NZ no longer has global dairy market to itself as rivals challenge on cost, supply, English says

New Zealand no longer has the international dairy market to itself as other countries step up production, and the industry needs to cut costs to cope with a lower price environment, Finance Minister Bill English said.

Dairy prices have slumped below the cost of New Zealand production since hitting a record high in the 2013/14 season as increased supply from New Zealand, Australia, Europe and the US combined with lacklustre Chinese demand and an import ban imposed by Russia. Economists expect weak prices may continue for a third straight season in 2016/17 as oversupply persists.

"What's becoming a bit clearer I think is that we are not necessarily the lowest cost producers at the margin," Mr English said. "There is growing capacity in other markets to participate in the international dairy trade, which we've had largely to ourselves for a long time."

In January, Auckland-based Fonterra Cooperative Group [NZX: FCG], the world's largest dairy exporter, cut its forecast payout to farmers this season to $4.15 per kilogram of milk solids, below industry organisation DairyNZ's estimate of $5.25/kgMS needed by the average farmer to break even.

Fonterra said the timeframe for supply and demand rebalancing had moved further out and largely depended on a downward correction in EU supply in response to the lower global prices, which it said were unsustainable.

Mr English cited the increased influence of Europe and the US in international dairy trade, and China's ability to increase its domestic capacity and therefore reduce demand on international supply.

New Zealand's dairy industry had to reduce production costs, adapt to having less capital "which had been plentiful", and maybe even shrink supply, he said.

"It means an industry that's probably now starting to think about structural adjustment rather than waiting for prices to bounce back to where they were making significant profits," English said. "It's going to bring a much stronger focus on costs."

For dairy companies such as Fonterra, access to capital would shrink as supply dropped off, while shareholders were likely to pressure the company to maintain payouts, he said.

"The value-creating strategy isn't all just about pipes here," English said in an interview. "It's about what you spend offshore and they've made some big investments in that in recent years, so it's just going to be a lot more capital scarcity when they've come out of a pretty lengthy period where valuations of farms was rising, the implied valuation of their investments were rising, and that's all going to flatten out and maybe drop, it's quite a different dynamic," English said.

Dairy farms with too much debt would come under "real pressure" but English said he was confident buyers would emerge for those assets.

"Long-term confidence is going to underpin this, and the banks seem to share that but the longer it goes clearly people right at the margin who are too high cost and too much debt are going to come under some real pressure whereas I think six months ago you would have said they could get through," he said.

"The extended period of much lower cashflow is going to impact through the rural community – there will be continued impact, they have seen it this year and it will just keep going," he said.

The impact will be felt in related industries such as dairy support, crop growing and tractor sales, he said.

Landcorp Farming, the government-owned farming business, would have to go through the same process as other farmers exposed to low dairy prices in adjusting its cost structure and adapting to lower valuations, he said.

Wellington-based Landcorp has forecast an annual net operating loss of between $8 million and $12 million this year, citing lower milk prices, and said it won't pay a dividend to the Crown.

Mr English reiterated that the business wasn't for sale after the Act Party called for it to be sold with funds put toward native wildlife sanctuaries.

(BusinessDesk)