Will downturn in sector profitability lead to land use change?

Will downturn in sector profitability lead to land use change?

By Allan Barber, Rural News,; 3 May 2015

Previous downturns or relative changes in sector profitability have generally led to a change of land use; and because sheep farming was the predominant 20th century rural activity, land use change was usually to a form of farming other than sheep.

Think forestry in the late 80s and 90s, dairy since the early years of this century, horticulture, grape growing and rural subdivision for lifestyle blocks since the 1980s.

Now the dairy payout has almost halved in 12 months because of global overcapacity and weaker economic conditions, the question arises whether there will be a flight from dairy, either back to sheep and beef or to one of the other agricultural options.

There are two main facts about the dairy sector: the current price is below the cost of production and global dairy production will continue to increase.

There are also differing opinions about the implications of the price downturn and the prospect of improvement in the near future.

Improvement will depend on recovery in the world’s major markets, notably the EU and China, as well as a resolution of the stand off between Russia and NATO countries.

China is going through an adjustment of its economy, as it tries to achieve a soft landing, but its growth rate will not be allowed to move back up to its previous heights.

While last year’s record payout was almost entirely due to the impact of Chinese demand, this is unlikely to be repeated in the next five years, if ever.

Europe’s economy is a basket case because of lack of demand and deflation in most EU countries, while the ECB tries to stave off a recession by printing billions of Euros.

However the removal of milk production quotas on 1 April will see a lift in volumes in some countries, including Ireland with an objective of 50% growth by 2020, western France, Denmark and the Netherlands, which will result in more dairy volume on global markets. EU exports have already increased by 45% in the last five years. The United States economy is improving and dairy production there is also rising.

Fonterra’s recent announcements don’t exactly give great confidence there is any improvement just round the corner. GDT prices have fallen sharply since February which contrasts with hope expressed before Christmas the price would recover to $3500 a tonne which was the average required to preserve a $4.70 payout. Now the payout forecast has fallen to $4.50 where NZX Agrifax has had it for the last two months.

Almost worse, the dividend payment is stuck at 20-30 cents per share, at a time when low milk prices should have flowed into better added value margins.

In an environment of greater milk production and hopefully increased global demand, the importance of a value added product strategy becomes ever more pressing. Fonterra appears to be stuck closer to the commodity end of the spectrum and its product mix is still geared towards the farmer milk payout priority.

Unfortunately this season has illustrated how limited that strategy is.

The V3 initiative the company is pursuing must make fast progress as suggested by the third V in the strategy, that of velocity.

But for those looking to change their farm activity, the main alternative farming type, sheep and beef, has failed to maintain its 2014 improvement, further progress on meat industry restructuring is unlikely to happen, until participants assess potential developments arising from Silver Fern Farms’ equity raising programme.

The red meat sector needs to get its act together in a hurry, if it is to have any hope of encouraging dairy farmers to jump back over the fence.

At the moment the best the sector can hope for is a slowdown in the rate of dairy conversions which surely must come to a sharp halt after the latest downgrade.

Next season will be a nervous time for both dairy farmers and New Zealand as a whole, as they wait to see whether the White Gold rush will come again or merely more milk down the drain.