26 December 1997

DAIRY

MILK producers have been under the cosh during the past 12 months, with prices falling about 5p/litre in response to pressure from sterling and buyers.

Recent projections put the drop in farm incomes this year at well over 50% on dairy units and some recent reports suggest large numbers of dairy farmers leaving the industry.

But the good news is that the bottom of the trough seems to have been reached and some limited recovery is probable for 1998.

Dairy commodity markets have had a buoyant second half to the year and that alone bodes better for milk prices, given the in-built "lag effect" between manufacturer and producer returns.

Butter in particular has benefited from strong Russian buying. Continental prices have climbed all year, with Dutch and German values putting on 15%.

UK butter prices were initially left behind due to strong sterling. But even these have now moved to 10% ahead of intervention values as demand has strengthened and the £ has come off peak levels. Bulk product is currently worth about £2450/t, compared with £2200/t at its low point in May.

Analysts believe butter prices have now peaked, but will only soften slightly in the months ahead.

Brussels recently imposed a five-point plan stop the market overheating, including a large cut in export subsidies, a similar reduction in subsidies on butter for food manufacturing and the sale of all remaining intervention stocks. But the expectation is that the trade will "shrug this off", especially if Russian and East European buyers return to the market in the new year.

Skimmed milk powder is also relatively buoyant throughout Europe, and expected to remain so. Good export business to Mexico and improved profits for Continental veal producers continue to support the market.

Similarly, cheese manufacturers have reaped the benefit of strong demand. Most of the main UK dairy companies point to mature Cheddar as being fundamental to their substantially improved profits this year. The fear is that it could be a victim of its own success, as more manufacturers have moved into production.

Farmhouse Cheddar is currently worth about £3500/t and has been at this level for over a year, following a gradual firming during 1996. Analysts suggest the bubble could burst some time in 1998.

But the good news is that mild Cheddar prices may now start to improve having slipped throughout 1997.

Output has been tapering off as manufacturers have diverted milk to butter or mature cheese, and have also made a concerted effort to curb excess production. Prices are expected to reach £2400/t soon into the new year, having bottomed out at £2200/t in the autumn.

One potential problem is that the GATT ceiling for the volume of subsidised exports has been cut again (by 5%) for 1997/98 and will result in more cheese looking for a home in the internal market. And continuing problems in the Pacific Rim countries could dampen demand for dairy products from the US and New Zealand, putting pressure on world markets.

Neither of these is expected to have much of an impact on UK dairy product prices.

So what does this all mean for UK milk producers? They will soon find out, as Milk Marque is due to announce its terms for the January selling round any day. This will set the trend for producer prices for much of the year.

Indicative of what might happen was a recent auction by United Dairy Farmers in Ulster. This showed a slight increase on prices achieved at its last sale in September, with 60m litres of milk sold on 12-month contracts averaging 21.56p/litre, compared with 21.24p/litre. Three month contracts were up marginally at 22.29p/litre.

It is likely Milk Marque will try to get a bit more from the market in January, though buyers may well hold off and try and force prices down again.

But this may be of less relevance as Milk Marque is heading towards "index-linked" contracts, tying milk prices more strongly to currency.

Thus sterling will play an even more important part in determining producer returns in 1998. But which way sterling will go is anybodys guess.n