We're getting close to the peak of the production season in southern Australia, in one of the most tumultuous periods in the recent history of the industry. In the past 18 months, an unprecedented volume of milk has moved between major dairy companies in a short space of time, and most likely has some way to go yet, as the aftershocks of the major step-down in milk prices towards the end of the 2015-16 season continue to reverberate.
Prices have surged in recent weeks - butter prices in the EU have reached record highs, which has knocked onto prices across the world.
How did we get here?
There’s been a gradual rise in demand for butter and dairy-based spreads over several years, after the messages to consumers about the health benefits of natural dairy fats cut through, dispelling myths about the advantages of vegetable oils.
We’ve seen that in the numbers for supermarket sales of spreads in Australia (sales of butter and spreads grew 23% in the five years to 2016), but that has also extended into wider usage in food service and manufacturing.
The rise of butterfat is a global phenomenon, evident in massive consumer markets of the US and Europe, including some recent high-profile decisions by major fast food chains to replace veg oils with butter.
The threat to the integrity of some brands from use of palm oil has also helped.
Demand has built in other markets as well. Global butter trade grew 20% over the 5 years to 2016, and could have been greater if there was more supply from major exporters.
The change in EU’s export trade has been more dramatic – it grew more than 40% in the year to September 2016.
However, the surge in butterfat prices in global markets is not simply due to a sudden lift in demand. While demand has steadily built, the crisis has come because of a recent fall in supply.
Ironically, the situation is due to a glut in the supply of protein, which has mostly been triggered and worsened by a series of Government policies.
European milk supply boomed after the EU Commission removed production quotas.
Milk output grew so rapidly without those limits and with a perfect season that an impressive stockpile of skim milk powder (SMP) quickly built, crashing prices across the globe for commodities.
Farmgate prices in Europe followed, tractors rolled into Brussels and milk cannons were aimed at police and government buildings.
The policy response from the Commission - to help stabilise markets and improve milk prices for EU dairy farmers – was to re-open an old device, an intervention program to take a significant volume of skim milk powder “off the market”.
The resulting intervention stockpile of 350,000t of SMP still overhangs the market, with the Commission’s stated selling price well above the market since buying stopped.
Low SMP prices have discouraged the production of fresh SMP… and therefore butter, as the returns from this manufacturing combination were much worse (and more uncertain) than those from cheese and whole milk powder.
In the second half of 2016, the Commission layered another reactive policy measure, offering cash incentives for dairy farmers to produce less milk – which worked – compounding the problem for butter buyers.
New Zealand’s lower milk output from a wet season it’s preference for WMP and cheese hasn’t helped alleviate fat shortages.
EU milk supply is on the way back in 2017, now almost at prior year levels, yet butter output is still well down in preferences for milk use.
A recent further burst in prices came as a cold spring slowed the EU’s milk recovery, buyers expected the usual spring flush would bring better butterfat supplies.
It’s ironic. Reactive policy measures to “rescue” farmers by propping milk prices have created a chronic shortage of one of the industry’s rising product stars, and hiked the costs for buyers – which may in turn prompt reformulation back to alternative fats.
Rather than the dairy sector managing a steady expansion in dairy fat demand across all market channels, it suddenly gets the chance to test the limits of hard-fought gains in demand at extreme prices.
More milk in New Zealand and Europe will help some stranded buyers in the trade. The future of SMP prices, which will be low for some time, hold the key to attracting more milk to make more butter.
The future of intervention powder is important, but becomes less relevant as it ages. It reminds us of the famous wool stockpile – remember how well that turned out?
There are other strange consequences of these freakish prices as a result of this glut/shortage dilemma. The values of pure protein and fat implied by product prices have taken the ratio of protein to fat below 1:1 - this ratio tends to sit between 1.5:1 and 2.5:1, consistent with milk price payment rates for protein and fat in southern Australia.
It would be a big call to alter payment ratios in response to these extremes, but stranger things have happened in milk pricing!
How will this unravel? Demand for butter will slow at record prices, but by how much will be interesting, given the changes in buyer preferences.
When the full effect of higher prices reaches shoppers there will be a response, but it’s hard to say by how much as we’re in untested territory given the shifts in eating preferences.
Steve Spencer is a directot of www.freshagenda.com.au