Coming year is a test for dairy market resilience

So far this year average milk prices paid to UK dairy farmers have been remarkably similar to those paid a year earlier, according to the DEFRA monthly survey.

The average price in the first eight months of the year of 18p/litre was less than 1% lower than in the same period in 2004.

In that time, however, many different pressures have influenced the markets both upwards and downwards.

In the EU, the second annual cut in intervention prices of 7% for butter and 5% for skim milk powder took place on 1 July.

This followed identical cuts a year earlier.

These cuts have been accompanied by big reductions in export subsidies on all products and reductions in the subsidies paid on domestic sales of butter used for manufacture and on skim milk powder used for animal feed production.

There have also been large sales of intervention stocks of butter and skim milk powder at discount prices.

Normally, these cuts would have led to reductions in market returns for the main dairy products of around 12%, with corresponding cuts in milk prices.

While the trend of EU market prices has been mainly downwards over the past year, the reductions have not been nearly as great as might have been expected and they have also taken place slowly.

The main reasons for the resilience of the markets are twofold.

Firstly, EU milk output last year was lower than normal, mainly because of poor weather, and this helped create tighter markets.

The second factor was that world milk output both in 2003 and 2004 grew at a slower rate than normal while demand from the main importing countries was strong.

These two trends combined to push world market prices for the main dairy commodities to record levels – and they are still high.

This year the UK industry has also seen two retail price initiatives — one on liquid milk and the other on cheese.

These initiatives may not seem to have had much effect in lifting farm-gate prices but at least it has stopped these prices falling as seen elsewhere in the EU.

Future prospects

Prospects look more worrying over the coming year.

The unexpected can always happen, such as a collapse in the value of sterling against the euro, which would push up UK intervention prices, but it seems there will be more pressure on milk prices.

For example:

• World milk production is rising faster again this year with output up 5% in the USA, possibly 3% in New Zealand and 1% in Australia.

This seems likely at present to push world prices lower.

Following big cuts in export subsidies, EU exports will shrink over the coming months.

• EU milk output has also risen again this year and milk quotas are due to rise by 0.5% next April.

This has not yet resulted in any build up of stocks but the first half of 2006 looks likely to see market prices falling back to the new lower intervention price, particularly if exports fall back.

This trend is shown in the butter price chart.

• The third round of the Mid-Term Review will be implemented on 1 July 2006 and this will cut the intervention value of butter by a further 7% and that of SMP by a further 5%.

If markets are already weak at that time, these price cuts might feed through into commercial markets faster than they did in 2004 and 2005.

The UK markets will not be immune from these downward pressures and the market returns for commodity products such as butter, milk powders and some cheese could fall by 10% to 15% during 2006.

Unless, therefore, UK farmers are protected from falling prices by currency changes or by further retail price initiatives (which ultimately invite greater import competition), then the probability is that the gloomier predictions made at the time of the MTR that milk prices could fall by around 20% will start to come true.

The markets could well take up to two to three years to show the full effect but next year will be a testing time for all those concerned.