Volatility is good (because NZ dairy is resiliant)

I was talking to a number of dairy farmers and professionals on Friday; we ended up discussing commodity prices, exchange rates and the outlook for the NZ dairy industry.  We all agreed that the outlook is for some volatility in prices - not normally a good thing in business.  But we came to a surprising conclusion; because the NZ dairy industry has so much in-built resilience volatility works in our favour.

The reason for this conclusion is based on a ratio; the ratio between the milk price farmers are receiving and the feed costs for producing that milk.

For the NZ dairy industry, the ability to feed low cost pasture is key to profitability, and NZ dairy farmers generally enjoy materially higher profitability than farmers elsewhere.

Based on Dairy NZ cost estimates, NZ dairy farmers spend on average 16 cents per kg drymatter with the costs made up from supplementary feed, grazing costs, fertiliser, irrigation, regrassing and weed and pest costs and run off costs.

At the current milk price of $6.75/kgMS, the milk to feed price ratio is 3.7 times.  Last year the ratio was much higher with the $7.60 milk price.

By contrast the ratio in the US milk price to feed cost ratio is 1.9 times*.  Generally the ratio needs to be higher than 2.5 times to promote milk production growth.  I note that in August 6% more cows were slaughtered in the USA compared to a year previous - probably because of this ratio.

The fact that our industry benefits from a low cost pasture-based system is the reason for our resilience; NZ dairy can operate profitably at a wide range of milk prices. 

So the reason that we believe volatility is good; a period of lower dairy prices will put 'the squeeze' on farmers using confinement dairy systems - which in turn means that the bull run in dairy prices has the prospect of remaining in at least the medium term.

*http://future.aae.wisc.edu/data/monthly_values/by_area/2058