Landcorp, the milk price and born again environmentalism

On Monday we heard that Landcorp will not be proceeding with all of the planned conversions of forestry to dairy farms in the central North Island. On Tuesday we learned  the predicted milk payout has dropped to the lowest level in 13 years. These two facts are not unrelated. While Landcorp claims to be halting conversions for environmental reasons, milk prices will be a huge factor also. Indeed low milk prices are probably doing more to protect our environment than the government’s fresh water policy. 

Landcorp’s decision
A few years ago, Landcorp’s plan was to capitalise on the low carbon price by cutting down thousands of hectares of forest in the central North Island and converting the land to dairy. This was going to have a huge impact on the environment – particularly the Waikato River – which under the Tainui settlement has to be swimmable. Landcorp was planning on farming 30,000 cows, but now apparently it will be stopping near to its current level of 17,000. This means that some 14,500 hectares formerly earmarked for dairy farming will now have alternative uses, including sheep milking.

Of course, Landcorp falls over itself to point out the environmental benefits of its decision. Good marketing and PR dictates that they broadcast that with fewer trees cut down, there will be less sediment and phosphorus lost into rivers. With fewer cattle on the land, there will also be less E. coli and nitrogen leached into rivers. The net result is fewer bacteria and algae in the Waikato, which leaves us closer to the goal of a swimmable river. Yay for Landcorp’s environmental awakening.

The SOE’s decision has been welcomed by their environmental stakeholder group, including environmentalist Mike Joy. Fair enough – this change will deliver environmental improvements. Landcorp’s chief executive Steven Carden has claimed that the driver of the change is the launch of Landcorp's new high-value Pāmu brand, which has created a need to exceed customers' environmental expectations.

Really? Let’s hear that again – Landcorp is now to be driven by their customers' environmental credo? It has seen the environmental light and overnight – the same night the milk price fell – it has a new Green livery. Gone are its intentions to totally bugger the environment it owns. Does Carden expect anyone to believe that?

What’s the price got to do with it?

Landcorp has denied that the change is driven by the drop in the milk price. Frankly, that is difficult to believe. If milk prices were still at $8/kgMS it seems unlikely that Landcorp would be reversing this decision.

Instead, yesterday we heard that the Fonterra payout has dropped to $3.90/kgMS. That is less than half what it was during the peak of 2013/14, and lower even than the $4.40 faced by farmers last year.

Many new suppliers face costs of upward of $6/kg MS, and for heavily indebted farmers the Reserve Bank estimates costs around $6.50/kg MS. If that is the case, these farmers are facing a loss of $2.50/kg of every milk solid produced. It is hard to know where Landcorp’s new farms sit on this scale but odds are that, at current milk prices, these conversions simply don’t make sense.

What is the cause of these higher costs?
Previous high payouts encouraged over-investment in dairy, in three ways:

1. Increased intensity of farming – farmers put more stock on the same land. To feed them they needed more inputs – irrigation and nitrogen to grow grass and also additional feed such as palm kernel.

2. Increased costs of operating on marginal land – farmers expanded on to land that is less suited to dairying so they needed to put new infrastructure in place such as irrigation.

3. Debt – primarily due to both of the above. Since 2000 we have seen a 65% increase in milk production, but over the same period dairy sector debt has more than doubled. Servicing this debt comes at a cost.

So, as a result of increased intensity of farming and operating on marginal land, dairy debt has gone through the roof, which has increased the risk faced by the industry (and our banks). At the same time, these changes have placed increased pressure on water quality throughout the country. Chasing the dairy boom has certainly been an environmental disaster – and may yet prove to have been an economic disaster too.

Debt is concentrated among a few farmers – 10% of farmers carry 30% of the debt. Those same farmers are likely to be borrowing more to cover their expenses, so it is no coincidence that a recent Federated Farmers survey suggested 10% of farmers were already under pressure from their banks. These more heavily indebted farmers are almost certainly going to struggle but, depending on how long the price slump lasts for, others could also be drawn in.

What will happen?
If the price of milk stays low, we are likely to see some farmers following Landcorp’s lead and destocking or converting land to other uses. They too may start mouthing on about their new-found environmental ethos as well. Several experts have now shown that farmers can reduce cattle numbers (reducing costs) without impacting production or profit – in some cases, profit even improves.

Organic milk has maintained its price despite the fall in the wholesale milk price. After years of being told there is no premium for organic milk, this premium is now stark – some seven times higher than the wholesale price for standard milk. Landcorp is experimenting with milking sheep; others are doing the same with goats. Some Canterbury land may revert back to cropping. Most such changes should provide a boost for water quality.

You can see their rationale for talking up the environmental gains. Farmers are realising that they can’t keep increasing production, so we will simply have to add value to the products we produce in order to increase our income. Actually living up to our clean, green brand might be one way to squeeze another dollar from consumers.

Eventually, under a low milk price, most farmers should revert to a less intensive, lower-ost mode of farming, which will be good for fresh water. The downside is that there will be less profit to invest in environmental improvements.

If prices stay low, heavily indebted farmers will probably lose their farms – this will place a heavy toll on our rural communities and the banks that fund them. Under the Reserve Bank’s worse case scenario, some 25% of farmers carrying 44% of debt could go under, reducing land prices by 40%. Banks will be probably praying that there are foreign buyers who will buy up the land without the land prices falling that far.

Landcorp is lucky – its balance sheet is probably strong enough to prevent it going under as Solid Energy did. However, after some expensive experimentation, the government may well be asking itself if it still wants to be the owner. It should have been flicked off years ago.

Gareth Morgan is a New Zealand economist and commentator who in previous lives has been an investment manager. This post first appeared on Gareth's World.

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