A surge of extra processing capacity has Australia’s dairy manufacturers thirsty for more milk, but also at risk of over-stretching the industry with another burst of ambitious farmgate payment incentives.
With seasonal conditions drying out fast across much of eastern Australia and milking herd consolidation still keeping cow numbers static, Rabobank is warning of potential costly over-capacity in the sector.
Already the big Murray Goulburn co-operative is estimated to have at least 1 billion litres of excess capacity after losing more than a third of its milk receivals to rivals in the past two seasons.
This is in addition to about 1b litres of extra capacity built into the local dairy market since 2015, and as much again planned to be installed as new and upgraded processing facilities by 2020.
It could potentially transform into an unsustainable squeeze on processors margins and profitability
In Victoria Fonterra, Freedom Foods, Australian Consolidated Milk have flagged capacity expansion in the coming year, as have regional processors elsewhere.
Aggressive pricing risks
Rabobank’s senior dairy analyst, Michael Harvey, described the “looming risk” of another sustained period of aggressive milk pricing as processors battled each other and potential seasonal challenges to win the extra milk needed to keep production lines running.
“It could potentially transform into an unsustainable squeeze on processors margins and profitability,” he said.
“Without a growing milk pool, the industry risks carrying too much surplus processing capacity, fuelling manufacturing inefficiencies.”
Farmers, bruised by the past two years of price despondency after peaks in 2014-15, badly want better price incentives.
However, Mr Harvey said another rapid run up in prices, or unchecked volatility would send milk company margin pressure “pin-balling” from one processor to the next.
It was in everybody’s interest for the Australian supply chain to have a globally competitive cost base, he said.
Total milk output restrained
National milk production is likely to end this financial year at 9.3 billion litres, still well down from about 10b litres two years ago despite better weather conditions in Victoria and Tasmania driving some volume recovery (about 3.5pc) in 2017-18.
However, a generally dry year in NSW and Queensland and a parched summer and autumn in most dairy regions has intensified pressure on feed and water prices going into next season, crimping chances of more milk volume recovery before spring, at least.
Mr Harvey said those dairy companies which had poached suppliers and milk from Murray Goulburn in recent seasons would be determined to hold their ground, but at the same time a significant battle for more milk was brewing between MG’s new owner, Saputo, and Fonterra.
The two global giants were set to go head to head rebuilding or expanding their intake volumes and processing activities.
Advocacy group Dairy Connect has highlighted Saputo as having a “unique opportunity to play a pivotal role in reforming the dairy industry”, by introducing more transparency and fairness to contracts with farmers.
“We also need to remove the current provision in short form contracts allowing processors to arbitrarily scrap contracted prices paid and to claw back a proportion of past payments,” said chief executive officer, Shaughn Morgan.
Near-term market caution
However, while more and fairer competition for milk supply would help compensate farmers for recent poor milk prices and depressed cull cow values, Rabobank’s Mr Harvey said global market risks still loomed in the near-term.
Although showing signs of gradual improvement, global market pressure was likely to keep dairy companies setting conservative prices for the start of 2018-19.
Saputo will have to work hard to win the faith of prospective fresh milk suppliers
He said price indicators, including this week’s better international dairy commodity auction, suggested tightening global dairy supplies and a brighter price outlook by spring and summer – Australia’s peak milk production time.
The NZ-based GlobalDairyTrade index rose by 2.7pc this week, its first gain since early February.
Rabobank forecasts a base farmgate milk price in southern Australia of $5.40 a kilogram (milk solids) from July – down from $5.60/kg at the start of the current season.
“However all this processor competition for milk is likely to bring higher value-add payments above those evident this season,” Mr Harvey said.
He tipped an average farmgate range in southern Australia of $5.40/kg to $5.90/kg in 2018-19.
New incentives needed
With early season price signals likely to be restrained, processors would also be under considerable pressure to find new ways to keep farmers on their books.
Mr Harvey said they were more likely to offer innovative tools, services and support to milk suppliers to facilitate future milk supply growth.
Dairy Connect’s Mr Morgan singled out Saputo Australia as having a valuable opportunity to create a new benchmark for the format and fairness of supply contracts and relationships between dairy farmers and processors.
“Saputo will have to work hard to win the faith of prospective fresh milk suppliers who will be closely watching and assessing the culture of the new enterprise,” he said.
“Any reforms introduced highlighting fairness and transparency will no doubt make their way through the industry nationally in the fullness of time.”