Milk – from cost/price squeeze to price/cost chase
I have worked with Irish dairy farmers a very long time, and I have never seen spring creamery milk prices at a base price at or above 50c/l. For top quality winter liquid milk making all the bonuses and premia in December or January, maybe.
But for creamery milk prices to rise to those levels in the run up to peak in April or May was unheard of. Once upon a time, this would have been cause for celebration: at long last a price that recognises the real value of milk, and the effort and cost that goes into producing it. But in 2022, the cost of producing a litre of creamery milk is estimated by Teagasc to have increased by a whopping 30% compared to 2021. This could lead, based on Teagasc 2021 Dairy Review and Outlook of dairy costs, to a zero margin increase despite a 20c/l milk price uplift.
We have for years spoken about the cost/price squeeze when farmers find their margins eroded as costs rise while prices fall. But now, we appear to be entering an era of price/cost chase – which may not a whole lot better. So, what is going on?
High milk prices: the new normal?
The invasion of Ukraine, the economic sanctions against Russia that followed, and the inability of Ukraine to release its stocks of grain onto the world market in wartime have acted as a wake up call for many who took food security and relatively low food prices for granted.
But global food price inflation had started before that. Energy prices have been rising for months. Supply chain difficulties – logjams in ports hit by Covid lockdowns, scarcity and rising costs of shipping containers, etc. – preceded the sanctions against Russia by two years. In addition, fast rising prices and reduced availability of fertilisers, made worse by the war, have impacted global food production.
Rising production costs are only part of the story for milk. Increasing environmental restrictions and climate action regulations also hit current and expected future growth. We just heard suggestions from New Zealand that dairy farmers could be made to pay for their greenhouse gas emissions, while the Irish Food Vision Dairy Group interim report proposes a voluntary retirement scheme and an emission cap and trade system, the aim of which is to at least limit milk production growth.
Supplies in many regions have only grown very modestly in recent months, with global milk output up 1.5% according to the FAO Dairy Market Review for 2021. Within that, Europe, Oceania – the regions actually driving global dairy exports – Central America, the Caribbean and Africa have barely increased output. The US and Asia, which contribute less to world trade, were more dynamic at +1.7%, and +2.8% respectively, the latter thanks to expansion in India, China Iran and Japan. But exportable surpluses have been tight, which pushed up dairy and milk prices.
Last March, Eucolait, the organisation representing traders of dairy products in Europe, and the International Farm Comparison Network (IFPN), organised an event titled “The New Normal in Dairy”. The IFPN predicted that milk prices will stay high for the rest of the year at least, as dwindling supplies fail to keep pace with steadily increasing demand.
It is hard to disagree with their analysis, at least from the supply side. The cost of production has increased substantially more for those dependent on bought in feed, and fertiliser cost inflation affects the price of grain as feed ingredients as well as the cost of growing grass. This is restraining production for the medium term at least.
Dairy price inflation
The FAO global food price index, and its constituent commodity price indices (see graphs), show that the war in Ukraine has accelerated the trend and the food price index had increased by 68% relative to the pre-pandemic 2019 annual average. No surprise that vegetable oils and cereals, of which Ukraine and Russia are sizeable exporters, have also seen spectacular price increases as rumours of invasion gathered from late 2021. While dwarfed by those commodities’ hikes, global dairy price inflation was nonetheless nearly 42% over the same period.
“The best cure for high prices… is high prices”
In a normally functioning market, high prices are almost never sustainable for very long, due to either or both of two things: a strong production response increases supply to levels exceeding demand, and/or demand flags because high prices reduce affordability. In theory, this balances out, and then, the best cure for low prices becomes – low prices. In theory.
This time around, there seems limited capacity, except in North America and Asia, to increase supplies, and exportable supplies remain tight.
Price evolution in coming months will depend on how demand responds to higher prices. Consumers the world over struggle with the cost of living with higher fuel, heating, electricity and food costs, and many in developed countries have reported cutting food bills to make ends meet.
In developing countries, the cost of staples like cooking oil, cereals and bread is pushing the cost of food to intolerable levels and it is almost certain that some regions will experience hunger, if not starvation. Some, like India, have even taken to abruptly changing strategy by banning exports of wheat in an effort to preserve national food security.
The IMF has in April revised down its global growth predictions for 2022 and 2023 to 3.6%, and its 2021 estimate to 6.1%. More recently, the World Bank’s June 2022 Global Economics Prospects is far more pessimistic, slashing 2022 growth prediction to 2.9%, and warning of impending stagflation – where sluggish economic growth or stagnation co-exists with price inflation, the type of economic crisis last encountered in the 1970s. With a growth prediction of around 3% for 2022 and 2023, the OECD June Economic Outlook is similarly identifying the war in Ukraine as slowing global recovery, and further warns of hardship and famine linked to cost of living inflation.
This may feel very gloomy, but the reality is we are entering uncharted territory, where geopolitical events compound climate change and climate action policies to upend the old predictable global price-determining factors in agricultural commodities. While we may see continued higher milk price levels for some time, and they might become entrenched because of persistently higher costs, margins will come into much sharper focus for dairy farmers.
Forward milk price contracts – baby v. bath water
The price/cost chase experience of the last year focused Irish dairy farmers on the adequacy of fixed or forward milk price contracts. Farmers who committed sometimes very high percentages of their supplies in recent years may be receiving 10 or 12c/l less than current prices for that milk but are not being spared the sky-high production costs. This takes a fair slice out of their potential margins and may even leave some in loss making situations.
I have always been a strong advocate of income risk management measures such as fixed milk price contracts. However, recent events have taught us that it is not the price we need to set forward or fix, but the margin.
Some co-ops have found ways of increasing the price of contracted milk to partly address the problem, and this is very welcome. Those contracts are built on agreements engaging every element of the chain, and so are very difficult for milk purchasing co-ops to renegotiate.
The war in Ukraine has shocked us all into the realisation that the dynamics of the food chain have changed utterly in the last few years. Global food production capacity cannot be taken for granted when geopolitical, climate change events and climate action policies conspire to restrict it.
Income risk protection is more essential now than ever for dairy farmers, and just because the previous form of fixed price contracts is no longer fit for purpose, we should not ditch the baby with the bathwater. New contracts must focus on margin protection. There are precedents in fixed milk price schemes factoring in production cost variations, such as those introduced by Glanbia a few years ago.
This approach needs conversations to change along the dairy, and more generally the food, chain. Recent developments have created an exceptional opportunity to start those conversations with dairy commodity and ingredients customers as well as retailers. They must be challenged and educated to integrate structurally higher and potentially volatile production costs into their pricing model. They need to understand that security of supply requires security of margins for milk producers, and they must integrate this fact into their sustainability plans.
At least some of this will further feed into cost-of-living inflation for consumers. But failing to secure farmers’ incomes has real food security and affordability consequences which could cost consumers a whole lot more.
© Catherine Lascurettes, Cúl Dara Consultancy
