Outlook 2019: Rising dairy costs to necessitate efficiencies

With much uncertainty over the future direction of milk prices, Andersons’ Mike Houghton says rising costs are likely to cause further industry consolidation and hasten the need for efficiency gains.

Markets have weakened towards the end of this year, but there remain many conflicting conditions that will affect supply, demand and prices.

These range from Brexit and currency fluctuations to farmgate supply, and Mr Houghton believes there is a positive outlook for good, efficient businesses.

Input price volatility will, however, have a big effect on many dairy farms through this winter, eroding the benefits of earlier milk price increases.

Mr Houghton anticipates the average milk price is likely to be close to 30p/litre by March 2019, but warns that last year’s challenging weather has resulted in higher feed, forage and bedding costs this winter, alongside significant inflationary pressure in energy and fertiliser costs.

“As a result, costs of production for many herds will increase by between 2p/litre and 4p/litre, mitigating much of the increased milk price, or indeed producing a lower margin.”

World market uncertainty

Producers can take some comfort from UK production now being very similar to last year and the fact that that it may well fall through the current winter, compared to a year earlier, Mr Houghton says.

Global supply and demand also remain finely balanced. The two key market indicators, the Intervention Milk Price Equivalent and the Actual Milk Price Equivalent, continue to trend at around 32p to 34p/litre, perhaps indicating processors can maintain prices, even though the talk is of cuts in spring 2019, says Mr Houghton.

“The larger concerns for global markets relate to demand and a possible downturn in economic growth worldwide, which could become a factor later in 2019. China remains a big unknown, as it stopped reporting data in March 2018, making future growth prediction difficult.”

World prices are also influenced by political events in the US, which has seen a dramatic fall in prices due to trade issues created by the Trump administration. However, US farmers will receive compensation for the lower price, via their Margin Protection Scheme.

Protecting against volatility

The UK dairy industry could be moving in the same direction as the US, with a number of volatility measures likely to be introduced in the next 12 months, Mr Houghton says.

“These will assist farmers with managing risk, both to the milk price and input cost volatility.”

Two schemes may become available in 2019 – one is ‘Stable’, which is effectively volatility insurance, while another is an income-smoothing mechanism offered by DairyVol.

“The sector will need to learn how best to use such tools, which provide an opportunity to smooth prices and provide assistance in crisis times.

“All of the above reinforces the primary objective of being as efficient as possible at the farm level.  Productivity – the amount of turnover a business can convert into profit – will be key to future success.”

Improving profitability

Mr Houghton believes all systems can be profitable, but predicts some businesses will move towards block-calving systems, which are less expensive and more efficient to run.

Larger level-supply businesses meanwhile, offer scale and ever-improving technical efficiency and output, he says.

“Key influences on profitability are likely to be the use of genomics, to produce a significant uplift in output, be it volume or solids, which will be achievable over a two- to three-year period.

“Much greater use of sexed semen will reduce the number of black and white bull calves in the system and improve overall returns from calves or heifers.”

Feed efficiency needs to be the prime focus of the industry, because this can be improved whatever system is operated, Mr Houghton adds.

Prepare for support changes

Increasing regulation and direct support cuts can now be much more accurately factored into business plans, Mr Houghton says.

Draft legislation governing ammonia emissions is already in place, and will be a potential high cost to the dairy industry, he warns.

The Agriculture Bill also confirms there will be no more direct payment after 2027 in England.

“It is worth viewing the remaining direct payments as a ‘capital gift’. The aim should be to construct a business plan that can deliver the returns required without subsidy but using the capital gift to invest if required to make this achievable.

“If this can’t be made to add up, then you have to ask whether you will be dairying in 2028.”

Changing retail

Retail models appear to be changing, says Mr Houghton, with three-year deals beginning to appear (Lidl and cheese), with the continued rise of the discounters.

He believes ever-increasing demand for home delivery means the current retail model will be significantly challenged over the next three to five years, potentially reinvigorating the daily delivery of fresh milk to the door.

“Retail pools could also come under pressure, with the rest of the industry already lifting production standards, although much may depend upon supply and demand.”

Proactively marketing dairy’s positive health and well-being aspects should be a priority for the industry, he adds.