Weak global dairy prices raise risk of further cuts to Fonterra payout

Further declines in dairy prices at the latest GlobalDairyTrade auction are casting doubt over Fonterra's [NZX: FCG] ability to meet its newly revised farmgate price.

It also prompting concern that next season's price may also be low.

The GDT price index fell 7.4% at last night's auction, the third straight decline this year. The average price for New Zealand's key product, whole milk powder, sank 10.4% to $US1952 a tonne, its lowest since August.

Last week Fonterra reduced its farmgate milk price forecast for the 2015/16 season to $4.15 per kilogram of milk solids, from $4.60/kgMS, citing a continued global imbalance between supply and demand.

Many dairy market analysts are now reviewing their forecasts for this season and next. Estimates in a BusinessDesk survey currently range from $4/kgMS to $4.32/kgMS for this season, and an opening price of between $3.75/kgMS and $6.50/kgMS for next season.

"Last night's GlobalDairyTrade auction introduces some downside risk to our freshly minted $4.20/kgMS milk price forecast for this year," Westpac Banking Corp senior economist Anne Boniface says. "But perhaps even more importantly, it also throws our $5.20 milk price forecast for 2016/17 season firmly into the spotlight."

Westpac's 2016/17 forecast assumes whole milk powder prices will average around US$2400 a tonne, but Ms Boniface noted "after last night's auction, these levels currently look some way off."

Fonterra said last week that while global demand remained "sluggish", it expected dairy prices would improve later this calendar year.

Weak dairy prices are weighing on the outlook for New Zealand's largest export commodity and putting increased pressure on the nation's dairy farmers, following a low $4.40/kgMS payout last season.

DairyNZ estimates the average farmer needs $5.40/kgMS to break even, and the Reserve Bank of New Zealand has flagged dairy sector debt as a growing risk to financial stability.

Prices are dropping as European milk production continues to expand, while New Zealand's production may not be crimped as much by dry El Nino weather as earlier anticipated.

ASB Bank rural economist Nathan Penny lifted his expectation for New Zealand milk production this season, saying it would probably only drop 3% compared with an earlier estimate for a 6% fall.

"Earlier fears of a summer drought, owing to the strong El Nino weather pattern, have largely receded," Mr Penny says. "The risk is that global production may hold higher for longer than previously thought. As a result, we place this season's and next season's milk price forecasts under review."

The latest dairy auction result reinforced ASB's view that the Reserve Bank will cut interest rates in June and August this year, taking the official cash rate to 2% from 2.5%.

Source: GlobalDairyTrade. Click to zoom.

Source: GlobalDairyTrade. Click to zoom.

(BusinessDesk)