Fundamental issues for Australia’s dairy industry

     

Dr Peter Stahle

Executive Director
Australian Dairy Products Federation (ADPF)

    
David Basham

Acting President
Australian Dairy Farmers (ADF)


Q1.  The current year has been a tumultuous one for the dairy industry in Australia, which has seemingly gone from poster-boy to problem child in a matter of months. Has this just been a case of the market working, or are there more fundamental issues that need a response?


Dr Peter Stahle, ADPF

The Australian dairy industry is a global player and there is no way of escaping the effects of the volatility that has characterised international dairy trade of late. By the end of 2015, the general optimism in the Australian dairy industry that had been driven by the opportunities flowing from Asia, more liberal trade arrangements, and the level of new investment, had been tempered by the spectre of continuing low international commodity prices. The combined effects of a slowdown in Chinese demand in 2014, the Russian ban on dairy imports and continued growth in EU milk production are likely to keep global product prices low until at least 2017.

For a time, Australian farmgate pricing was shielded from international pricing by strong processor competition for milk supply but price corrections (May 2016) have brought global realities to local markets. This has exacerbated the effects of very dry conditions in south-east Australia over 2015/16. While climatic conditions are forecast to improve, continuing low farmgate pricing in the south eastern states will make 2016/17 a challenging year for many dairy farmers and processors as they plan for a resetting of market dynamics.

 

David Basham, ADF

The fundamentals in the dairy industry are strong going forward, with strong growth in demand for Australia’s key markets, in particular Asia. The current downturn has been driven by the normal cycles within the dairy commodity markets but has been hard hit due to other factors.

The way the dairy industry operates in Australia is there are about 10 major milk processors, some mainly domestic players and some much more exposed to the export markets. At the beginning of every financial year, milk processors announce their milk prices (the price by milk solids) and then the amount they expect it to increase by the end of that financial year.

During the financial year of 2015/16 the milk companies came out with quite bullish pricing following the largest milk company, Murray Goulburn, forecasting a closing price of over $6 kg/milk solids.

Other factors contributed to the downturn. In 2014 when Russia used their military to forcibly remove the Crimea from the Ukraine, Australia imposed trade sanctions on Russia. Russia then responded by imposing the same trade sanctions on Australia leading to a ban on all dairy exports. Further to this, in 2015, Russian-backed rebels shot down Malaysia flight MH17 killing almost 300 people. The European Union (EU) responded and implemented sanctions against Russia. Vladimir Putin retaliated again by banning all imports from the EU, including dairy products, which is important because the EU is the world’s biggest dairy product exporter and Russia was its biggest customer.

So one of the major dairy importers globally, and a significant importer of the Australian dairy market shut the door, leaving the dairy markets flooded with too much product.

Murray Goulburn continued to tell farmers they would hold the $6 price all the way until the end of February this year. By April, the company also decided it could no longer afford to pay $5.60 for the year and slashed the annual milk price well below $4.80.

Meanwhile, Fonterra was intertwined because the company promised to match the highest milk price of their biggest competitor in the industry, which was Murray Goulburn. The New Zealand shareholders of Fonterra were demanding the company to follow Murray Goulburn down as the dairy farmers in New Zealand were receiving significantly less than their Australian counterparts.

Nearly every other processor in Australia managed to hold their price and remain steady.

The move forced dairy farmers to drop more than 10% off their milk prices for the entire year, in just two months. Imagine having to pay back 10% of your annual wage in two months on top of your regular expenses. That is essentially what Murray Goulburn did.


Q2.  There has been criticism that the current contracts between dairy processors and farmers put all of the risk on farmers, and are no longer appropriate in an era in which the industry is dominated by corporates rather than cooperatives. How do you respond to this?

Dr Peter Stahle, ADPF

I don’t abide by the suggestion that the industry is now dominated by corporates; cooperatives in Australia continue to play a major role in our industry.

With respect to contracts, it doesn’t matter which side you stand, it is human nature to wish to socialise the risk and maximise individual reward. Finding the balance between these opposing forces is at the essence of creating the ideal contractual relationship. Ultimately the parties to a contract will judge the fairness of a contract by their perception of their respective gain, or cost; and how that exchange is perceived at any juncture will vary with the passage of time and circumstances.

The model dairy milk supply contract will form the basis of an enduring mutually beneficial relationship between the farmer and processing company, and I would argue, whether corporate or cooperative, dairy processing companies will ultimately only thrive if they look after and remain attractive to suppliers.

It’s in everyone’s interests to work together to uphold the reputation of the industry, particularly as we as a society create an increasingly litigious and complex operating environment. Under the Auspices of the Australian Dairy Industry Council, the dairy companies welcome the opportunity to engage constructively with the farmers to develop contracts that serve the needs of both sides of the farm fence, and comply with the new Contracts Legislation that will come into force in November.

 

David Basham, ADF

We have committed to working with processors to ensure all contracts comply with the Unfair Contracts Legislation that begins on 12 November 2016.

The new Unfair Contracts Legislation extends existing protections that consumers have to small businesses for the first time.

For example, protections that help to ensure that prices or payments in a contract cannot be unilaterally varied. Dairy farmers are at the start of the supply chain and must deal with much larger businesses with significantly more market power and resources, putting them at a disadvantage.

Farmers bear a significant part of the risk along the supply chain and this risk needs to be better balanced between retailers, processors and farmers – the new unfair contracts law, along with other competition changes such as the Effects Test, will help this.

Processors and retailers should ensure that farmer contracts and supply agreements are transparent, fair, simple, realistic and easily understood.

ADF has lobbied hard for this change, and others such the Effects Test, and welcomes all efforts to balance the current imbalance in market power that exists across the value chain.

It is important for farmers to be aware of these new protections, to ensure they get a fair deal when entering into a standard form contract with a larger business.

The thresholds in the new legislation will cover the majority of dairy farmers but may not cover all dairy farmers. We are still working with the government to ensure all dairy farmers are covered by the unfair contracts law.


Q3.  There has also been criticism levelled at dairy farmers to the effect that the market signals were very clear about an impending milk price drop well before the events of this past April, and farmers should have been better prepared. Is this a fair criticism?

 

Dr Peter Stahle, ADPF

There is no doubt that amongst the broad industry commentary of the past two years, or so, there have been grim market signals and projections. These have been observed and discussed over the farm fence, in the corporate boardroom and in the halls of government. Whether, and how, farmers (and companies) chose to respond to these signals are questions that can only be answered and understood in the context of the personal situation and risk profile of those concerned.

In business, as in life in general, there are those that succeed through their ability to astutely observe and respond decisively to market signals; and there are those that don’t. With hindsight it is fair to say that there will be both farmers and dairy companies wishing they had responded differently to recent circumstances. The fact that there are still profitable dairy companies and farmers, bears testimony to the inherent integrity of the industry and the worth of the information exchange that underpins its operations. The challenge to the industry is to ensure that all that need that information have ready and easy access to it, and a carefully formulated and promoted market index may just provide a major part of the solution.

 

David Basham, ADF

Almost 50% of farmers in Victoria were affected by the Murray Goulburn and Fonterra price drop earlier in the year. Regardless of fluctuations in world price, Murray Goulburn continued to forecast a price that seemed to be above most market analysis and encourage their suppliers to produce more milk.

The farmers were constantly checking prices and watching global markets. They were asking the right questions, but were being told by Murray Goulburn not to worry and that everything was ok. Fonterra was telling their farmers that the price was too high but had an agreement to at least match Murray Goulburn.

This crisis is not the fault of the farmers. They were misled into thinking that they were going to continue to get a fair price for their milk. The global oversupply should have been recognised by Murray Goulburn much earlier so this situation never happened.