Oceania Gets a Much Needed Break in China

Australia-China trade pact moves ahead as New Zealand dairy farm debt reaches dangerous levels.

The U.S. dairy industry’s biggest competitor in world export markets—at least on a cost basis—has gotten a lot of attention lately. Dairy product prices in Oceania, a region that includes New Zealand and Australia, have been tumbling and a new bilateral trade agreement between Australia and China could tip the advantage further in Oceania’s favor.

After a decade worth of wrangling, officials in both China and Australia signed a letter of intent last week to formalize the Australia-China Free Trade Agreement (FTA).

“It’s a significant boost for the Australian dairy sector because it provides direct access to China’s growing dairy market,” says Sara Dorland, analyst with the Daily Dairy Report and managing partner of Ceres Dairy Risk Management, LLC, Seattle. All Chinese tariffs on Australian dairy products will be eliminated over the next four to 11 years, depending on product, according to initial news reports from Australia.

“This FTA levels the playing field for Australia relative to New Zealand in China and quite possibly will further Oceania’s dominance in the Chinese market,” says Dorland.

China already is Australia’s largest market for dairy exports, and China’s importance to Australian exporters has increased over the past 15 years, Dorland notes. Between 2000 and 2013, Australia’s whole milk powder (WMP) exports to China have logged a compound annual growth rate (CAGR) of 14.6 percent. Over the same period, Australian skim milk powder exports to China have grown by 9.2% (CAGR). Cheese exports have climbed 52.6% and butterfat exports are up 20.6% (CAGR), according to the Global Trade Atlas.

While the Australian dairy industry was cheering the news about its new FTA with China, dairy product prices worldwide were falling or, at best, stabilizing. Prices have fallen or are forecast to drop so low in New Zealand that an estimated 10 percent of dairies there could be in trouble financially, says Dorland.  

Last week, New Zealand’s central bank issued a warning about the potential risk of default for dairy-sector loans, according to a report from the International Business Times. This past September, New Zealand’s largest dairy cooperative, Fonterra, forecast its 2014-15 average payout price at $5.30/kg (NZ) of milk solids, a drop of 37% from 2013-14’s $8.40.

At the same time prices are falling, dairy farm debt in New Zealand and cost of production has been rising to unsustainable levels on some farms. According to Dairy NZ’s Economic Survey 2012-13, the average operating costs for owner-operator farms that season were $5.03/kg of milk solids, and farm “working expenses” have accounted for nearly 57% of annual milk checks since 1991.

“Based on these numbers, farms have lost $1.77/kg of milk solids in spending power from the 2012-13 season to the 2013-14 season, suggesting they need to seriously look at putting spending controls in place sooner than later,” says Dorland. “In recent years, New Zealand dairy farms likely spent considerable resources on supplemental feeds to enhance and extend milk production during periods of high prices. In some cases, supplements were a good choice when pasture quality was poor due to drought, but today spending on supplemental feeds could be one area ripe for cutback.”

Of greater concern, Dorland notes, is the Reserve Bank of New Zealand’s report issued earlier this year that put New Zealand’s total dairy debt at $32 billion (NZ), triple what it was just 10 years ago.

“Not all farms have taken on large debt loads, and it appears most of the debt is isolated to about 10 percent of dairy farms,” says Dorland. At the end of the 2012-13 season, 13.5 percent of New Zealand dairy producers had a debt-to-asset ratio of more than 70 percent and between 2 percent and 4 percent of farms were already in a negative debt situation. “The structure of dairy debt could also give cause for alarm, with an estimated 70 percent of dairy loans being floating rate mortgages,” Dorland adds.

With dairy product prices expected to drop further, producers in Oceania and other surplus dairy regions will be scrambling to sell products to choice markets like China.

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