Finest cheddar, made better

The latest update from Fonterra has provided some reassurance that conditions in the dairying industry won’t be quite as tough as expected this season. But we’re still cautious on the scope for further upside in dairy prices.

In announcing its annual results, Fonterra upgraded its forecast milk price for the current season from $3.85 to $4.60 per kilo of milk solids, equating to around $1.4bn of extra revenue for the industry. While this is still below the break-even price for the majority of dairy farmers in New Zealand, the increase will mean less need for additional borrowing and for drastic cost-cutting measures than previously thought.

The sharp rebound in world dairy prices – up nearly 50%, albeit from very low levels, in the last three GlobalDairyTrade auctions – appears to have been sparked by Fonterra’s predictions that its milk collection will be lower this season. As we’ve noted in the past, world prices are very sensitive even to small unanticipated changes in supply. In the short term, many buyers of dairy ingredients don’t have a lot of flexibility in their requirements, and are willing to bid prices up in order to secure supply.

Fonterra initially forecast a 2% decline in milk volumes; in last week’s update that was revised to a decline of 5% or more, which is in line with the shortfall for the season to date (since June). That announcement itself all but ensures a further sharp rise in prices over coming auctions. We will update our payout forecast after the next auction in early October, but a milk price of $5 or more is now looking plausible for this season.

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