Focus on our competitive edge, says DairyNZ economist

With milk prices down, the industry needs to focus on the fundamentals of successful dairy production which have given the country its competitive advantage. DairyNZ senior economist Matthew Newman explains.

New Zealand is unique amongst developed countries because nearly three quarters of its export earnings are generated from the primary industries of agriculture, horticulture, viticulture, forestry, fishing and mining. In 2013-14, dairy alone accounted for a third of the total value of merchandise exports. Therefore, the New Zealand economy and wellbeing of New Zealanders is heavily reliant on the success of dairy, our largest export industry.

The New Zealand dairy sector is competing with other dairy exporting nations to supply safe, reliable and quality dairy commodities, ingredients and products to the world. To continue to do this successfully we need to maintain our reputation and ensure we can continue to grow milk production efficiently and sustainably.

China, a very large market

Undoubtedly, the big change in dairy markets in the last decade has been the increase in demand for dairy from Asia, particularly China. Since 2000, Chinese dairy consumption has almost quadrupled to around 30 million metric tonnes (compared to 0.7 million metric tonnes in New Zealand). However, on a per capita basis, Chinese dairy consumption is about a third of average global consumption, so there is plenty of opportunity for further growth.

There is increasing risk that we have locked ourselves into high cost systems that are difficult to adjust when milk prices are at low levels.

Chinese domestic production has failed to keep pace with the rise in dairy consumption, increasing the reliance on imports, which now account for 17 percent of global dairy imports, compared with just 4 percent in 2000. New Zealand has benefited greatly from the dairy consumption growth from China, particularly for whole milk powder, where it has the largest share of Chinese imports. However, other countries have seen the high returns and market share New Zealand enjoys in China and a number of dairy companies throughout the United States (US) and European Union (EU) have been expanding production capacity to compete.

New Zealand’s increased dependency on China’s dairy market comes with greater risks. Firstly, we rely on continued strong demand from this key market, to keep global prices at higher levels. Secondly, it may become increasingly difficult to maintain our market share as global milk supply expands and competition for Chinese imports builds.

US increases exports

The US has increased its dairy production and exports over the past seven years. Annual US milk production has increased by 1.5 percent, while exports have nearly doubled to approximately 15-16 percent of total production (see table below). While much of the exported product had been destined for close neighbour Mexico, increasing volumes are now being exported into Asia. The US has built strong export volumes into South East Asia, China, Korea and Japan, primarily in cheese and powder products.

Cost of production crucial

In the commodity business, cost competitiveness is the most critical element in being able to achieve rewarding margins. This is where New Zealand has excelled and holds an advantage over the US and EU producers, but the US’s most profitable farms are closing in when capital requirements and operating costs are considered. There are risks of New Zealand farmers acquiring land at too high a cost as well as locking into high farm working expenses to achieve production growth.

The cost of our production has increased over the last decade, as we have intensified and chased higher profits due to higher milk prices. This can impact negatively on our resilience as an industry. There is increasing risk that we have locked ourselves into high cost systems that are difficult to adjust when milk prices are at low levels.

New Zealand’s challenge is to maintain our on-farm competitive advantages at relatively low cost and the sector’s ability to deal with regulatory pressures such as environmental issues. As the ability to increase milk production from expanding land area becomes more difficult, the future growth of the industry will depend more on efficient milk production from sustainable and resilient systems.

Greater efficiency will keep us competitive

Despite fluctuating milk prices, the New Zealand dairy industry is in control of its own destiny. It has the ability to sustainably convert low cost, high yielding pasture into nutritious, high protein dairy products. Beyond the farm gate it is also equipped to make the most of its product mix with its global reach and scale, along with supply chain efficiencies and full traceability.

For many farmers, remaining competitive and profitable in the medium to long term, may mean seeking options involving less intensification. Upholding productive capacity, while concentrating on cost effectiveness and meeting environmental requirements and other on-farm compliance will be the challenge. Other farmers will need to manage their intensive farm systems in a manner that will remain profitable in the volatile world of commodity markets combined with currency markets. Regardless of the production system, it is time to reassess for the long term.

The message is:

It is a good time to review your farm business, including the risks and opportunities and determine where you want to be in the future and what needs to be done to get there. In the short term it is back to basics. Focus on improving efficiency and managing cashflow and borrowings in a prudent manner. By doing this you will be contributing to your own business’s resilience and to New Zealand’s competitive position.

This article was originally published in Inside Dairy July 2015

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