Propelled by milk-hungry markets and limited availability, global dairy commodity prices took off in mid-2021 and have continued to climb steadily.
Amid the turbulence created by widespread logistical issues, buyers have scrambled to secure supply, and price barriers have been broken as risk calculations and practical reality continue to evolve.
Although peak altitude does not appear to have been reached yet, many are beginning to question what the inevitable price descent might look like.
Dairy Australia's March 2022 Situation and Outlook report shows there is little to suggest short-term rebalancing from a supply perspective.
Milk production in the four major exporting regions has continued to lag for several months, and higher commodity values and rising farmgate milk prices have so far failed to drive any material increase in supply.
In Australia, above-average rain during spring affected milk yields, while hot and dry weather in January 2022 further weighed on production. A similar scenario has played out in New Zealand, where challenging weather conditions have seen milk production fall for six months in a row. In the US and the EU national dairy herds have declined as rising input costs pressure farm margins. Given these constraints and the timeframes required to reverse them, it appears milk flows are unlikely to pick up anytime soon.
Meanwhile, demand for dairy remains robust. In the 12 months to November 2021, total global exports increased by 6.5 per cent, while imports by Greater China (Mainland China, Hong Kong and Macau) rose by 21 per cent.
While China is a key driver for dairy commodity values, strong demand from other markets, such as Southeast Asia, has created a solid foundation for prices. Many buyers who have been waiting for a market correction now seem to have accepted higher prices, and the resulting flurry of activity to secure supply has only pushed values higher.
Costs are going up across the board, due to a combination of pandemic-related disruptions, geopolitical tensions and a messy energy transition, and none of this looks likely to change any time soon.- Eliza Redfern, Industry Analyst, Dairy Australia
Logistical challenges are also fuelling elevated commodity prices. Shipping congestion, staffing issues and the lack of available containers continue to make moving and handling products more difficult and costly. Building tension ahead of Russia's invasion of Ukraine also spurred on purchasing activity due to the threat of further disruptions.
A heightened need to ensure supply chain security has resulted in some buyers shifting between suppliers, willing to pay a premium for guaranteed delivery. This has further supported dairy commodity values, with all major products trading above five-year averages.
Despite supportive market fundamentals, there are some headwinds that could affect the current price trajectory. Demand destruction in price-sensitive markets such as the Middle East and North Africa (MENA) region is an early counterbalance, as affordability declines. In the 12 months to November 2021, global dairy exports to this region fell by 11.5 per cent.
China's domestic milk production has been growing rapidly, reaching record levels in 2021. While this is yet to affect China's position as the world's largest dairy importer, further developments in local milk production could dampen dairy demand and encourage prices to descend.
The cyclical nature of the market dictates that, eventually, prices will start to come down. The key to not getting burned is to keep an eye on whether this will be a smooth descent or a rapid spiral.
The last time commodity prices reached similar levels in 2014, the severity of the subsequent market downturn took many by surprise. With global production looking set to remain tight for some time, and supply chain pressures being far from over, a supply-side shock looks less likely this time around.
Similarly, despite declining affordability in some price-sensitive markets and Chinese milk production pick-up, broad ongoing demand strength helps to mitigate the impact of a sharp demand-side disruption. Overall, dairy commodity prices look comfortable cruising at altitude for now.
Rising inflation pressures markets
Inflation, inflation, inflation - every news outlet in Australia seems to be talking about it.
Dairy Australia's March 2022 Situation and Outlook report confirms that, while dairy markets look strong and milk prices are expected to remain high in the short term, costs are rising all along the supply chain and inflation is becoming a widespread concern.
Logistics providers are already acutely aware of inflationary pressures, with Adblue prices abruptly quadrupling in late 2021. Dairy manufacturers and exporters have seen container rates skyrocket, along with port charges and all manner of ancillaries.
Farmers are all too conscious of surging fertiliser and diesel prices adding to the ongoing challenges of sourcing (and housing) employees.
Costs are going up across the board, due to a combination of pandemic-related disruptions, geopolitical tensions and a messy energy transition, and none of this looks likely to change any time soon.
In the near future, this means margins will get squeezed right along the supply chain. Strong dairy commodity values as the result of a tight global milk balance have so far cushioned processors, while firm farmgate prices due to supply constraints in Australia have helped cushion farmers.
However, the incentive to invest and take risks is somewhat less than headlines proclaiming "record prices" might suggest. In turn, as higher prices at the commercial level are inevitably passed on to consumers, spending is likely to be reined in.
For dairy, this could see consumers shift to buying cheaper products, rather than buying less overall. This could possibly include purchasing fewer convenience or discretionary items, buying larger pack sizes and favouring private label offerings. Even if volumes are not as severely affected, lower average unit prices constrain value generation within the supply chain, which restricts the opportunity for pass-through to farmers via milk prices.
Those who have been through this cycle before will remember well that inflation leads to rising interest rates - effectively, the 'bucket of water' used by the Reserve Bank of Australia (RBA) to take the heat out of the economy.
Although rates are coming off historic lows, for those carrying significant debt, this can lead to a new round of pain. RBA Governor Phillip Lowe has recently described rate rises this year as "plausible", while financial markets have priced in around 1.15 per cent in hikes by the end of the year.
Fortunately, although milk production has not shown significant growth since the dairy downturn five years ago, successive seasons of improved returns have allowed many farmers to reduce debt - and hence their exposure to interest rate movements.
It appears the broader economy could be in for a challenging time. Australia's dairy industry is closely linked to the rise and fall of consumer fortunes, both locally and in key export markets, and it will not be immune to pressure.
However, the combination of recovering profitability, rising asset values, limited impact from COVID-19 and the risk aversion of recent years means farmers are entering this period in better financial shape than many businesses and, indeed, households.
The key will be to approach this period with caution to successfully navigate the turbulence ahead.
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