Dairy Australia published the July figures for Australian milk supply last week and the news was positive. July milk production jumped 3.2% on the prior year and more than 4.4% in the important dairy production centre of Victoria.
If you were puzzling over what this was signalling for the coming year then it is a reasonable bet that you are not alone. But don't fear, here at Xcheque we are on the case and can give you some insight into the long term trends and prognosis for 10/11.
This story starts in Victoria where milk production fallen 20% or 1.4 billion litres since reaching peak production in 2002. With the overlay of Australia's fires, and droughts and flooding rains it can be a little hard to get a bead on this trend. Drought in particular has been a major issue over the past decade and has been blamed for much of the decline. We've had a close look and come to the conclusion our pet topic of economic gravity is the major culprit - farmers just can't make a reliable living in the market enviroment they are exposed to.
To see the real trend in Victorian milk production you need to look at production each year in two halves. Peak milk production coincides with the flush of spring grass growth and extends into summer. Offpeak milk production runs through the autumn and winter. The chart below shows the trends from 1999 - 2010 for the two production periods.
What is clearly evident here is that offpeak milk is relatively stable whereas peak milk is declining steadily. Victoria is moving away from the seasonal pasture based dairy system to a flatter supply. The change in the peak to trough ratio (ratio highest production month to lowest) has been from just over 3:1 to just under 2:1. It is a dramatic change and has a profound effect on the processing sector as well as farm management and economics.
Northern Victoria in decline
The primary source of this change in supply volume and seasonality has been the northern region of Victoria. That region has lower rainfall and a heavy reliance on irrigation. There has been a heavy toll from the dry conditions of the past 10 years, reduced water allocation, higher water costs, and most importantly three very serious milk price shocks. Northern Victoria accounts for 1.1 billion litres or 78% of the total production decline since 2002.
Monthly milk data for the north shows the pattern of decline and the massive shift away from peak milk production. The fall in peak milk production has averaged 6% per year over the decade. Offpeak milk has fallen on average 1% per year but against this trend there has been a slight rise in production for the lowest production month (July).
Looking more closely at this trend we can see that the fall in overall volume has occurred in two major steps. The standardised milk production chart below takes the seasonality out of the milk supply and shows a calculation for the daily average milk production for the region. Variation in the standardised daily average is telling us whether milk production in any given month is moving above or below the long term average trend.
In 02/03 production dropped from a peak of 15% year on year growth to a low point of 15% decline. The same occurred in 06/07 and the slow recovery from July 07 - December 08 was reversed in February 2009.
(Point and click on image to enlarge)
The rainfall data for Kyabram in northern Victoria shows that the two major drops in milk production were preceded by extended periods of below average rainfall. That provides some explanation for the fall (less water allocation). To my mind however the most powerful driver has been money. The final chart above provides an indicative margin from milk in $ per kilogram of milk solids. This is based on the opening milk price in each year. The estimated margin is by no means definitive, there will be huge variation from farm to farm, but it is reflecting the drama of a fall in milk price. In the case of 02/03 and 06/07 there was also a coincident rise in costs - exaggerating the effect of the fall in price.
The West and East hold the line
The Western District and Gippsland regions have shown much more resilience to drought and the milk price shocks of the past decade. There has been a very slight rise in average daily milk production in both regions but this increase is almost too small to be differentiated from normal seasonal variation. What is clear however is a shift away from seasonal milk supply. The effect is less than in the north but is none-the-less evident. In both regions the peak:trough ratio has moved from 4:1 to less than 2.5:1. This effect can be seen in the monthly milk production chart.
The seasonal trend over the decade shows a similar story to the northern district in terms of the factors driving milk production. The charts below are for Gippsland but they are much the same for the Western district.
(Point and click on image to enlarge)
In these charts you can see both price effects and climate effects. The price / margin slumps of 02/03, 06/07 and 09 had an immediate effect on production but no where near as much as in the north. This reflects the more reliable rainfall and the associated pasture supply. On the pasture based systems of Gippsland and the Western District a price slump is a good reason to reduce brought in feed and then do what you can to maximise production off the available pasture. This drive to get more from pasture compensates for the fall in brought in feed.
The southern regions of Victoria are not completely immune to climate and you can see this in the first 6 months of 2005. Very good rainfall in January and February boosted production above normal levels. This then collapsed when the rains failed from March to June. This demonstrates the "natural" variation in milk supply and the extent to which it can move in a short period of time. It is also to some extent a reflection of the capacity of the cows to respond - if you give farmers a good milk price, and cows more feed, production can rise very quickly. We have seen a similar effect in the past 6 months although it is less clear whether the production increase is a result of the very good autumn break or the high profit margin (better than expected milk price and a low feed cost).
Can and will the north of Victoria recover? That is the $64,000 question of the Victorian and Australian dairy industry. The answer is tied up in the trends of climate, international commodity prices, as well as feed and water price. Perhaps I'm being controversial but my personal view is that no - the party in the north is over.
Water is becoming too scarce and too valuable to pour on the ground and make grass. This means the cost of production will revolve around the cost of grain and fodder and the higher operations costs associated with managing these feed systems. Remember that the competitors for milk production in the north are the pasture based systems of Gippsland, the Western District, Tasmania and, most importantly, New Zealand.
The north will remain an important source of milk for the Australian domestic market. It also presents an opportunity for specialist processors who can generate a return on a higher cost of milk production and the associated (and necessary) higher cost of milk. The transition to purchased feeds and harvested crops brings with it a flat milk supply. That is better for fresh milk markets and for processors capacity utilisation. The other benefit of note will be a change in the characteristics of the milk. The higher proportion of grain will take the milk closer to the characterstics of European and American milk. The colour / flavour profile of this milk is different and attracts a premium in some markets.
The other question is of course whether Gippsland and the Western district will continue the current trend of stable milk production and a shift towards more offpeak milk. That is likely to be all about the international dairy commodity market and the associated milk price. Farmers will buy land and milk more cows if there is a profit incentive. The land and climate is ripe for production growth but farmers (and banks) will need confidence in the future of milk price and margins.
A final comment that arises from this analysis is the very big question of whether the change in seasonality of milk production in Gippsland and the Western District is a good thing. In my view it is the relatively high milk price that is being paid during the offpeak period that is driving this change. It seems to me that the market is responding to local competition for milk supply which is entirely disconnected from the reality of the value chain that applies to export commodity markets.
This issue of the right supply pattern to give the best cost equation for both farm and processor is very complex. The nub of it is however that offpeak milk is more expensive to produce and export competitiveness relies on a low cost of production on farm and in the factories. Contrast the Victorian milk price system with New Zealand where the milk price per month is relative flat - encouraging farmers to produce as much as possible when it is cheapest to do so - ie. when the grass is growing. It would be a tragedy if the international competitiveness of the Victorian dairy industry was destroyed by tactical competition for milk supply.
Thanks are due to Dairy Australia for the milk volume data and the Bureau of Meteorology for rainfall data