Friday, July 8, 2022

Fluctuation here to stay

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With many movements in the dairy payout last season, finishing with a 30c/kg milksolids (MS) reduction in the season’s dying days, most farmers see volatility as the “new normal” for dairying. Research released last year by the Organisation for Economic Co-operation and Development (OECD) indicated that after the upheavals in food prices through to 2008, dairy products continued to stand out as the agricultural commodity still plagued by volatile price movements. The report authors noted the widely held view that recent spikes and declines in “soft” or food commodities suggested greater volatility in all sectors.

However, the extensive analysis of eight agri-commodities – beef, maize, rice, soybean oil, sugar, wheat, butter and milk powder – largely suggested otherwise.
It concluded price volatility in all products, other than dairy, was not greatly different from past decades, and since the January 2008 “spike” had returned to movements typical of previous decades.

Rabobank’s global agri-analyst Hayley Moynihan said this finding supported the bank’s own work carried out two years ago. Dairy product volatility remained a reality and looked likely to be here to stay.

The first obvious explanation for this is the reduction in volumes of European Union and United States subsidised “overhang” product, with intervention prices sitting well below current average global prices.

“It used to be when milk powder prices rose above US$2000, and slightly higher for the EU, the sale of intervention stockpiles would occur, limiting price increases,” she said. “These stockpiles no longer exist as the prices governments now buy at are so far below market price levels they are not meaningful to producers.”

The result is that buffer stockpiles are no longer available to limit global price increases during periods of strong demand growth.

Intervention

While intervention purchases are less common now, other policy changes are likely to continue, fuelling volatility in dairy products. In the wake of the US election the US Farm Bill still requires ratification and is likely to have some significant changes around payments made to dairy farmers.

“The broad gist of it is that what will be done is rather than an intervention price, a payment or type of margin insurance will be made to cover producers when prices drop,” Moynihan said.

“This could possibly be linked to an income over feed cost benchmark.”

However, a quid pro quo from producers that legislators might expect is some level of control over the volumes of milk produced when that payment kicks in.
“But whatever name you give it, it’s a type of milk production quota,” she said.

“So while intervention mechanisms may be out, there are other mechanisms coming into play and they do not necessarily mean reduced volatility, just different drivers.”

Climatic factors invariably have their part to play in shifting prices and the increasing reliance of milk production on grain across the world will only exacerbate that.

“In your traditional low-cost pastoral systems, like New Zealand and Argentina, the level of potential growth in volume produced is more limited.”

But with well over 50% of the world’s milk now produced using grain, the link between grain’s fortunes and dairy product prices is stronger. This is to the extent milk processors and herds in the US are now establishing in traditional grain-growing areas like Nebraska. Kansas governor Sam Brownback declared last month his goal to see the grain-growing state become an “ag powerhouse” for dairy and pig production.

The severe drought across the US has many optimistic the lower payout will rise this year as grain feed costs take a hike. In mid-November Westpac hiked its payout expectation to $6.00/kg MS, partly on grounds of the drought’s impact on grain stores and ultimately milk production in the US.

At the same time supply chains’ stock levels have got tighter, with processors of dairy ingredients seeking to align production more closely to real-time product demand. This “just in time” inventory re-stocking for production is partly to try to avoid being caught holding high-value inputs in a poorer sales volume environment.

Globally dairy trade is also regarded as “thin”, with relatively few sellers and NZ forming 26% of that global trade. So the impact of supply shocks like drought out of one supplier country can shorten that supply relatively quickly.

Dominated

The buying side of the equation courts more participants than the selling side, but is also dominated now by a few large countries with erratic purchasing behaviour. This includes China and Russia, Algeria, Venezuela and occasionally India. Those countries can also be influenced by government tender and trade policy decisions based on domestic priorities.

At a consumer level demand tends to be less volatile than supply, and over time as incomes grow in developing markets that “income effect” will mean demand will become more inelastic and less susceptible to decline because of upward price changes.

“Demand-side volatility tends to be more driven by market shocks, such as food safety incidents or trade regulations,” Moynihan said.

Globally she doesn’t see any significant shifts in dairy cow numbers influencing supply, rather a consolidation of herds into fewer larger herds in some countries, particularly China, while emphasis goes on increasing production per cow.

Rabobank expectations are for some backing out of production from southern Mediterranean countries as the Common Agricultural Policy (CAP) is lifted mid-decade, but this will be balanced by greater production coming from the north. Ireland in particular has dairy farmers relishing the opportunity to boost production without being hit by crippling milk taxes past a certain production volume.

“Our view though is that the world will be needing that increased production – there will be a place for it. There could, however, be some initial transition disruption around 2015/16 as quotas come off.”

With the launch of dairy futures trade here, the possibility of speculation driving volatility in price movements is a possibility. However, unlike grain futures, trade remains light and even the Chicago-based dairy futures market has only relatively small volumes through it compared to total milk production, so the speculative influence is minimal.

Moynihan said there was also a solid argument that greater market transparency could deliver lower volatility, thanks to more of the market having “perfect” information throughout on which to base decisions.

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