What’s driving higher milk prices in Australia?

Article

What’s driving the opening milk price?

Agribusiness Bulletin

Dairy prices in Australia have had their share of ups and downs over recent years with the industry undergoing significant change. As the new financial year fast approaches, all eyes are on the milk processors as they announce their opening milk price for the year. This edition of the Agribusiness Bulletin takes a look at the driving forces behind current milk pricing and forecast pricing for the 2019/20 period.

What is the opening milk price?

The Australian dairy industry has traditionally run on a ‘milk year’ from 1 July to 30 June. As a result, the large dairy processors generally announce their year opening milk price in June for milk protein and fat content per kg, commonly referred to as milk solids ($/kg MS).

Typically, processors start the year with a low price and then provide ‘step-ups’ as the year progresses, once they can better estimate prices achieved on the sale of their manufactured dairy products. Price step-ups are generally announced in line with competitor step-ups, however, the number and size of step-ups varies from year to year, being at the discretion of processors.

The table below shows the difference between the opening milk price for 2018/19 and the current milk price, with some processors currently offering a marginally higher price at the end of the year.

2018-19 season opening price announcements and current milk price at 14 June 2019 (for Southern Region including Victoria, Tasmania, South Australia)

Key players

Opening Milk Price
($kg MS)

Current Milk Price
($kg MS)

Saputo Dairy Australia

$5.751

$6.152

Lion Dairy and Drinks

$5.823

$5.824

Parmalat Australia

$6.105

$6.206

Fonterra Australia

$5.857

$6.058

Bega Cheese Limited

$5.859

$6.0510

 

The opening milk price is important for farmers as it provides a benchmark for the year, allowing them to plan for optimal herd size, capital investments and/or the best use of land including alternative uses. The opening price also provides farmers an option (for those with no lock-in contracts) to look elsewhere if other processors are offering higher prices.

From a processor’s perspective, the opening price is a balancing act. Milk costs are the largest portion of a processor’s cost base (approximately 75%) so the incentive is to keep these costs as low as possible. However, if the price isn’t high enough, processors will lose suppliers to competitors and won’t be able to run their processing plants efficiently, or supply existing customer contracts.

Key factors likely to affect milk price this year

Since deregulation of the industry in 2000, milk processors ultimately decide what price they pay for milk based on various factors including the capital employed, sales contracts with customers and forecast sales. Ultimately however, forces of supply and demand largely determine the milk price. A number of key market forces this year are collectively placing upward pressure on raw milk prices in Australia. These include: lower domestic supply volumes; increased domestic competition; and higher global prices. This article explores what each of these three market forces suggests about future prices.

1. Lower domestic supply volumes

Australia is experiencing declining milk production for reasons including; seasonal conditions such as drought resulting in higher feed prices; reduced water allocations and significantly higher water prices; reduced feed growth; and competing land uses. Whilst milk productivity has increased, this is unlikely to offset falling herd numbers. This lower supply places upward pressure on prices as strong demand continues.

Australian Milk Monthly Production – National total 2017/18 & 2018/19

Australian Milk Monthly Production

Source: Dairy Australia

2. Increased domestic competition

Competition for domestic milk supply has been growing amongst the largest players in the Australian dairy processing industry: Saputo Dairy Australia (includes the previous Murray Goulburn Co-Op operating assets and Warrnambool Cheese & Butter), Fonterra Australia, and Lion Dairy and Drinks.11

During 2018, the Australian Competition and Consumer Commission (ACCC) allowed the purchase of the Murray Goulburn operating assets to Saputo Inc (Canadian Listed Entity), although it did not allow Saputo to acquire the Koroit processing plant in Western Victoria due to competition concerns.12 This lead to Bega purchasing the Koroit plant, providing it with a footprint in the Western Victoria milk processing market for the first time.

This increased competition already appears to have had an impact with the announced closure of the Fonterra owned Dennington Factory in Western Victoria, which is a short distance from Koroit. The Dennington factory had been in operation for more than 100 years13 after being acquired by Fonterra in 2005. Fonterra announced the closure in May 2019 stating that the factory was under-utilised and that the site was not viable in a low milk pool environment.14

3. Higher global dairy prices

As approximately one third of Australian dairy production is exported, the farm gate milk price is closely aligned to export sales.15 The Global Dairy Trade (GDT) index is a reference point for future Australian milk prices. It has been in operation since 2008 and is based on dairy ingredient auctions held twice each month to more than 600 registered bidders from around the world.

The GDT fell to a two-year low in November 2018, but has since recovered strongly on the back of slowing production in the EU and NZ, combined with a period of strong demand for milk powders from Asian economies, including China. This trend has reversed a prolonged period of strong supply of dairy products in the global market which dampened prices. Further, the Australian Dollar has weakened significantly against the USD over the last 5 years, which has improved the AUD export prices received for Australian dairy exports.

GDT - average annual AUD equivalent pricing

 

 2014-15 

 2015-16 

 2016-17 

 2017-18 

2018-19

 AUD per tonne 

3,364

3,194

4,183

4,333

4,337


Source: Dairy Australia

What does all this mean for future milk prices and the FY19-20 opening price?

According to the Commodity Milk Price Index (CMPI), Australian dairy export prices have increased 11% since April 2018, and have demonstrated a clear upward trend since July 2016.16

The CMPI is forecast to continue its upward trend in late 2019 and 2020 and be around 1% above current levels in April 2020. Deloitte Access Economics forecasts 2019 global dairy prices to improve from late 2019 following a correction in the coming months.

What does all this mean for future milk prices

For the 2019/20 milk year, we have already seen a major processor announce their opening prices of $6.60/kg MS on 31 May 201917, which is around 10% higher than what most large processors are currently paying ($6.05/kg MS). Another major processor has since announced an opening price of $6.80/kg MS for 2019/20, along with a step-up for the current 2018/19 season. These price announcements will put some pressure on the other processors to match pricing to maintain their milk supply base. Therefore, whilst farmers have faced some tough conditions over the past years the upcoming season is looking more positive for them already.

As a result, opening 2019/20 prices are almost certain to be higher than closing prices for 2018/19 across all Australian processors, and we expect these prices to remain stable for the remainder of the 2019/20 season. This may result in some further industry consolidation as processors shift their milk intake to service long-term customer contracts and higher performing products.The step-up in milk prices should also encourage milk producers to stay in the industry and, depending on seasonal conditions, expand herd numbers. This would reverse the significant decline in milk production observed over the last 12-18 months.

AuthorTerry Ludeman – Director, Audit & Assurance.

The Agribusiness Bulletin

The Agribusiness Bulletin focuses on national and local industry, as well as cross-industry insights and trends. This includes some of the drivers we expect to shape the future of the industry and potential challenges that may arise. To get more articles like this delivered straight to your inbox, subscribe to the Agribusiness Bulletin.

References:

1. https://www.wcbf.com.au/en/our-company/newsroom/opening-price-2018-19-southern-milk-region
2. https://www.wcbf.com.au/en/our-company/newsroom/opening-price-2019-20-southern-milk-region
3. https://www.lionco.com/media-centre/lion-announces-competitive-opening-price-for-the
4. https://www.lionco.com/media-centre/lion-announces-competitive-opening-price-for-the
5. http://maxumfoods.com/higher-farmgate-prices-on-offer-as-processors-move-to-secure-volumes/
6. http://maxumfoods.com/parmalat-promising-milk-suppliers/
7. https://www.fonterra.com/au/en/our-stories/media/fonterra-australia-announces-opening-milk-price-18-19-season.html
8. https://www.fonterra.com/au/en/our-stories/media/fonterra-australia-announces-opening-milk-price-18-19-season.html
9. https://www.weeklytimesnow.com.au/agribusiness/dairy/farmgate-milk-price-bega-cheese-announces-its-opening-milk-price-for-suppliers/news-story/5a0e1f900f2efbabd34cabc479ac9f33
10. https://www.begadistrictnews.com.au/story/5882515/saputo-and-bega-lift-farmgate-milk-prices/
11. https://www.accc.gov.au/system/files/Farmer%2520Power_0.pdf
12. https://www.accc.gov.au/media-release/accc-approves-saputo-murray-goulburn-acquisition-after-undertaking
13. https://www.abc.net.au/news/rural/2019-05-23/fonterra-factory-closure-dennington/11140992 
14. https://www.weeklytimesnow.com.au/agribusiness/dairy/fonterra-australia-announces-opening-farmgate-milk-price/news-story/b7b1f6ae88d40117c0d8bef0438a20b2
15. https://www.dairyaustralia.com.au/dairyaustralia/industry/exports-and-trade/dairy-export-markets?keyword=export
16. http://www.agriculture.gov.au/milkpriceindex
17. https://www.fonterra.com/au/en/our-stories/media/opening-price-for-2019-20-season.html

Published: June 2019

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