Lagging behind Europe

13 October 2000

Lagging behind Europe

This time last year, the dairy industry was reeling from successive price cuts which saw milk prices sink to historic lows.

The slump has worsened. For some farmers, enough is enough, and in this special feature a leading researcher suggests

some alternatives. But there is also talk of better prices this autumn. Independent consultant

Michael Bessey starts with an upbeat look at dairy markets and how UK producers could benefit from their recovery

AS with many agricultural products, the dairy industry experiences periodic cycles when excess supply and low demand combine to create falling prices. Then a recovery sets in when demand outstrips supply and prices move ahead to earlier or even record levels.

Two years ago, the combined effect of financial crises in Asia, South America and Russia together with economic recession in much of Europe produced a slump in dairy product prices which fell in 1999 to some of the lowest levels seen for several years.

In the UK, the depression was accentuated by the rising value of sterling against the k which reduced UK support prices and made exporting difficult. These two pressures, together with the inability of farmer organisations to negotiate strongly with milk buyers, resulted in average farm-gate milk prices falling last year to a little over 18p/litre, a drop of 27% in three years.

While UK milk prices have continued to drop so far in 2000, the world and EU dairy cycle has clearly turned. In the world market, demand has recovered in Asia and South America – but little yet in Russia – booming oil prices have put extra buying power into many dairy importing countries and the economy in most EU countries has staged some recovery.

The result of all these factors is that EU exports of many dairy products have been booming, demand in Continental markets is rising and prices at the world and EU level for milk powders in particular, but also with butter and cheese, are all well above year earlier levels. The table shows the extent of these price changes over the past year. The increases in Germany are typical of those seen in all Eurozone countries.

UK dairy farmers are entitled to ask why they have suffered falling prices when, as is now clear, their Continental colleagues are enjoying an upward trend.

The major reason put forward by UK milk buyers is that sterling has continued to rise in value against the k and that this has led to further declines in the intervention prices for butter and skim milk powder. This is certainly true – as the average UK butter and SMP intervention prices in September were 6% lower than in September 1999 but were only 1.6% lower than in January when milk prices were being considered for this year.

What is more debatable, however, is whether UK intervention price levels are of any relevance when looking at milk prices. The last time any UK butter was intervened was in early May; skim milk powder has not been intervened throughout the summer. This is because market prices for these products have been rising well above the intervention level and no manufacturer has had any need to use the intervention system. By September, UK market prices for butter were showing a premium of about 10% above the intervention level and for SMP the position was even more dramatic with a premium of over 30%.

In the past few years, milk buyers have argued that prices should be based on the value of milk used for butter and skim milk powder, in other words the Intervention Milk Price Equivalent (IMPE). This was regardless of the fact that only a minority of UK milk supplies were being used for these products, with nearly half still going into the liquid milk market. When intervention is not being used IMPE loses its relevance and many believe that actual market returns for butter and skim milk powder should form the base level for milk prices.

If actual market returns had been used in September then farm-gate milk prices would have been 4-5p/litre above the IMPE level. Clearly they were well below this, leading to optimism among farmers that milk prices should, and will, rise significantly from October onwards.

Some of the offers on the table from milk buyers clearly fall well short of farmers expectations and do not appear to be based on actual market returns for butter and SMP. Perhaps there are other reasons why milk prices should not rise in line with actual market prices for these products although, in the past two years, they fell in line with returns.

For example, the volume of milk being used in the UK to make cheese is larger than is used for butter. In this sector, market prices until recently have not bumped up in the way that butter and SMP have.

However, cheese prices generally have risen by at least 10% since July and it seems likely that prices will rise further by Christmas. Similarly, prices for whole milk powder, which is mostly exported, have shared in the price boom seen in EU and world markets.

Turning to the liquid milk sector – the most important market for UK milk – although retail prices have fallen relatively little in the past three years, it would seem that dairies have passed on their lower raw material costs to their supermarket customers and they will no doubt find it difficult to recover higher costs once again.

There are some signs, however, that major retailers recognise that prices have fallen to the point where dairy farmers are losing money and they have expressed sympathy with the idea of higher levels. With milk values for all other markets now rising, this must be the time when the dairy companies put these retailer sentiments to the test and demonstrate that the liquid milk market must pay the going rate if it is to be supplied on a priority basis.

Looking ahead, there is considerable optimism in the European dairy industry that todays higher prices will remain for some months to come and that supply and demand around the world are now more in step with each other. Some of the existing premium market prices may well slacken off next year, but the overall market prospects remain good unless and until the next major turn of the cycle takes place, perhaps if the world economy fell into a depression.

The UK industry should share in this more optimistic position – the only risk being that the £ might rise even further against the k. The recent decline in sterling against the US$ suggests that the value of sterling may now have peaked, but no crystal ball can foretell this with certainty.

UKdairy farmers are being left behind their counterparts in the euro-zone.

Liquid milk remains the key outlet. Some retailers now realise farmers are losing money and dairy companies must react and test those sentiments.

Changes in dairy product

prices: Sept 99-Sept 00

Butter -6 % +14 %

Cheese No change +12 %

Whole milk powder +37 % +11 %

Skim milk powder +80 % +33 %

Whey powder +10 % +25 %

*Germany