We’re still an agricultural economy at heart

No matter which way you look at it, agriculture is bigbusiness for New Zealand’s economy.   Together dairy and meat accounted for 34%of the total value of exports for the year to June 2009.   There are also spin-offbenefits to the economy from having a thriving agricultural sector, includingintellectual property that is licensed offshore.   Much of the recent talk abouteconomic recovery has centred on household spending, but a strong agricultural sectorwill be required to underpin any sustainable growth on the other side of therecession.   This article looks at the recent trends and future prospects forthe dairy and meat industries, and specifically at the recent jump in lambprices.  

Dairy hung out to dry

Dairy farmers have now long put the 2007/08 drought behindthem, with pastures having recovered across much of the country.   Theparticularly severe and widespread nature of the 07/08 drought came at anunfortunate time for dairy farmers.   The dairy payout had peaked (unbeknown tofarmers at the time) at an impressive level, but most were desperately short ofgrass and feed.   Production suffered greatly in the second half of the season,costing the wider economy dearly.   The drought was a key reason why NewZealand’s economy entered recession earlier than the rest of the world.

Graph 1.1

A casual glance at Graph 1.1 could give the impressionthat dairy production has rebounded spectacularly over the first half of 2009.  This may be true, but there are a couple of mitigating factors to keep inmind.   First is simple mathematics – a 20% rise doesn’t put you back where youwere after a 20% fall because it is off a smaller base.   Even so, the size ofthe jump in exports during the March and June 2009 quarters is impressive, andthe 599,000 tonnes exported during the June quarter was the highest quarterlytotal on record.

Another factor to keep in mind is the reports of stockpilingby Fonterra in late 2008 and early 2009.   It is likely that the divergencebetween production and exports has exaggerated the weakness in export volumesduring the second half of 2008, and the extent of the recovery during the firsthalf of 2009.

Will low prices affect dairy production?

There are some underlying factors driving stronger dairyproduction at present.   The previously high dairy payout drove significant investmentinto the dairy industry.   There was a rush of dairy conversions away from otherland uses, notably meat and forestry.

Some of the dairy conversions that were begun at theheight of the price boom would have just come into production recently.   Althoughthe payout has fallen substantially, it would make little sense to simply abandonthe land or convert it back to meat or forestry production considering thesubstantial investment involved in the original conversion.   Many farms arebeing run at a loss at present, but if any individual farmers go bankrupt theassets will be picked up at lower market prices by someone else and put backinto production.  

Farmers do have some scope to expand per-hectare productionwhen prices are good by re-pasturing, bringing in extra supplementary feed, andincreasing stock numbers.   But the effect of the weather dwarfs the limitedcontrol that farmers have over per-hectare volumes, and farmers will continueto try and get the most out of their herds to avoid a further fall in income.   Accordingly,we don’t expect low prices to have a noticeable effect on dairy volumes in theshort term.

There are likely to be longer-term effects on volumes however,due to the fact that the previous incentives to convert to dairy haveevaporated.   Once the current spike in exports has levelled off, we expect tosee much slower volume growth over the next five years.  

Demand is key

With farmers producing milk in record volumes, a reboundin prices is dependent on a significant recovery in demand.   The market for NewZealand milk is broad, as illustrated by Table 1.1.   The importance of Chinahas been growing fast, with China’s share of total New Zealand dairy exports increasingfrom 3.3% in 1999 to 9.2% in 2009.   Indeed, China is now the most importantmarket for New Zealand dairy produce and growing demand from China was a keyfactor behind the historically high prices seen during the 2007/08 season.

Table 1.1

Lamb prices soar

The meat industry was also hit hard by the 2007/08 droughtbut, in contrast with the dairy sector, lamb prices surged during late-2008 andearly 2009.   According to Agrifax, New Zealand dollar lamb prices were up 44%from a year earlier for the three months to July.   As seep farmers work torebuild stock numbers following the drought, they are finding an environment offavourable returns for those in a position to take advantage of them.

Beef prices haven’t performed as well, with the price ofsteer meat falling 6.6% from a year earlier for the three months to July.

Graph 1.2

The weaker New Zealand dollar has helped support pricesover the last few months, but international lamb prices are also healthy.   Highdairy prices up to mid-2008 led to a growing stream of conversions away fromsheep farming over the last few years in both New Zealand and Australia.   Thissqueezed the available supply of lamb and is a key reason why lamb prices havestrengthened over the last year.

Considering the high cost of converting to dairy, it is unlikelymany farmers will be rushing back into lamb while dairy prices are most likely ina temporary lull.   However, higher returns inevitably encourage moreproduction, and as breeding stock numbers increase across Australasia, supplywill also increase.   

Conclusion

The drought of 2007/08 hit dairy and meat farmers acrossmost of the country.   It slashed New Zealand’s export earnings and helped tipus into recession earlier than the rest of the world.   Tighter supply has ledto better returns for lamb farmers.   As breading stock numbers recover, higherlamb prices will help boost export earnings over the next season.

Dairy prices remain low and could take some time torecover.   Export volumes have never been higher, although the extent of therecovery has been exaggerated by Fonterra’s previous stockpiling.   But dairyproduction will grow more slowly over the next five years as lower prices atpresent lead to less new investment in the dairy sector.   Following the recentrecovery in volumes, a further boost to export earnings from the dairy sectorhinges on strengthening global demand soaking up current world supply andpushing up prices.

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