UPDATED: Fonterra's reduced milk volume forecast may help lift weak global prices - Westpac

UPDATED: Fonterra Cooperative Group’s[NZX: FCG]  3.3 percent reduction in its milk volume forecast for the 2014-2015 season may provide a lift for  depressed global dairy prices, Westpac Banking Corp economists say.

Fonterra expects 1,532 million kilograms of milk solids this season, matching last season’s production of 1,584/kgMS, reflecting the impact of dry weather. It had already cut its December forecast to zero growth, 

The world’s largest dairy exporter today said than in some regions pasture quality has declined markedly since mid-January and some farmers are drying cows off early. There has also been a drop in feed supplements as it doesn’t stack up economically to use them given the lower forecast payout for this season of $4.70/kgMS.

Fonterra said daily milk production was now 6.1 percent lower than at the same time last season and as a result it will reduce the amount of product offered on the GlobalDairyTrade auction platform and through its direct sales channels.

Westpac economist Michael Gordon said the 3.3 percent drop doesn’t fully convey the severity of the downturn. Production was up 3.7 percent on a year ago over the first seven months of the season to the end of December so the forecast implies production in the remaining five months through to May will be down 13.4 per cent on last year.

He said the 6.1 percent drop in daily milk production compares to the 4.3 percent fall as a result of the severe drought during the 2007/2008 season. The 2010 drought, which was short-live but intense, led to a 2 percent drop in Fonterra’s production over that season, he said.

“Judging by those two previous events, the current drought is likely to take a significant chunk out of total GDP growth over the first half of this year – mostly in terms of lower exports, but with some impact on household spending and business investment as well,” Gordon said.

Given the positive economic growth, especially in construction, Westpac doesn’t expect this to result in a technical recession of two quarters of negative growth, but GDP growth is likely to be low over the next two quarters, making a cut in the OCR more likely.

Lower milk production in New Zealand is also likely to force up global milk prices above the current low levels.  The last few droughts in New Zealand saw world dairy prices soar to record highs, he said.

The supply situation is not as stretched this time around with milk production in the Northern Hemisphere having grown strongly and Russia’s ban on imports from several Western countries putting a big chunk of product back on the world market.

“That only argues against prices returning to record highs; it doesn’t negate the point that prices rise when supply falls short of expectations,” Gordon said.

The dry weather has come too late to make a significant difference to this season’s milk price but it may mean forecasts for next season will need to be revised higher, he said.

The government is keeping a close eye on the impact of the dry weather and is yet to declare a medium scale adverse event.  Rain is forecast for most regions later this week.  

(BusinessDesk)