Supermarkets not to blame for cheap milk

milkDr John Lingard, associate at the Centre for Rural Economy at Newcastle University in the UK, discusses the price of milk, which  has direct relevance and parallels to the dairy outlook in New Zealand

According to him, British dairy farmers are once again protesting over the low prices on offer for their milk. They worry that too many producers are going bust, and that long-term milk supplies are at risk.

Supermarkets are usually cast as the villains in this piece and this time it is no different.

However it is too simplistic to blame the supermarkets – the real problem is global. Too much low-value milk is being produced around the world.

He explains that over the past decade UK milk production averaged 14 billion litres per year, of which around 500 million litres are exported. Just 139 million litres are imported. Milk made in the UK tends to stay in the UK.

Nonetheless the number of dairy farmers continues to decline, from 40,000 at the start of the 1990s to 14,159 in 2013. This is alarming to some, but it should not be. For long-term security of milk supplies, it doesn’t really matter how many dairy farmers pack up production. The cows often move to another farm and it is easy enough to step up production through more intensive feeding and selective breeding.

After all, even though the total number of cows in the UK has halved since the 1970s,  production has remained steady thanks to the fact average yields have doubled. Farmers are literally squeezing more out of each cow.

Half of domestic milk production has to be diverted from the more lucrative liquid market into cheese, yoghurt, ice cream, butter and other manufactured products.

This is partly because people drink a lot less milk these days; from five pints per week in the 1960s to around three pints today. Consumption is down 8.1 per cent in the past ten years alone. Any industry would struggle in such circumstances.

This supply and demand problem is replicated across the world as being seen in NZ, and there is currently a massive oversupply of manufactured milk products on world markets due to similar issues.

This surplus, combined with a collapse in global demand, especially in China, has depressed prices. A Russian import ban in retaliation for EU action over Ukraine has also hit prices. Russia used to buy 27 per cent of the EU’s cheese exports and 19 per cent of its butter.

The Global Dairy Trade auction, the industry’s main dairy commodities index, hit a 13-year low in August 2015. The GDT has now lost 64 per cent of its value since a record high in February 2014.

This has resulted in the amount paid to farmers – the UK’s farm gate price – declining sharply since early 2014 to just 23,66 pence per litre. When it costs farmers around 30 pence to produce each litre, it is easy to see why they are annoyed.

The major milk processors have to balance their operations across the various markets they sell in and, as a consequence, pay dairy farmers an average price. Farmers will not get, and should not expect to get, the supermarket price for liquid milk. Some supermarkets – Tesco, Marks & Spencer, Sainsbury’s and Waitrose – have agreed direct contracts with dairy farmers that allow them to recover their production costs, but these only involve a small number of farms.

Retail supermarket prices for liquid milk are much higher than farm gate, at typically 55-60 pence per pint (£1.30 or so per litre) as in NZ, but there is no evidence that milk is being used as a “loss leader”. “Four pints for 89 pence at Asda is probably as low as they can get, but the price spread is understandable, appropriate and market-justified; we can’t just hold supermarkets alone responsible. If there is a villain in this piece, it is the world market,” says Lingard..

With too much supply and not enough demand, farmers have two options. Those near big cities can opt out of the globalised milk market through establishing farmer co-operatives to supply just the local area where they can possibly charge higher prices. Or they can seek high-value, niche markets such as yoghurts, farm-produced ice cream and organic milk.

One other way of dealing with supply-demand imbalances would be to bring back dairy quotas, at least at lower levels. The EU introduced quotas in 1984 to control milk production and eradicate butter mountains.

The problem currently facing the British dairy industry is that it is easy to produce milk in the UK’s green, wet and pleasant land as in NZ, but it is very difficult to find profitable markets for 14 billion litres of the stuff in the UK. Until dairy farmers resolve this overproduction dilemma, many will continue to go out of business.

Uneconomic dairy farms, like uneconomic coal mines, must close down and the adjustment process is harsh and painful for farmers and miners alike. In today’s highly globalised world a more humane outcome is unlikely.

This is the case in NZ where the government is loathe to take responsibility for dairy farmers in an environment where Fonterra has lowered its farm gate milk price forecast for the 2015/16 season to $3.85 per kilo of milk solids, from an initial forecast of $5.25/kg. “This is similar to our forecast of $3.70/kg and within the range of market forecasts between $3.50 and $4.00/kg,” says Michael Gordon, senior economist at Westpac.

“In recognition that the dairying industry is facing a very tough season, Fonterra has offered some modest relief on two fronts. Firstly, it will help farmers to smooth cashflow across seasons, by providing a loan of 50 cents per shared-up kilogram of milk solids. The loan would be interest-free for two years, and would be repaid once the farm gate milk price rises above $6/kg.

“The second measure is less encouraging than it first seems. Fonterra is forecasting improved earnings of 40-50 cents per share for the added-value side of the business. However, Fonterra’s stated dividend policy is to pay out 65-75 per cent of earnings over time. Taking the midpoints of these ranges would give a dividend of 32 cents a share, not a significant improvement on last season’s forecast of 20-30 cents per share.

“Fonterra expects its milk collection to be two per cent lower than last season, as a result of reduced stocking rates and less use of supplementary feed.

“Compared to an average milk price of around $5.80/kg, that implies $3.3 billion less revenue than normal for Fonterra’s suppliers.” Source: The Conversation.

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