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Dairy markets have witnessed a strong recovery in recent weeks, with product returns and milk prices responding. The recovery has been largely driven by a decrease in milk supply, intervention purchases of SMP in Europe and, to some extent, an increase in demand.
Supply
EU milk output has experienced the most dramatic decline, with sharp reductions witnessed in major producers like Germany, France and the UK over late Q2/early Q3. The reduction is in response to an extended period of low milk prices since late 2014 and poor 2016 spring/summer weather. The factors behind the supply reduction are increased culling (+8% in H1), less concentrate feeding, and reduced milking intensity and farmers exiting the sector.
Many of these factors are more structural than temporary and imply that milk supplies will take time to recover (H2 2017), despite improving milk prices and lower feed costs.
While the quality of breeding stock post culling has improved, feed and fodder quality is reported to be poor.
The incremental impact of the €150m Voluntary Reduction Scheme is unclear, but is adding to supply contraction sentiment.
New Zealand’s milk output is forecasted to be down 3% for the 2016/17 season while Argentinian collections are 13% off last year’s levels. US milk flow remains at a high level, despite low milk prices. The availability, cost and quality of heifers and feed implies expansion by intensive units. A strong US dollar is required to hold US exports at 2015/2016 levels.
Demand
Global demand for dairy in 2016 has been influenced by the developed world’s interest in dairy as a healthy and nutritious food, low dairy prices and cheap oil. There are positive signs for cheese and butter consumption in the US and EU across the retail, food service and food ingredient sectors.
The 2015/16 collapse in dairy prices stimulated strong domestic consumption to many new countries. These demand factors will be tested as product prices increase. These new markets will also be required to offset UK concerns (currency, trade barriers and recession) regarding Brexit.
Low oil prices have increased disposable income for oil importing nations while reducing the buying and currency power of oil exporting nations (Middle East and North Africa).
An oil price in the range of US$60-70 per barrel would be optimal.
While Chinese demand has recovered, most notably for cheese, butter and infant formula, it remains some way behind record 2014 import levels for base powders.
Outlook Globally, farmers react faster to rising milk prices than they do to falling milk prices.
The current supply constraint is required well into 2017 to clear surplus legacy stocks (powder in EU and cheese/butter in US) and to keep new supplies in balance.
Low feed prices (spot and futures) are concerning as they favour large intensive producers i.e. US.
Overall, demand has been solid, but there are demand head winds with regard to Brexit, oil prices below US$50 per barrel and the price increase impact on consumption.
Some commentators are also concerned about the speed and magnitude of the recent price recovery.
Markets will remain volatile, but on balance the recent recovery in product spot and forward prices indicate a milk price in the 28-32c/litre VAT inclusive range (26.6-30.4c per litre excluding VAT) in early 2017.
Maintaining these levels or further increases will be mainly determined by supply.
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