Sunday 25 September 2016

End of milk quotas turns sour

Five months after the lifting of the EU cap on milk production, Irish dairy farming is in crisis, with prices down almost a quarter

Published 16/08/2015 | 02:30

The milk price collapse takes €1bn out of the economy
The milk price collapse takes €1bn out of the economy

EU milk quotas, which had artificially restricted Irish milk output since 1984, were abolished at the end of March. Under the quota system, Irish milk output was limited to 5.5 billion litres a year.

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When quotas were first introduced 31 years ago, Irish milk output was within touching distance of New Zealand's, which then produced about 7 billion litres annually. More than 30 years later, we are still producing 5.5 billion litres while New Zealand's annual output has soared to 19 billion litres.

The idea was that the end of quotas would allow the Irish dairy industry to fulfil its true potential as output rose to New Zealand levels. That was the theory anyway. Five months later, the reality has been somewhat different.

In 2014, dairy processors paid an average milk price of 36c a litre, according to the Irish Farmers Journal/KPMG annual milk price review. While full-year figures for 2015 are not yet available, it is already clear that average prices paid to dairy farmers will be well down this year.

Glanbia and Kerry - two of the country's largest processors - paid their milk suppliers 28c a litre in June. And there are almost certainly more price cuts to come. Glanbia Ingredients Ireland, the joint venture between Glanbia PLC and the farmer-owned Glanbia Co-Op, paid only 26c a litre in June, with the Co-Op topping up the price paid to farmers by selling PLC shares and dipping into its reserves.

Meanwhile, Lakeland Dairies has cut its July milk price to 27c a litre. Based on what we already know, it seems that the average 2015 milk price paid to farmers will be somewhere in the 27c to 28c a litre range - a reduction of almost 25pc on the 2014 price.

Where did it all go wrong?

Milk is a highly-cyclical, global market. Global dairy commodity prices have been very high for the past five years. This year the cycle went into reverse.

"Production increased in many countries in response to the higher prices of recent years. Now with the slowdown in China, the demand is not there for this increased supply. The Chinese had been stockpiling dairy products. That has now stopped. Demand in the Middle East has also eased," says Alan Renwick, UCD professor of agriculture and food science.

"Global supply and demand are out of synch. The end of quotas and the current volatility are not connected," says Glanbia spokesperson Mark Garrett. "Demand for dairy imports into China has fallen very substantially over the past 12 months."

Glanbia is also experiencing reduced demand from Russia and South America.

While dairy products accounted for only €3bn of Ireland's €10.5bn food and drink exports last year, dairying is very much the beating heart of Irish agriculture. Irish dairy farmers milk 1.14 million cows. Each one of these dairy cows produces a calf every year, of which only a fifth are needed as replacements. This means that over 900,000 surplus dairy calves are produced every year - almost as many as the 1.1 million calves that come from the suckler herd.

This means that the beef sector, which had exports worth €2.3bn last year, is critically dependent on dairying.

While city-dwellers may be inclined to dismiss protests from farming organisations who have previously cried wolf on too many occasions, there are signs that dairy farmers are suffering at current milk prices.

"There is genuine pain. Many farmers are at the margin of losing money at these prices. New Zealand is also feeling the pain," says Prof Renwick. However, he is sceptical of the merits of the EU stepping in to prop up milk prices.

"There have been calls for the EU to raise the intervention price. That should really only be a safety net, otherwise you drive production. The removal of quotas makes EU intervention very difficult. While it would be good to have a floor, it would be very difficult to get the price right."

Those calling for an increase in the EU intervention price would do well to remember the butter mountains and milk lakes of the late 1970s and early 1980s that did so much to drag the Common Agriculture Policy into disrepute.

Dairy farmers had geared up to increase production following the end of quotas. Prof Renwick had been expecting a 12pc increase in output this year, and the Government is hoping for a 50pc increase in output to more than 8 billion litres by 2020.

Based on these predictions, Ireland will produce about 6 billion litres of milk this year. However, with average prices likely to be 8c to 9c lower than last year, farmers will receive €480m to €540m less than if they had been paid 2014 prices. With the multiplier effect from the dairy sector estimated at two, this means that the collapse in milk prices will take €960m to €1.08bn out of the broader economy this year - the equivalent of more than 0.5pc of the domestic economy as measured by GNP.

The current low prices are likely to intensify existing long-term trends in the Irish dairy sector.

"Lower margins will force processors to look at every possible way to cut costs. If there are economies to be gained from mergers, they will have to look at that. It is not just plants but also management and logistics," says Prof Renwick.

Average farm and herd sizes will also continue to increase. The average Irish dairy farmer milks 60 cows. In New Zealand it's 400.

Although lower milk prices are undoubtedly hurting, we shouldn't overdo the pessimism. The recent fall in international dairy prices is part of a wider phenomenon, which has seen sharp falls in the prices of most of the other major commodities too. As Ireland is an importer of most commodities, particularly energy, we have been net beneficiaries of the global commodity downturn. Swings and roundabouts.

Prof Renwick and Glanbia's Garrett are optimistic that dairy commodity prices will recover.

"The fall in prices will choke off supply. We are going to have cyclical patterns, but in the longer term production will be absorbed," says Prof Renwick.

"Global trends are running in favour of dairy products and proteins," adds Mr Garrett.

However, with the bulk of 2015 Irish milk production now having been collected by the processors, both men agree that it is likely to be early next year before farmers feel the benefit of any increase in dairy prices.

The long-term fundamentals of the global dairy market are also good. Increased prosperity and the emergence of large middle classes in newly-emerging economies such as China will drive increased demand for dairy commodities for many years to come.

Ireland is well-positioned to benefit from this increased demand.

"We have a number of advantages. Ireland has a low-cost, grass-based system. Irish dairy farmers are not highly-indebted (see panel), says Prof Renwick.

"There is reason to be optimistic in the long-term. We must not lose sight of that, even as we go through events like this. We can be competitive, we can grow."

Milk lending up

Many dairy farmers borrowed to increase production after the end of quotas, but Irish farm borrowing is still low by international standards.

The average Irish dairy farm has borrowings of €62,000. This compares with average farm borrowings of €4m in New Zealand. Even when one takes the much larger size of Kiwi dairy herds into account, that's still an enormous difference.

At the end of March, the Irish banks had lent a total of €3.45bn to Irish agriculture. The vast bulk of this lending is from AIB and Bank of Ireland.

While agricultural lending actually fell by more than 10pc in the 12 months to March this year, there is strong evidence that the banks cranked up agricultural lending in the run-up to the end of quotas, with more than a quarter of all new SME lending in the first three months going to agriculture.

While some of this new lending has gone to purchase land, most of it seems to have gone on milking parlours and machinery. Which is probably just as well. Average dairy grazing land in Ireland now sells for €12,000 an acre. This compares with average land prices of €8,500 an acre in New Zealand and €7,900 in Denmark.

With agriculture accounting for less than 20pc of their non-property SME lending, the capacity of a dairy bust to damage the banks is limited. However, the resumption of bad news from the Irish banks could make it more difficult for the Government to refloat AIB or sell its remaining 14pc stake in Bank of Ireland.

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