The EU produced about 2.7 billion litres more milk in the 11 months to November, which is higher than the 2.1b litres New Zealand produced in total during the 2014-15 season.
NZ cut production by 1% in 2015 and that’s expected to rise to about 2-3% for the 2015-16 season as farmers respond to weak prices by destocking and buying less supplementary feed. Dairy prices fell 2.8% in this week’s GlobalDairyTrade auction, the fourth consecutive drop this year, because of concerns about worldwide oversupply.
Fonterra said when cutting its forecast farmgate milk price in late January that the timeframe for rebalancing supply and demand had moved further out to the end of the year and largely depended on a downward correction in EU supply.
Chief executive Theo Spierings said at the time that prices were clearly unsustainably low for farmers globally and couldn’t continue longer term.
Agri market commentators have mixed views on when and whether European production will “return to normal”.
Keith Woodford, a Lincoln University agribusiness professor, said the structural change in EU dairy was permanent and still in the early stages.
Removing milk quotas unleashed major restructuring that will mean economic forces will increase production in Northern Europe and decrease it in Southern Europe, he said. Farmers in Ireland and the Netherlands are responsible for 55% of the production gain since quotas were lifted.
“Across all of Europe there will be pain as the inefficient are no longer protected by quotas but those who are efficient will now expand,” Woodford said.
He said it was still unclear what the “new normal” will be although he expects Europe will remain a major exporter of dairy products with the low euro making it more competitive internationally.
“Europe’s competitive advantage currently lies in value-added products where it is beating countries like NZ,” he said.
BNZ agri economist Doug Steel said an increase in EU production was unlikely to pull back too far.
Milk quotas were introduced in the early 1980s to resolve oversupply in the EU market that led to the infamous milk lakes and butter mountains by guaranteeing farmers a price above that of world markets providing they kept production under a cap.
Steel said milk production was ramped up in 2014 in Europe and then pulled back sharply for just a few months before quotas ended by producers who had exceeded their cap and wanted to avoid paying a super-levy.
It’s likely to be the middle of the year before the market gets a clear read on the long-term intentions of the now unrestrained EU producers, with early signs low prices are forcing out some inefficient farmers, Steel said.
“The jury is still out on whether they will pull back production and in a way they don’t have to, they just have to get the growth rate back to the growth in demand globally,” he said.
Others say low pricing signals must eventually constrain current European expansion. Kiwi dairy farmers are among the first to feel the brunt of a global downturn because of NZ’s reliance on exports whereas EU producers were buffered by higher domestic prices and continued market intervention despite the removal of production subsidies.
Rabobank agri analyst Emma Higgins said the European Commission is currently intervening by storing excess skim milk powder and butter products because of the floor for prices being hit.
There’s also private storage aid where producers are paid not to release product to avoid flooding the market at times of oversupply that has also kicked in.
In Ireland, Higgins said, dairy co-operatives were topping up global prices by an extra 1-2 euro cents per litre to farmers.
“The pain is being felt asymmetrically in this downturn with NZ farmers feeling the heat since last season. These guys are only feeling it now,” she said.
One constraint is likely to be new environmental legislation in the Netherlands that will introduce restrictions on phosphate levels.
“Farmers are getting anything with four legs on the ground now” because the rates will be retrospective, Higgins said.
Westpac economist Anne Boniface said ultimately low pricing incentives will force a reduction in European supply as has happened in NZ, despite the different support systems in place.
ASB agri economist Nathan Penny shares that view, saying European farmers won’t be happy to continue losing money for too long although production growth has lasted longer than expected.
Long-term, providing Russia comes back into the market and there’s growth in demand in new markets like India, Penny thinks NZ will continue to be a major player in the export market.
