Last month we aimed to give a helicopter view of global dairy trade, and the way it’s changed in recent years.
We have been looking at the international dairy market for a long time, and what has struck us more recently is how much the levers that drive commodity prices have changed.
You can only work with material that is available. That’s true for most markets.
Although very little of the world’s milk production is traded — around 8 to 9 per cent on a milk solids basis — it’s data on these shipments that is the most visible, timely and complete.
Trends in trade and milk production in exporting regions are the focus of most global market discussion.
The 90 per cent of the world’s milk that isn’t traded is looking more like the iceberg we hadn’t really paid much attention to while we have all been focussed on the tip!
The small volume of milk traded in the world is often cited as a reason that global dairy markets are so volatile.
It’s true a small change in production or demand from the key players can have a big impact on trade balance and commodity prices.
It’s no wonder we have all spent a great deal of time looking in this direction. Yet 62 per cent of milk produced in exporting regions is made into cheese, which is largely consumed within the US and EU.
While the US has lots of data and has largely operated in its own bubble in recent years the EU market is much less transparent and is having an increasing influence on global market dynamics.
While the EU has been a dairy exporter for decades, last month’s article highlighted its increased presence across all major importing region since Russian embargo and production quotas were removed. However, it’s the internal dynamics that are also driving global dairy markets.
Firstly, the dynamics around butterfat in the EU have shifted. On the one hand there seems to have been a step change in butter and cream demand from European consumers.
At the same time the large intervention stockpile and depressed protein prices have constrained SMP/butter output.
The prolonged shortage of butter has pushed prices to historically high prices, but lack of product means more marginal demand hasn’t really been tested.
For EU manufacturers dealing with additional milk supplies, decisions about where to direct milk — toward cheese or SMP/butter — can be finely balanced in the current climate.
In determining which way to go, the state of the EU internal market is critical — and largely undiscernible — especially to those outside it.
Through the early part of the decade, the big story in dairy trade was WMP, as China hoovered up New Zealand’s milk growth.
WMP influenced values for fat and protein in other dairy commodities as it dominated the trade story.
As the dominant source of WMP, news on New Zealand production had a big effect on global prices. However, in recent years, with China’s partial retreat from the 2013 peak buying frenzy, this effect has been less important.
The increasing availability instead of highly competitive EU SMP powder has encouraged substitution with cost-effective fat-filled milk powders.
This substitution effect has helped curb WMP values, even when New Zealand production has undershot market expectations.
The key driver for WMP value has switched from NZ availability to being driven by the divergent values of fat and protein while being capped by SMP and substitutes.
It’s a complex picture, with the slow release of SMP intervention stocks under the EU Commission’s current tendering approach adding to the uncertainty, although those in Brussels would regard it as an opportunity to “manage the market”.
It’s a running joke in our office that EU Ag Commissioner Phil Hogan has a ready reckoner on his phone which shows how low he can go on SMP sales to maintain farmgate returns at around 28–30 euro cents and keep the tractors out of nearby streets! Yeah, we need some new jokes.
The rhetoric from the Commission at present is that there won’t be another rescue of farmgate prices, but that resolve will be tested if they head lower.
What does it mean for Australian dairy farmers with cheese being the biggest driver of milk values?
How much cheese and butter Europeans can consume themselves really matters — particularly in the coming months when spring milk begins to flow!
In the medium to long term the Commission’s commitment to letting market signals be transmitted to farmers will be important in this post-quota era in regulating milk flow.
The adjustment of European dairying is ongoing — favoured “green-belt” regions will continue to grow and, as has been demonstrated already, can compete vigorously in export markets.
Other regions will retreat over time.
The large domestic market will always come first for European dairy, and continued cheese demand will remain the key to future export availability — and how hard they’ll have to compete to clear stocks.
• Joanne Bills is a Director of www.freshagenda.com.au