In last week's Blog we took a glimpse at the history of the Fonterra payout. The question posed was whether Fonterra's forecast of better than $NZ 7.00 / Kg MS was justified by current market conditions. We didn't have long to wait. The Fonterra auction this week gave further insight into the direction of the market as has the latest news on sales of EU intervention stock. This week I'll take a closer look at the Xcheque NZ payout index and the prognosis given recent commodity price data.
First the news of the week. The June Fonterra Auction was eagerly awaited - this being the first auction since the recent downturn in world economic markets and announcement of the release of EU intervention stock. When the news broke early on Wednesday morning (NZ time) there must have been a collective sigh of relief across the South Pacific. The result was as bland as the comments in the Fonterra press release: "Paul Grave, globalDairyTrade Manager, said the market continued to be relatively stable with supply factors the primary driver of market sentiment.". Whew, that's a relief Paul!
The more important news in the auction result was the easing of buyer interest for product requiring shipment in the latter part of this year. We have added the forward pricing Founterra Auction price chart shown in our News Headlines this week. SMP and WMP in particular are falling and clearly the high AMF pricing reflects a short term supply problem. Relative to the peak price in April, buyers are discounting SMP and WMP December shipments by 10 - 12%. As Paul Grave says, "relatively stable" - and actually not a bad result given the market conditions.
The other news of the week comes from the EU where results of the first round of intervention stock sales are just emerging ("Blog alert: First butter sales from intervention", Philip Clarke, Farmers Weekly,3 June 2010). According to the Farmers Weekly, the EU has sold 11,000 of 76,000 tonnes at $US 4,240 - $4,730. Very good prices but in a market with tight supply. More significantly they rejected other bids because they were too low and rejected all bids for SMP. For reference, the current market price for SMP in the EU is ~ $US 3,100 - ie. almost 20% lower than the Fonterra auction price for immediate delivery and 10% lower than the December delivery auction price.
With the Fonterra Auction and EU market prices as background, we come back to the 10/11 forecast payout. We have put the forward commodity pricing into our payout index and projected what it might look like (at the current NZ:US exchange rate of 0.68). For good measure we have also added in the most recent commodity price and futures data from the US.
What you are seeing here is the Xcheque index calculated with Oceania, EU, and US market prices. The actual payout and Fonterra's forecast for 10/11 is also shown (this includes the value add component). We don't have any indication of forward pricing for the EU but it smells like the market is going down.
The chart shows that Oceania commodity prices track the EU market reasonably closely. Although not shown on the chart, this is also the case during the period from December 08 - October 09. In this period the EU export subsidies brought their export prices down to the level of Oceania and the US. We have shown their internal market conditions on the chart so that you can see the magnitude of the subsidy effect.
The bottom line from this chart is that if everything stays the same from here then the 10/11 Fonterra forecast payout of $NZ 7.00 / Kg MS is achievable. So are things likely to stay the same?
Let's duck across to Australia for moment and see what is happening there. Quite unexpectedly Fonterra have opened the batting on the new season's milk price (congratulations Fonterra!). They are reported to have set an opening price of $AU 4.36 / Kg MS ("Fonterra announces opening price", The Weekly Times, 24 May 2010). By my calculations that is roughly $NZ 5.40 / Kg MS. This is not a final price. It will follow the Australian market (Murray Goulburn) up, and down, as necessary. It is however a respectable opening price and a good reflection of current market conditions and the outlook. It is also a long way from $NZ 7.00 / Kg MS. So unless Fonterra are expecting to pay some pretty significant step ups, or are expecting that the Australian milk price will be significantly below that of NZ, then something doesn't quite gel with their NZ payout forecast.
The final payout will be a function of two primary drivers, the value of dairy commodities and the NZD exchange rate relative to the USD, Euro and AUD. With regard to commodity prices my personal view is that Oceania export prices are overcooked and will come down in the not too distant future. Supply will ramp again with the onset of: the EU summer; Oceania spring; and increasing production in the US. On top of this we have the release of EU intervention stock. The global economy is fragile and credit is still tight everywhere. Most companies can ill afford to hold stock against the potential of better pricing in the first half of 2011. There is also the spectre of EU export subsidies and, if European prices fall too far, or perhaps if they have trouble selling all that intervention SMP, then the international market will drop below the level of the EU dairy commodity market.
It all comes down to the projections of the New Zealand Dollar. A quick check of market forecasts suggests that it will weaken further, dropping to about 0.60 USD by December 10. That's good for NZ export and will provide a healthy buffer against a fall in dairy commodity prices. It may not be so good for inflation, the current account deficit and NZ interest rates - there is always a quid pro quo in a currency devaluation.
This article has prompted me to have a much closer look at the Fonterra payout and so it would be remiss of me to leave you without a glimse of what I can see in that cloudy crystal ball. I'm sticking to last week's prediction of the value of NZ dairy exports in terms of USD and Euro. To bring this into Kiwi speak however I'm going to have to try and pin the tail on the NZ currency donkey. My random number generator came up with a weighted average rate of US 0.62 and a payout forecast of:
$NZ 5.70 - 6.50 / Kg MS
And to go with that, here's the headline you should look out for in August / September this year:
"EU reintroduce export subsidies on SMP and WMP ... Fonterra revises payout forecast downward"
I'll cheer with the rest of NZ if I've got the forecast wrong - it will mean that the world is getting closer to a level playing field.
For good measure, here's a piece of gratuitous advice if the final result is above the $6.50 mark. - Retire some debt! Those low interest rates are not going to last forever.