Ornua operative : Market Outlook for 2018

January 04, 2018

Ciarán Aylward, Economist, Ornua

Farm-gate milk prices have recovered strongly after they hit a trough in mid-2016. European milk prices have increased by over 45% on average since then and this has been reflected in Irish milk prices which have grown by over 50% over the same period (from 23 cpl to 35 cpl). Combined with an increase in deliveries and lower input costs, Teagasc estimate that the average dairy farm income in 2017 will exceed €90,000 which is a new record.

The recovery in farm-gate milk prices came about after a period of price weakness that began in mid-2015. This eventually lead to global milk supply, particularly supply from Europe and Oceania, easing back through the first-half of 2016. With global dairy demand remaining stable, supply struggled to match demand and the price of dairy commodities (i.e. butter, cheese and milk powder) increased which facilitated the recovery in milk prices.

The supply and demand imbalance was especially evident in the butter market. The combination of falling milk flows, poor SMP returns curtailing butter production (SMP is a by-product of butter) and solid demand, resulted in butter stocks becoming extremely tight as the year progressed, particularly in Europe. This tightness was exacerbated by strong cream exports to China which drew significant volumes of cream from the butter churn.

As a result, European butter prices rocketed from €2,350 in March 2016 to €6,500/t in September 2017 - a rise of over 175%. Even with SMP returns at historic lows, record butter prices and strong export demand for cheese from the likes of Japan and South Korea meant that processor returns increased. This in turn lead to a rise in farm-gate milk prices from late 2016 which has continued through 2017.

With farm-gate milk prices on the up the inevitable happened - farmers supplied more milk. In recent months the recovery in collections has been most noticeable among Europe's 'Big 3' (i.e. Germany, France and the UK). However, it's noteworthy that over the past 18-months flows among the '2nd Tier' (i.e. the Netherlands, Italy, Poland, Ireland, Spain and Denmark) have grown consistently even as the 'Big 3' faltered, and this cohort is fast becoming a highly influential driver of European flows.

Meanwhile, US collections continue to grow steadily while New Zealand deliveries are expanding despite wet weather conditions over peak season. With deliveries in the likes of Australia and Argentina in recovery mode, we are in an unusual situation where milk flows across all major dairy exporters are growing simultaneously. Indeed, cumulative global flows are now expanding at about 3% year-on-year.

On the demand side, while EU export trade for dairy commodities has been growing by circa 5% per annum, domestic demand in Europe and the US is muted with consumption of fresh milk, yoghurt and cream in decline. This means cumulative dairy demand across the globe is growing by between 1% and 1.5%, much slower than supply. With domestic demand sluggish, most of that surplus milk is being diverted into export markets which are becoming increasingly saturated with exporters jostling to offload product to keep domestic stocks down. This is especially the case for SMP with European and US stocks at record levels.

The demand situation has been further impacted by record butter pricing. European butter exports are down by 17% this year as price sensitive end-users use less butter and switch to cheaper vegetable alternatives. In addition, German retail sales of butter are down 10% year-to-date with reports that some consumers are now substituting butter with spreads and margarine.

With global supply over-shooting demand, commodity prices have fallen rapidly. Butter has fallen from September highs of €6,500 to €4,000t, cheddar has slipped from €3,500 to €2,900t while SMP price levels remain rock-bottom at less than €1,300t despite strong European export volumes as Intervention stocks continue to overhang.

As European milk flows loom large, farm-gate milk prices are now coming under major pressure after a period of growth as processors seek to stem the tide and prevent further weakness in commodity prices with spring flush approaching. Spot milk prices on the Continent are being slashed with a large Dutch processor announcing plans to introduce a 'dual pricing' system where farmers receive a significantly lower price for any surplus milk they produce over a certain level. US milk prices futures are also trending downwards (€0.28 cpl) and New Zealand pay out forecasts for the season have also been cut (€0.26 cpl).

Looking forward to 2018, butter pricing, while significantly lower, is likely to remain high historically as stocks will take time to replenish with SMP pricing so weak. Cheese exports should also offer some support, and likewise, forecasts of strong Chinese demand for butter, cheese and WMP through 2018.

However, barring a major weather event or some other supply-side shock, the sheer volume of milk in the pipeline indicates that global supply will exceed demand through the first half of 2018. Considering the length of time it typically takes to reduce milk supply in response to lower commodity prices, farmers can expect farm-gate milk prices to fall from current levels. Moreover, in the absence of another spike in butter pricing, exceptional Chinese imports volumes and/or a significant jump in oil prices, milk prices may not recover to the extent that they did at the tail end of 2016. All being considered, it seems unlikely that an average farm-gate milk prices above €0.30 cpl can be sustained through 2018.