season. But the bigger impact of recent improvements is likely to be felt in the form of a good start to the 2010/11 season.

Declining production caught up with exporters in January, with export volumes down six per cent YOY. Exports are expected to fall at double-digit rates in Q2 2010 as weak supply and solid domestic demand start to eat away surpluses.

Argentina

Argentine milk production continued to fall below previous -year levels through the three months to January. An extended dry period reduced feed availability, with an overly hot and wet January also subsequently impacting milk supply.

Supply constraints have curtailed export trade, despite the continued absence of export restrictions. Export volumes in the opening 2 months of the year were down 20 per cent YOY.
However, the benefits of improved export prices are now flowing through to the farmers. And with lower production encouraging competition for milk, farm-gate prices have risen to their highest levels in a decade.

Improved weather, low feed prices and high milk prices could encourage a strong tail to the milk production season. But after years of underinvestment and with seasonal shifts underway, Rabobank expects limited YOY growth through Q2 2010 and ongoing constraints on exports during the same period. Potential excessive rains pose a risk through the autumn.
Brazil

Brazil was the one major Southern Hemisphere milk producer to experience a strong seasonal peak in late 2009 on the back of firm milk-price signals.

However, production is now in seasonal decline and, with recent adverse weather in many key dairy regions, the month-on-month decline may prove sharper than usual.

Despite a strong milk production season, robust domestic sales growth continues to limit the amount of product available for export, with Brazil still a net importer through February 2010.

The combination of a seasonal decline in milk supply and good local consumption growth is expected to keep Brazil largely absent from world export markets through Q2—and, in all likelihood, keep Brazil a net importer through this period.

Demand side

Data for the closing months of 2009 have highlighted the strength of buying in international markets during the period. MEQ trade volumes rose 16 per cent in Q4 2009 YOY. While the extent of YOY growth owes much to the weakness of financial crisis -impacted trade in the previous year, in volume terms it was still the strongest trade period for many years (still 10 per cent above Q4 2007).

However, more recent developments lend support to the hypothesis that this period of vigorous buying—fuelled in part by restocking—has now passed, with the market contemplating a more modest set of underlying demand-side fundamentals.

Figure 3: Change in Export Volumes for ‘Big 6’ Exporters

The world economy is improving and has a marginally better outlook than it did 3 months ago. But the recovery is still dual speed, disconcertingly ‘jobless’ in the West, and many key dairy consumption regions still sit behind pre crisis levels in terms of consumer spending power.

We continue to see retail dairy prices rising, or at the very least stabilising at high levels, in most of the markets we follow.

And while butterfat has lost some of its price premium to vegetable oils, it remains at very high levels, encouraging substitution where possible.

In markets that do report timely dairy consumption data, the rate of growth in sales volumes has slowed in recent months (e.g. Q4 US domestic cheese disappearance) or turned to contraction (Jan US fluid milk sales). Anecdotal evidence suggests that EU consumption remains stagnant.

Last but not least, a significant fall in international prices in the New Year despite falling milk production in almost every key export region (and very little destocking) makes the concept of strong market demand hard to swallow.

This is not to say that significant pockets of strong demand growth don’t exist. Chinese buying has remained extremely strong, with imports of dairy product from NZ alone hitting 40k tonnes in January – more than double last year’s already elevated flows. Orders are also flowing in from Middle East and parts of South East Asia, while the Algerian government has put a substantial order out to tender.

But the improvement in end consumption is distinctly patchy (strong in some regions, weak in others) and at aggregate level likely to be reasonably slow.

Rabobank expects that the demand recovery will gradually accelerate and become broader based as 2010 progresses, in line with improvements in the general economic environment. But for Q2 10, sellers are likely to find the improvement in demand slow and uneven.

Outlook

• Advanced economies, and in particular the US, may yet surprise on the upside in coming months.
  
  
• The Northern Hemisphere spring is likely to yield less milk than 12 months prior, with only limited improvement in on farm profitability and questions over the likelihood of a repeat of what were exceptional growing conditions last year.
  
  
• what were exceptional growing conditions last year. The Southern Hemisphere is almost sold out of milk for the current season.
  
  
• There are signs that India may need to increase imports in 2010 to cover market requirements through the summer.

• The EU holds several downside risks for the market: incl. the potential for a strong spring flush, the possibility of a regional double dip recession and further devaluation of the Euro (increasing the competitiveness of European suppliers on world markets). A combination of two or more of these would exert considerable downward pressure on pricing in the international market.
  
  
• Butterfat for the time being remains expensive relation to competing vegetable oils, encouraging substitution.
  
  
• Any sharp reduction in Chinese buying would materially impact powder markets.

Rabobank expectations

Rabobank’s primary expectation is to see international prices across the dairy commodity complex generally remain in touch with current levels as we progress through Q2 2010.

The recent market correction has brought pricing back into a more comfortable range, flowing through to prices that buyers can live with, even against a generally weak economic backdrop, and which will soon stabilise milk production, but not encourage too much of it .

Butterfat may well prove an exception, with pressure from cheaper substitutes bringing the prospect of a further downward drift.

Across the dairy markets, the risks still appear weighted on the downside, though less heavily than three months prior.