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Why are UK milk prices falling?

Insights
An imbalance of global supply and demand is driving the recent wave of price cuts which have knocked more than 5p per litre off many farmers’ milk cheques. But does this tell the whole story?
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There is one question retailers and processors have still not answered, Farmers For Action (FFA) chairman David Handley told a packed meeting in Frome, Somerset, last Thursday.

 

He said: “Why, if we are utilising 85 per cent of the milk we are producing in the UK, are we taking the global hit?”

Global supply and demand

DairyCo estimates supply in the major milk-producing and exporting countries grew by 4 per cent in the first half of this year, compared with last year, as farmers responded to better climatic conditions and higher milk prices in 2013.

 

But global demand is relatively weak, forecast to rise by just 2-3 per cent this year, with China, previously the biggest driver of demand, forward-buying in 2013 and therefore ‘distant from the market’ this year.

 

EU milk production rose by 5.1 per cent in the first six months of this year, with much of the increase used to produce milk powders – skimmed milk powder and whole milk powder production are up by 9.6 per cent and 16.7 per cent respectively.

 

The situation has recently been compounded by the Russian import ban which, according to DairyCo, has created uncertainty over product availability and put a brake on trade.

 

World wholesale prices have tumbled accordingly. The Global Dairy Trade auction (GDT) price index for all products has virtually halved since the start of the year, falling from more than US$5,000/tonne (£3,083/t) to US$2,787/t (£1,718/t) at the most recent auction.

 

So why have UK prices been falling?

So why have UK prices been falling?

UK milk production in the current milk year, from April to August, is nearly 8 per cent up on the same period last year.

 

But, even with most of the milk sold domestically, it is the global imbalance which is forcing prices down, according to DairyCo.

 

The fortnightly GDT, which deals primarily with New Zealand and Australian dairy products, is the best indicator of the state of the market. While there is no direct link with UK prices, the graph illustrates how EU and UK wholesale prices track the GDT price.

 

The UK is a net importer of dairy products, with a trade deficit of about £1.3 billion – about 40 per cent of UK dairy demand satisfied by imports.

 

Patty Clayton, senior analyst for AHDB/DairyCo, said: “Global market conditions, such as those at present, impact the UK due to trade competitiveness.

 

“Those products which are kept in the domestic market are under threat from imports, while those products which are exported face competition from other exporting nations. This means UK processors will need to be price competitive or offer a product of sufficiently high quality to obtain a premium.

 

“These pressures, in turn, feed back into UK farmgate prices.”

How big a factor is Russia?

The major processors, including Arla, have been quick to blame the Russian factor, at least in part, for the recent price cuts.

 

But this does not add up, according to Jonathan Ovens, Arla Milk Company chairman and British farmer director of Arla Foods amba.

 

Echoing comments made by Mr Handley, Mr Ovens told the Frome meeting Russia was being used as a ‘convenient excuse for reducing milk price’.

 

Stressing ‘virtually nothing’ was going into Russia from the UK’, he warned farmers not to be ‘fobbed off’ with this story.

 

But Mrs Clayton said it was difficult to separate out the impacts of the Russian ban and the wider global demand-supply issue.  

 

But she said there was a ‘relatively large drop’ in EU wholesale prices during August after the ban was announced (see graph).

 

Mrs Clayton said the size of Arla in the UK meant farmgate prices were ‘likely to react a bit quicker to changes in global and EU markets’ because its price was adjusted on the basis of its total global market returns.

 

This impacts on prices paid by milk buyers, which need to be competitive in order to retain supplies and will therefore move to stay in line with the market. 

Are milk buyers playing fair?

Mr Handley acknowledged global market imbalance was the ‘main driver’ of price cuts, but claimed this could only account for about 3.3ppl of the reductions, meaning 2ppl was unaccounted for.

 

He also acknowledged the transparency provided by Arla’s pricing model, but added: “As one of the 7,000 who did not sign up, I don’t see why I should be driven into the ground because of that [the Arla] factor.”

 

He predicted prices could come down another 2-3ppl or so as the retail ‘vultures’ prepared to swoop. “There is absolutely no justification for this,” he said.

 

NFU dairy board chairman Rob Harrison contrasted today’s situation with 2012 when farmers were not receiving the highs of commodity market fluctuation, but were exposed to the lows.

 

Are milk buyers playing fair?

“‎Today, the UK milk price has fallen less than commodities, which reflects the limited exposure to them, yet is still at or above the price of most other European countries,” he said.

 

He added different processors will be ‘more or less exposed to global issues’, which should be reflected in their price.

 

“Even if a business is solely focused on retail, with skim milk powder, cream, and cheese prices on the floor, there will be more competition in liquid and other retail sectors.

 

“With buyers seeing this as an opportunity to reclaim lost margin no company is immune, sadly, but you would expect the companies which struggled to pay higher prices when commodities were high to be paying a relatively better price now.”

How bad is the current situation?

Mrs Clayton said milk prices, while declining, remained at ‘relatively high levels’ at both the farmgate and wholesale level.

 

“Input costs on-farm have been declining so margins should not be too hard hit unless prices continue to drop, and at a faster rate than the decline in input costs.”

 

Mr Handley has expressed his frustration at this view taken by some within the industry. He believes Tesco and other supermarkets will retain cost of production contract prices at well above the 30ppl mark.

 

“How anyone can accept milk prices going from 30ppl to what could be 23-26ppl when costs are above 30ppl is beyond me,” he said.

What are the prospects of recovery?

DairyCo cites anecdotal reports UK commodity prices are ‘close to stabilisation’, although there is not expected to be a big rebound in price.

 

Mrs Clayton said: “Markets will take some time to rebalance and the amount of time will fundamentally depend on how long supply continues to outperform last year, when buyers return to global markets [especially China], and whether the Russian import ban remains in place for the full year.”

 

She warned the UK market is becoming increasingly volatile.

 

“If UK milk production increases, the likelihood is milk used for manufacturing will increase more than liquid,” she said.

 

“The increase in dairy products combined with only moderate growth in UK domestic demand means import substitution and/or exports will increase, thus increasing the UK’s links with the EU and global markets,” Mrs Clayton said.

 

There are mixed views on the merits of the European Commission’sdecision to introduce Private Storage Aid to take cheese, powdered milk and butter off the market.

 

Mr Harrison has welcomed the move, which the NFU was pushing for, but has acknowledged this potentially raises problems when they do inevitably hit the market next year, a point echoed by DairyCo, which said the release needs to be timed so it doesn’t flood the market during the sprong peak.

 

But Mr Handley vehemently opposes the policy, arguing the release of these products back onto the market, possibly around next May, could stifle any recovery underway by then.

 

“The one thing that slows down receovery of any business is if you have got a stockpile to get rid of,” he said, adding that global buyers would now be tempted to wait until stocks are released to take advantage of likely lower prices.

 

Mr Harrison added: “Farmers all around the world have increased production, at the same time commodities have fallen back. Long-term demand growth has always been predicted to result in volatility as markets react then over compensate.

 

“The challenge for the UK is to improve its competitiveness so we can maintain and grow our share of the global and domestic market.”

 

What are the solutions?

Various solutions, long- and short-term, have been proposed the problems within the UK dairy market.

NFU

  • Wants whole UK industry to continually improve competitiveness to maintain and grow share of global and domestic market.
  • Wants more milk buyers to offer ‘determinable milk pricing mechanisms in contracts’ to manage volatility; for instance a percentage of a farmers’ volume on formulas, fixed price, cost of production.
  • Wants supply chain to add value through brands, products and differentiation.
  • Wants clearer labelling and promotion of what sets British dairy apart from the competition.

David Handley

  • Wants dairy industry to focus on the UK market first, before looking at export opportunities.
  • Is urging farmers to consider entering into collective ‘self-restraint’ to limit UK supply.
  • Believes there is a place for futures in the dairy market.
  • Wants Government to buy up surplus milk products and distribute to poor and needy in UK and beyond.
  • Is seeking views on protests in October if situation does not improve.

DairyCo

  • Wants farmers to assess farm efficiency through benchmarking and/or discussion groups.
  • Is urging farmers to push for more transparent milk contracts.
  • Provides market intelligence and analysis to inform farm investment and other business decisions such as contract change.
  • Encourages closer discussion within the industry between buyers and farmers to align short, medium and long term plans with market needs and production capacity.
  • Wants farmers to assess and evaluate ways of working and where appropriate implement new management approaches such as ‘Lean’ management techniques to ensure continuous improvement and maintain competitiveness.  
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