The Situation and Outlook for Dairying 2002/03

Summary

The two relatively good years financially for dairy farming (2000 and 2001) have been followed in 2002 with a serious decline in net margins from milk production. This translates into an equally serious fall in total dairy farm incomes. There will be sizeable differences in the impact on farm incomes because of regional differences in the severity of the adverse weather conditions in mid-season and the consequential exposure to higher costs of production. Despite the higher costs incurred, the large reduction in milk prices (averaged at 8.5% or 2.7 cent per litre), was the main contributing factor in the lowering of net margins by an estimated 20% on average. In the absence of the EU support system for dairy products, the fall in milk prices would have been much larger as happened in other non-EU major export dependant countries.

There is a low probability of any major improvement in the margins from milk production in 2003. However, there are positive signs that international prices for some dairy products could continue to improve into next year. Whether such price improvements would be of sufficient magnitude, or be realised before the major portion of Irish milk deliveries are made, is very uncertain. Milk production costs are expected to show no appreciable change next year, which means that this years' relatively high levels will be repeated. As product prices and costs are forecast to be largely unchanged, the historically low net margins per unit of production are likely to hold again for 2003. The eventual outcome from the deliberations of the Milk Quota Review Group and the Minister's decisions may provide a better platform for improvements in productivity and cost efficiency in the future.

Review of 2001 and 2002

The actual financial results for dairy farms for 2001, derived from National Farm Survey (NFS) data, turned out even better than had been estimated a year ago. The value of gross output per cow, and per hectare, had higher than expected increases of 9% and 8% respectively. The main reason for this was that the average milk prices paid per litre were up over 6% (rather than the 4.2% estimated) from 29.6 cent to 31.4 cent. The contribution to gross output from calves was unchanged in 2001, but there was an increase in cow replacement costs, the third component of gross output.

Source: Derived from National Farm Survey data and own estimates
¹Actual, ²Estimated, ³Forecast

Total input costs also increased at a slightly faster rate than direct costs. The more modest increase in costs compared to gross output resulted in average net margins earned in 2001, of €678 per cow, €1352 per hectare and 12.85 cent per litre. The actual results per cow and per hectare for 2001 are shown in Table 1.1 and results per litre are shown in Table 1.2.

Milk yields increase strongly

Another notable feature of the results for 2001 was the further improvement recorded in average milk yields per cow for the fourth consecutive year. This persistent increase in cow productivity follows a period of years in the mid-nineties when negligible changes occurred in national average milk yields. The increase in yield per cow on NFS farms in 2001 was 3.5%. The cumulative average increase in milk yield since 1997, on dairy farms with good soils, has been over 13%. Since the quantity of milk per cow retained on farms, mainly for calf feeding, has varied little for many years, it follows that the quantity of milk sold per cow has increased in tandem with the upward shift in yields. It is therefore puzzling that milk sales per cow derived from published national statistics do not appear to have increased at anything like the rates indicated by results from a representative sample of farms in the NFS.

Figure 1: Milk sold and yeild per cow-NFS v CSO: 1991-2001

The extent of the deviation which has occurred in milk sold per cow since the Agricultural Census year of 1991, between the NFS and official aggregate statistics, is shown in Figure 1. This figure also includes the evolution in average annual milk yield per cow based on the results from all milk producing farms in the NFS. The comparison shows that in 1991 (the Census year) there was fairly close agreement between both sources. But, there has been almost continuous divergence since then with latest results available for 2001 showing a difference of 518 litres per cow sold.

There is ample evidence that milk yields on farms were moving up in recent years due to greater use of higher genetic merit bulls. Average yields would also have been boosted due to the annual exodus from milk production of mainly smaller dairy herds, which have comparatively lower milk yields. Estimates from official sources are based on the total milk intake (deliveries) reported by milk purchasers and the June enumeration estimates for the total dairy cow numbers. The aggregate milk intake figures are likely to be quite accurate because of the application of the milk quota regime reporting and auditing requirements. This leaves the possibility that the estimated national dairy cow numbers in the June (or December) enumerations have progressively become more inaccurate since the 1991 Census year or that the results from the "representative" sample of farms in the NFS have become extremely biased over the years. It is the writers' view that it is more likely that revisions are needed in the enumeration estimates of national dairy cow numbers. This author estimates that a reduction in the region of 100,000 dairy cows may be needed in the June 2001 enumeration estimate to more accurately reflect the number in the national dairy herd at that time.

Margins decline in 2002

The estimated results per cow and per hectare (ha) for 2002 are also shown in Table 1.1. A major decline in the gross margins were sign-posted a year ago, but the size of the reduction was larger than forecasted. The average fall in gross margins per cow and per ha were just over 10%, while average net margins were down by 20%. A fall in milk prices, by an estimated 2.7 cent per litre (cpl) or almost 8.5%, was the main contributing factor to the decline in margins. But the estimated increase in total input costs (+3.5%) added to the decline. Higher calf values (+25%) in 2002 made a positive contribution to gross output equivalent to 0.7 cpl.

The decrease in Irish manufacturing milk prices this year has varied quite a lot between milk processors. Also it would appear from using the Irish Dairy Board on-account prices paid for butter and skim milk powder (SMP) as a guide, that several milk processors may have drawn on cash reserves to prevent milk prices falling to the full extent reflected by market returns throughout 2002. All of the major dairy product categories had a very challenging year in the market place. Butter has been strongly dependent on the current intervention price since falling to that level in August 2001 and staying there ever since. In addition the quantity of Irish butter production sold into public intervention increased markedly in 2002, from 13,660 tonnes in 2001, to an estimated 47,500 tonnes by the end of this year. This equates to an increased dependency from 10% to 36% of total butter production.

The market for SMP in 2002 was similarly depressed and substantial sales of product into intervention occurred for the first time since 1999. In all, about 26% of SMP production was intervened this year. Full intervention price from February until June helped put a floor under Irish milk prices. At that time, the volume of SMP going into EU intervention stores triggered the price tendering procedure for the first time since 1991. As a result, subsequent sales of SMP into intervention were at reduced prices falling from 98.5% to a low of 95.5% from the first to the final tender prior to closure at the end of August. In the weeks following this, there was a strengthening in international market prices for SMP, but this appears to have plateaued for the present. EU export refunds for dairy products having been restored to a relatively high level in July were adjusted downward several times since then. These reductions have eroded the competitiveness of EU products on export markets. Casein prices derived from the main market in the US also remained depressed throughout the year and probably yielded returns similar to or below that available from SMP. Weaker market returns resulted in a decrease in casein production of about 10% and the consequent increase in SMP production.

Cheese was the major success story in the Irish dairy product portfolio in 2001. A record 120,000 tonnes were produced and cheese prices returned at least 5 to 10% above basic intervention price for most of the year. A major downturn in prices was in progress during the final months of 2001. This continued into this year with excess stocks and increased production driving down prices in the UK - the main export market for Irish cheese. Seasonally high milk production, very low milk prices and restricted manufacturing capacity for alternative products, in the first half of 2002 in the UK, led to higher UK cheese production and further price reductions. Cheese prices in the UK have shown an upturn since September. However, Irish cheese prices on average in 2002, probably returned a milk price equivalent below that obtainable from intervention products. Despite the difficult year for Irish cheese manufacturers, the quantity of cheese produced only fell by about 6%. This can be interpreted as a positive sign for the future and underpins the need to diversify away from the dominant dependence on butter/SMP production.

Production Costs Rise

Higher costs were again a feature of milk production in 2002. Direct costs rose by an estimated 3% and overhead costs by nearly 4%. A rise in purchased concentrate feed costs was the main factor in driving up direct costs. The extended period of wet weather from mid May to July made grazed grass utilisation very difficult and the volume of purchased feed input went up by an estimated 30% since early May. Luckily the exceptional increase in mid season feed demand was largely counter-balanced by a significant decline in the quantity of dairy feed purchased in the early months from January to early May. The net result is that the average volume of concentrates fed per cow in 2002 may be only about 6% higher than that fed in 2001. But because of the differential regional impact of the weather conditions, there will be major deviations in the additional feed purchased on different dairy farms. Concentrate prices rose again in 2002 by over 3%. Forage costs have fallen this year due largely to an estimated reduction in the volume of fertiliser used, but also, due to a reduction in fertiliser prices of 1.5% and 3% for PK compounds and CAN/urea respectively. An increase of 4% has been built into overhead costs, which is slightly below the general increase in price inflation.

In summary, the large drop in milk prices in 2002, partially offset by an increase in calf values, has resulted in a substantial fall in the value of gross output on dairy farms. Further increases in both direct costs and overhead costs have exacerbated the serious decline in the estimates for gross margins (-10%) and net margins(-20%) experienced this year. The trend over recent years, expressed in cent per litre, for gross output, costs and margins for manufacturing milk produced on specialist dairy farms is shown in Table 1.2. The estimate and forecast for net margins per litre for 2002 and 2003 are the lowest, even in nominal terms, since 1991. The fall in real terms, after adjusting for inflation from 1990 to 2002, is of the order of 45%. This would mean that the real net margin this year is equivalent to 5.7 cent per litre at 1990 prices.

Source: Derived from National Farm Survey Data and own estimates
E = Estimated
F = Forecast

Outlook for Dairy in 2003

The degree of change that might be expected in producer milk prices in 2003 is not totally clear at this stage. Some signs of recovery in international demand for dairy products are evident. However, there is always the question of whether some milk purchasers, who absorbed part of the price fall this year, may take the opportunity to replenish reserves unless there is a very strong recovery in product prices. The information available suggests that the probability of any substantial increase in milk prices in 2003, is quite low, at least up until June or July.

Butter is most likely to return prices closely tied to the intervention price equivalent, which prevailed throughout 2002. Per capita consumption of butter continues to fall in the EU and an overhang of intervention stocks in the EU will not allow for any appreciable price increases. Some recovery in milk powder prices may be more likely, but limited. The overhang of EU milk powder stocks in the EU will prevent any major price increases initially, as they will be released periodically if international prices rise. It should also be noted that current EU export refunds rates will be further reduced if market prices harden. Another dampener on SMP price recovery in 2003 would come into play, if the US authorities proceed with their stated intention to release a large tranche of the current stockpile of 540,000 tonnes of SMP, for food aid. Such an action would inevitably depress commercial prices on export markets.

A more likely factor leading to an improvement in dairy product export prices is the current difficulties affecting Antipodean milk production. In Australia, a prolonged and severe drought is depressing milk deliveries. Recent industry forecasts indicate a 3.3% reduction in 2002/2003. The potential for further growth in milk supplies in New Zealand is also expected to be limited with an expected fall in milk prices of 30% in supplies in 2002/2003 and farmers there had to contend with variable weather conditions in the early production months. Argentina is also experiencing a contraction in milk production, which may leave some opportunities in export markets in South America.

Another major question of relevance is whether the euro will continue to strengthen against the US dollar. This now seems less likely as the near term prospects for economic growth in the main European economies are predicted to be weak. Prospects for growth in the US economy are better but are subject to major uncertainty due to the potential for conflict in Iraq.

A more sustained recovery in EU cheese consumption and in market prices in the UK and a lowering of production in Oceania may prove the best hope of providing scope for a lift in milk prices. But given that cheese production only accounts for about 24% of the utilisation of Irish manufacturing milk supplies, the potential to raise prices in 2003 is still limited. Casein has also become a more important dairy product in recent years. It accounted for over 50% of skim milk use in 2001 and yielded better financial returns then SMP last year. However, this year, it appears the position was reversed with casein returning no better than SMP. As a result, casein production fell by almost 10%. Casein returns may be stronger than those from SMP in 2003. Steady growth in milk powder use in infant formula provides an important added value outlet for Irish dairy ingredients. Expansion plans announced recently by a major international player with a manufacturing plant in Ireland, has given a major boost to this small but growing market led production base.

Taking all the factors discussed into consideration, manufacturing milk prices will be closely linked to the intervention price equivalent for butter and SMP. This is about 30.2 cpl before processing costs are deducted. This assumes a lower average constituent levels for milkfat and protein than currently prevails on farms. Adjusting for this, deducting a guesstimate for processing costs and including the VAT rebate - a conservative average manufacturing gross price for milk next year would be around 28.7 cpl. Any significant price recovery in the UK cheese market and / or in international commodity markets would enhance producer price expectations. Calf values are not expected to be quite as strong next year and cow replacement costs are assumed to remain unchanged. Therefore, gross output values may be only marginally higher.

Production Costs in 2003

Total milk production costs are unlikely to change greatly next year. Dairy concentrate feed is expected to rise by about €5 per tonne (2%) but a reduction in the quantity fed per cow should reduce the overall cost of purchased feed. The reduction in purchased concentrates, possible in a normal year, will be constrained due to the extra supplements that will be required to compensate for the much lower quality silages conserved this year. Fertiliser prices look set to rise early in the new year and could be about 4% above average prices in 2002. Reports indicate that there are no surplus stocks in Europe and with IFI closing all their production plants, there will be a further reduction in availability of supplies. Stocks held by IFI, equivalent to about 50% of annual output, are likely to be released on a phased basis in 2003 in order to maximise price returns. Fertiliser application rates on dairy farms should stabilise in 2003 after three years of decline. Stability is also expected in the level of other direct costs. Thus with higher forage costs being offset by lower purchased feed costs, total direct costs should remain largely unchanged in 2003. Some overhead costs may fall if investment falls, but other elements of overheads will be affected by the general inflation in prices in the Irish economy. Thus total costs being forecast for 2003 will remain at the relatively high level reached this year on dairy farms.

Since only minor changes in milk and calf prices are reflected in 2003 and total costs stay largely unchanged, the margins earned per cow, per hectare and per litre, (particularly net margins) will remain close to the historically low levels estimated for 2002 (See Tables 1.1 and 1.2).

Given that the current cost / price squeeze in unlikely to be significantly reversed in the foreseeable future, this leaves improvements in farm productivity and in cost efficiency as the main means available to maintain real incomes from dairying. The rate of productivity improvement that can be achieved largely depends on the quantities of milk quota that can be acquired over time. In the last three years, under the revised national quota regulations, there has been a permanent transfer of 550 million litres to active producers. This equates to an average of about 3.5% per year of the national quotas, as compared with an annual transfer of less than 1.5% annually in the 1990's. Maintaining permanent quota transfers at this higher rate annually would provide the basis for a very satisfactory gain in productivity levels for very many committed dairy farmers.

However, providing more equitable opportunities for quota acquisition on a nationwide basis and across all size categories would need to be addressed if productivity gains are to be maximised and cost efficiencies enhanced. This would be a relatively straightforward exercise if only private costs and benefits had to be assessed. Currently, there are positive externalities applying to certain production areas under the present quota regulations and clearly defined discrimination in favour of small and medium sized milk producers is in place. The Minister of Agriculture and Food recently requested the Milk Quota Review Group (MQRG) to make submissions on those issues with a view to amending the current restrictions on quota transfers from the restructuring scheme. The administratively set price for quota sales and purchases is also included in the review. The recommendations from the MQRG, and the final decisions by the Minister, will be of major relevance to the entire Irish dairy industry on the road to further reform of the C.A.P.

Acknowledgements

Data supplied by the Central Statistics Office and by the Department of Agriculture and Food were used in making the estimates for 2002. Staff of the National Farm Survey provided the basic data used to compute the results for 2001. Invaluable information and very useful comments were contributed by Anne Randles (Irish Dairy Board), Sean O'Sullivan (Dairygold) and colleagues in Teagasc. The technical assistance from Michael Cushion is much appreciated.