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Next six months will be critical to survival

With milk prices at critically low levels, surviving the next few months will be a real testing time for producers. Ian Powell, managing director with The Dairy Group, gives us his thoughts on the industry’s future.

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The fundamental issue is the relationship between supply and demand.
The fundamental issue is the relationship between supply and demand.

The range in milk prices received by dairy farmers is huge ranging from 12ppl to 34ppl, but with many milk buyers, including Arla, paying just 20ppl, such figures are now a reality for UK dairy farmers.

 

There are some positive market signals with the Fonterra GDT index up 6% in April and increased Chinese imports, but the fundamental issue is the relationship between supply and demand.

 

The graph shows the sixmonth daily average supply for the EU, New Zealand and the US. The UK MPE (market price equivalent) shows the sensitivity of the UK markets to relatively small changes in supply. The black line represents the growth trend over the last five years. Markets only take off when the supply is below the trend line for a sustained period, beyond the normal seasonality pattern.

 

The red line is the forecast supply which is expected to reduce below the normal seasonal pattern from late summer. A similar departure from the trend in 2012 did lead to a market response which was sustained and enhanced by a weak supply response. Markets are unlikely to respond unless supply weakens more than either 2014 or 2015.

 

The degree of market response will depend on the levels of supply and the speed public stored dairy products are released back onto the market. World milk production was up 3.4% in January and February 2016, but there are now signs of milk production falling, with New Zealand down 1.7% in March and Australia also reported down.

Time lag

Six-month daily average supply for the EU, New Zealand and the US

Source: Nick Holt-Martyn, The Dairy Group

There are also increased cow slaughterings, which in the UK increased in March by 20% compared to the previous year and +40% in Ireland. So while there are signs of the market starting to improve, there is normally a three to six-month time lag before improved market returns are reflected in farmgate milk price.

 

Most market analysts do not expect to see any real improvement in milk price until the beginning of 2017, which is likely to be too late for many hard-pressed dairy farmers.

 

The key factors will be the willingness of dairy farmers to continue to produce milk at a loss, and whether their business is strong enough to survive the drain on cash. The next six months will be critical as milk prices are likely to be at their lowest due to seasonal price deductions and the spring input costs for seed, fertiliser and contractors incurred in growing the forage ready for next winter.

 

Understanding the cash needs of the business and the peak borrowing requirement is essential management information for those requiring additional funding or looking at ways to mitigate the cash crisis. The worst situation is to simply run out of cash and to be unable to pay for the key inputs to the business.

 

There clearly are opportunities for cost reduction and with cereals remaining at just over £100/t there should be scope for feed cost reduction down to 4ppl, whereas, for many, the feed cost is still over 8ppl.

 

Dairy farmers should be looking at their mediumterm (five-year) budget to examine business viability, cost of production and opportuwhere improvements can be made in business performance. Many business accounts ended in March, so now is a good time to review and benchmark business performance and to look at cash flow over the next 12 months.

Volatility

There is also a need for businesses to plan how to deal with future volatility and whether there is scope with milk buyers for contracted volumes at fixed prices.

 

Ireland does seem to be further ahead in helping its farmers deal with volatility, with Glanbia offering ‘phases’ of voluntary fixed price for up to 33 months, and flexible loans and repayment systems based on milk price.

 

The proposed changes to five-year averaging of farm profit in the UK should help mitigate some of the impact of price volatility, so that more cash can be retained during the higher priced periods to help fund the business through the troughs.

 

While the current dairy crisis is grim for many, UK dairy farmers have coped with major external challenges in the past and for those who are committed and willing to adapt there remains a long term future in dairying.

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