Fonterra Cooperative Group is likely to increase its forecast payout to dairy farmers next season by enough to make production profitable for most farmers as lower global milk supply drives up prices, according to economists who follow the sector.
Average prices dropped 10.8 percent in the GlobalDairyTrade auction overnight, with New Zealand's key product, whole milk powder, falling 13.3 percent. Still, economists said weak prices are occurring at a low point in the nation's milk production cycle and prices are likely to pick up in late 2015 and early 2016 when production and manufacturing rise, and farmers get the benefit of a lower kiwi dollar.
Economists at the four main New Zealand banks which forecast Fonterra's payout expect the cooperative to pay between $5.75 per kilogram of milksolids and $6.20/kgMS for the 2015/16 season, which would be from the cooperative's forecast of $4.70/kgMS for the 2014/15 season, according to a BusinessDesk survey.
Fonterra is expected to provide its forecast for the next season following its May 27 board meeting. Forecasts for the current season ranged from $4.50/kgMS to $4.90/kgMS.
"Prices are weak and we are still pretty cautious on pricing for the near term at least but we do see some improvement at the end of the year and into 2016," said Bank of New Zealand senior economist Doug Steel. "We think these weak prices will see global milk supply growth slow down and we should see some uplift in price as a result of that."
The New Zealand milk production season spans June through May with peak production in the spring months covering September through November, with a couple of months' lag for production before the product is sold.
"It's extremely early days, the season hasn't even started," said BNZ's Steel. "It's not as worrisome as if prices were very low during the peak period."
Fonterra's forecast for the current season is below the cost of production for many farmers and, combined with reduced production due to dry weather, is expected to shrink dairy sector revenue for the current season by at least $6 billion, Steel said. That's likely to weigh more on the current account deficit than economic growth because farmers are able to use cash saved from the previous season's record $8.40/kgMS payout, and expand overdrafts during tight periods this year, he said.
Steel expects next season's payout to be $6/kgMS which he said would allow most dairy farmers to make money. However he said he is still cautious about the outlook for international prices over the next few months.
Prices in the GlobalDairyTrade auction have declined on the expectation of increased New Zealand supply following recent rain, and amid uncertainty about the potential for increased supply from Europe after the lifting of European quotas this month and as a weaker euro makes production from the region more competitive. Low international grain prices is also stoking production in the northern hemisphere while demand at auction remains weak, Steel said.
The New Zealand dollar, which recently traded at 74.44 US cents, will decline to 70 cents by the end of the year, according to the median forecast of 21 currency traders, strategists and economists surveyed by BusinessDesk last week, all of whom expect a decline. The kiwi declined 4.2 percent against the greenback in the first quarter of this year.