After one of the most turbulent years in recent memory for the dairy industry there is much hope that prices will begin to ease downwards in the first half of 2014. However there is still much reason for caution as we are most certainly not witnessing the easing of prices just yet. The clearest indication of this is in New Zealand, where they are in the middle of a so far successful production season when compared to last year. There have been no immediate signs of the Fonterra GDT auction prices easing as there have been further increases in the latest auctions after a slight easing in October/November. That is a prominent sign that supply has still not caught up with demand worldwide with most exports still heading to the Asia Pacific region. Prices increased 3.9% at the last auction for example and this means the total increase of the index for the entire year is +47%. As New Zealand has enjoyed a much healthier season this year it is again a clear indication of the buoyant Asian demand sustaining dairy prices at extremely tight levels. There are warnings this could continue until Q2 at least. When hopefully prices do ease up it is not expected to be anything too dramatic.

Prices for milk powders are still rising. Demand is still extremely high with reports of forward volumes of SMP being sold for $4,920 for May 2014. China has experienced an especially tough season with a large culling of cows due to a foot and mouth outbreak.  This has put pressure on domestic production and has further contributed to larger than expected demand for imported powders recently. To sum up their situation in general, the Chinese demand for higher quality imported milk products after the 2008 melamine scandal has inevitably caused the exit of small farmers. This has caused big problems as they have traditionally made up the backbone of the industry. There has not been a sufficient increase in larger commercial farms to compensate for this loss. With a vastly expanding middle class who are now buying dairy products, the domestic market can simply not yet provide for itself. This is again reflected in the commodity prices as the big 7 exporting regions have all enjoyed increased productivity in 2013 without seeing prices drop. China’s reliance on international imports looks set to continue for the foreseeable future. There are indications that because of this, current commodity prices could sustain similar levels longer than what we witnessed when the market crashed in 2007.

Hopefully 2014 will not see any adverse weather conditions we have witnessed in the recent past. If the Northern Hemisphere production season is disrupted again we are then at the mercy of extremely unpredictable markets. Stock levels are still low across the main exporting regions and show no signs of immediate recovery due to high export demand. This leaves the market particularly exposed if production falls and prices would then inevitably rise past current levels which would be another unwanted new record. The European and North American markets are being controlled at the moment by overseas demand as domestic consumption of dairy products has remained relatively stagnant due to uninspiring economic conditions. The occurrence of rising retail dairy prices has further hampered the purchasing power of consumers and because of this the major processors have been keen to drive for further exports. Stock levels will stay at similar levels with this desire to feed the Asian demand so there is a downside to these vibrant market conditions at present.

Back in the domestic market there was a very interesting development back in October with a major merger announced. After a month of speculation it was finally revealed that First Milk and the Irish Dairy Board have signed up for a long term strategic partnership where the IDB will take control of all packaging and marketing of F/M’s cheese production. This will allow F/M to focus on growth areas and export markets. It is believed F/M have committed to supplying the IDB with at least 50,000 tonne per year. The packaging will take place at the IDB’s current facilities at their plant in Leek, Staffordshire. They have stated they do not need to make any significant investment at their site to accommodate the extra volume so this is a clear indicator that they are actually currently running with vast excess capacity.

The deal is intriguing and many in the industry believe it is a clever strategic move for both sides. F/M have been struggling recently as they have posted less than inspiring annual financial accounts for the past few years. They also lost a key deal with Asda to supply their own label cheddar recently which was a huge blow, causing them to announce the closure of their plant in Wales. The volume of the Asda contract was 25,000 tonnes annually. Apparently the Asda buyer was in America at the start of the year and correctly predicted the potential turbulence ahead in the European market from his assessment of market conditions in the US. He wisely sat F/M down to negotiate an annual price on his return. F/M hugely erred by agreeing to this deal and the market then rose to the level where they could not sustain pricing. They then made the fatal mistake of trying to backtrack on their agreement by threatening a force de majeur on the contract. This inevitably led to the loss of their contract along with 230 jobs at the Maelor cheese packing plant causing much anguish for an already economically depressed region.

For the IDB the benefits seem particularly obvious. They straight away have a chance to boost their turnover from £350m to £500m with the extra volume taken on board. Their strength is also in marketing and packaging with their state of the art facilities so they should thrive on this opportunity. The IDB owned brand ‘Pilgrim’s Choice’ (Adams) is already the second top selling cheese brand in the UK behind Dairy Crest owned Cathedral City. With this brand already fully established in the UK market they can only go strength from strength with this link up. They now have more access to British cheese and this is vital as retailers are being more insistent on most of their cheese being locally produced. F/M were also worried about the extra influx of Irish cheese into the British Market after the EU quotas will be abolished in 2015. It is now rather ironic they have now decided the best course of action to protect their interests in this area is by linking up with the Irish!

The IDB have had a busy few months as they also announced they are investing up to €20m in projects in Saudi Arabia, the world’s fifth largest dairy importer. They acquired a 75% share in the Al-Wazeen dairy importer and distributing company and also announced they will develop a new cheese manufacturing plant at the Al-Wazeen facility in the capital, Riyadh. They will produce specially made white cheeses mainly at this plant to cater for the preferred tastes of the local people. The IDB have also outlined their long term plans for Saudi Arabia and they see it as a key manufacturing hub for the supply of Islamic Halal markets in the MENA region (Middle East/North Africa). As Saudi Arabia and the MENA region in general do not have suitable milk production capabilities due to the extreme climate, it is an ideal potential growth market for the IDB and one they will be hoping to benefit from when the quotas are abolished. With this announcement they have stolen a march already on their rivals.

In Australia there are many eyebrows being raised as the bidding battle for Warrnambool Cheese & Butter has reached astronomical levels and shows no immediate sign of halting. The two main players in the bidding process are Australia’s largest dairy Muray Goulbourn and the giant Canadian dairy Saputo. Currently the highest bid is at A$9.60 per share from Saputo with many believing it could go as high as A$10/share which seems to be far above WCB’s true value. The reason behind this manic bidding by Saputo is the desire to gain a foothold in the Oceanic market due to its close proximity to the key growth zone of South East Asia. Its growth opportunities are limited in Canada so now we are seeing their determination to grow in this area. By bidding such astronomical amounts though they are undermining their reputation as a “disciplined acquirer”.

Looking into the crystal ball again it has been projected that the global demand for dairy is expected to increase 30% to 515bn litres by 2021. With the way dairy consumption is growing worldwide it is predicted that supply will struggle to keep pace with this demand so it could very possibly lead to familiar tightening of prices that we are currently witnessing. There is also reason for optimism though. NZ’s production is expected to increase from 19bn litres to 22bn litres by 2021. It is hoped this growth along with an EU free from the burden of quotas, the US and a growing Latin American market will be able to cope with the demand. Ukraine is also rapidly increasing their production and this is also important on a global scale as they are the main exporters to Russia, who are the world’s largest importer of dairy products. It is also hoped by this time that the Asian dairy industries will have improved production significantly enough to help with their own domestic supply which is driving the growth.

To conclude we are once again hoping to see improved market conditions in the months ahead but unfortunately going by market information nothing is guaranteed. Unless we see a dramatic increase in production in the key exporting regions where they can cater easily for their own domestic markets as well as the main export markets, we will see prices remain tight for another few months at least. However this is easier said than done. As you are already well aware of we are your source of guaranteed supply and we look forward to working with all of our customers again in 2014 where we will again enjoy mutually beneficial rewards. As we have excellent long term trading relationships with all our suppliers from every corner of Europe we can also offer very competitive prices to ease the burden of the drastic price increases we have all experienced. This has been the most volatile year I have ever experienced in all my time in the industry and I want to express my gratitude for the faith you have shown in us by staying with us and offering your support. We wouldn’t be in the position we are today without you and we won’t forget that. I wish a happy and prosperous new year to all and best of luck for the coming months.

Ian Galletly

Managing Director