Dairy sector facing uncomfortable decisions

The Irish Dairy Board is an organisation always worth listening to when discussing prospects for milk prices.

It commenced operations as Bord Bainne but evolved into the IDB as it built a major marketing and distribution platform largely focused on finding markets for Irish dairy products. In other words, it works at the coalface of the milk market.

When the IDB made some frank and honest remarks about international dairy markets last week it caught my full attention. It is effectively warning that dairy markets are under pressure from a variety of sources and weak prices are the result. Milk powders and butter are declining at a relatively rapid pace, particularly on spot markets. The Global Dairy Trade auction, for example, is marking prices that are 40% below their 2014 peaks while butter is 29% lower.

These price moves are stemming primarily from those hoary old chestnuts of demand and supply. Supply is gathering pace in some markets including Europe where quotas are abolished from April 2015. Already, 2014 output, undoubtedly helped by the fine weather, is up almost 5%. At the same time, demand is being affected by Russia’s ban on food imports from Europe and some signs of weaker demand trends in China.

These factors add up to uncomfortable decisions under way within the Irish dairy industry. Processors, be they co-op or privately owned, have to lower raw milk prices when their output values fall. Although contracts can delay this dynamic somewhat, it is clear that milk prices across the country are beginning to fall from the 35c per litre level.

While the impact of this is somewhat alleviated by seasonal production patterns (winter output is much lower than summer), the prospects for spring and summer 2015 that must now be considered.

Dairy farmers have been encouraged to prepare for expansion post-quotas and material investment in equipment and leased land is taking place in conjunction with that. This investment, and any debt attached to it, must be judged next to a milk price that will be fundamentally more volatile.

While Chinese and Indian demand are important factors for the long-term health of the dairy sector, short-term price fluctuations could be vicious. It is imperative dairy farmers set out their stall conservatively.

If recent international trends continue and prices weaken further in 2015, there will be calls to reinstate EU supports for milk products. In the years before quotas were introduced in 1983, export refunds and intervention purchases were used to shore up farm milk prices as markets faltered.

We now live in a very different world. Political support across Europe for farming has declined in line with population shifts to urban centres. The budget process in the European Commission has become more difficult as taxpayers are tackling recessions in their national economies. Therefore, any ideas about Europe riding to the rescue if milk markets capsize should be ignored.

Liberalised markets are great when demand and prices are strong as producers can raise output and trade profitably. It is much tougher when these trends are in reverse. There is no doubt the dairy industry in Europe is moving to a more liberalised framework and all stakeholders must incorporate the consequences of such a system for their own enterprises.

At a processing and farm level, my own instincts would be to run a balance sheet with modest levels of debt and tight operating costs. In that scenario, when conditions are good I can buy the Cuban cigars and when times get tough I can survive. Approaching this any other way is a dangerous and risky tack.

Joe Gill is director of Corporate Broking with Goodbody Stockbrokers. His views are personal.