Dairy production has declined from its peak in 2000 and many dairy farms have converted to alternative land uses. In this agribusiness bulletin, we explore the underlying reasons behind the decline in production (and confidence) among Australia’s dairy farmers, but also consider the longer-term prospects of a resilient sector.
How did the industry get here?
Prior to 2000, the Australian dairy industry was heavily regulated, by both state and federal governments. Price controls, subsidies, and quotas were applied in various jurisdictional forms to market milk (i.e. fresh drinking milk) and manufacturing milk (used to make butter, cheese, and milk powder).
At that time, this provided a level of income protection for dairy farmers by creating a level of certainty in the ‘farm-gate’ price of market milk. However, some would argue that this protection came at a cost to consumers who were paying a higher price.
Following state level shifts towards deregulation, in 2000 the Australian dairy industry was deregulated at the federal level. Existing protections were largely eliminated and, despite programs intended to ease the transition, many dairy farming operations became unviable without price protections in place.
Dairying became more centralised into fewer, but more intensive, dairy regions. States where farms primarily supplied drinking milk to domestic markets saw significant numbers of farms exiting the market. In Victoria, the largest producer of milk with lower costs of production, the dairy industry began focussing more on export markets.4
The wash-up of all this was that, following deregulation, Australia’s total milk production fell from the high levels of 2000, and has not recovered in the near two decades since.
What are the issues currently impacting the dairy industry?
Fast forward to 2019, and dairy producers are grappling with pricing practices and global commodity trends (two issues previously insulated by regulation) along with variable seasonal conditions.
Milk price transparency
Currently, dairy farmers have relatively low bargaining power when selling their milk to processors, because milk is perishable and not differentiable and there are many competing producers. Farmers generally sell their raw milk by entering into short term contracts with milk processors, where the farm-gate price received may vary between farms.
Some milk price contracts can end up bestowing processors with unusual rights such as ‘indicative pricing’ which allows processors the ability to alter the price they pay farmers after the contract has been entered into. This can happen mid-season, well after farmers have begun supplying their milk and can result in farmers repaying them for sales already made. Price revisions in 2016 reportedly led to some dairy farmers exiting the industry or selling their farms to meet these surprise repayments, which resulted in intervention by the ACCC.
The lack of price transparency is an issue for farmers, who aren’t well-informed by processors about how farm-gate milk prices are set. In response to this, the Federal Government initiated a Milk Price Index which is prepared by Deloitte Access Economics and is intended to help demystify Australia’s dairy commodity milk pricing.
Furthermore, the ACCC has proposed a mandatory code of conduct to prevent instances such as retrospective price cuts occurring in future, which has growing industry support. A mandatory code might lift the confidence of farmers, many of who are currently disenfranchised suppliers with continuing suspicions about the pricing strategies of milk processors.
Major supermarkets also feature heavily in the milk price debate with $1 per litre milk. Yet, the ACCC has not found any evidence that the $1 milk had any direct effect on farm-gate prices. Instead, in a 2018 report, the ACCC found that if the retail price of drinking milk were to increase, most of the benefit would flow to retailers and processors, rather than to farmers.
Increasing exposure to global commodity trends
A broader issue around milk pricing is that the Australian dairy industry is increasingly at the mercy of the global market, with a growing share of the industry’s revenue coming from exports of dairy products. While Australian producers have benefited from growing global demand, such as Chinese demand for milk powder, they have also encountered market volatility resulting from seemingly unrelated factors, such as Russian sanctions.
As such, processors tend to take on risk when choosing what commodities to produce and can pass this risk on to farmers through farm-gate pricing.
Seasonal conditions have also contributed to the recent decline in milk production. With drought affecting multiple dairy-producing regions, farmers have had to contend with poor pasture growth, high feed prices and reduced water allocations. Under these conditions, many farmers have opted to milk a lesser portion of the herd, de-stock, or even exit the industry.
Long term prospects for Australia’s dairy sector
With all these factors at play, farmers face tremendous uncertainty over their future income. By the time milk is sold, farmers have purchased inputs such as hay and water throughout the year, with uncertainty over the price they will receive for their product. With the added uncertainty of weather and seasonal conditions, this makes it difficult for farming businesses to invest. Even investments that would improve productivity and increase resilience tomorrow impose too high a cost today.
However, while recent conditions have not been favourable, we consider the prospects for Australia’s dairy sector are strong over the long term. Global dairy commodity prices have increased modestly and stabilised since 2016 and, in the long run, the demand prospects for dairy remain strong reflecting rising middle class incomes and growing demand for dairy-based products such as baby formula.
Furthermore, while individual farmers may struggle to justify investment in the current environment, the local and foreign investment environment for dairy assets, particularly in Tasmania and Victoria, has been fertile ground in recent years. This investment may see smaller dairy farmers exit the industry, with fewer but larger farming operations remaining. Over time, this shift may allow farmers to leverage their size when negotiating prices with processors.
While it might take some time to eventuate, the two factors of new investment and increased prices will bring benefits to Australia’s dairy sector – a sector that has demonstrated resilience in remaining competitive through all of its recent challenges.
Source: Deloitte 2019-02