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What the dairy payout means for Taranaki's downstream economy compared to the last three years

Taranaki is known for its strong dairy industry. With many farms and businesses relying on the dairy industry for their livelihood, the annual dairy payout is a key indicator of the region's economic performance.

However, due to heavy reliance on international commodity prices, the dairy sector experiences fluctuations in income from year to year. This can have a significant impact on the downstream economy of Taranaki, affecting everything from local businesses to household incomes.

In this blog, we will discuss what the current season forecast farm gate milk price means for Taranaki's economy compared to the last three years' payouts. Additionally, we will examine how input costs and interest rate rises have countered current higher levels of dairy payout.

What is the farm gate milk price?

The farm gate milk price is a measure of the amount of money that dairy farmers receive for their raw unprocessed milk. The farm gate milk price is determined by a combination of factors, including Global Dairy Trade (GDT) auction prices and direct sales from dairy processors, with GDT auction prices being influenced by international demand for dairy products and the NZD/USD exchange rate. The GDT serves as an online auction platform for dairy products such as milk powder, butter, and cheese. The dairy payout is not solely determined by the GDT, as a significant amount of dairy products are not traded through the platform. This is one reason why dairy companies have varying payout rates.

In New Zealand, the forecast farmgate milk price is announced at the start of the season by dairy companies such as Fonterra and is based on current GDT prices and the dairy futures market prices, along with the dairy companies' view of the season ahead and where both the NZ/USD exchange rate might sit over the season. The initial farm gate milk price is typically announced in May or June and covers the period from June through to May. The payout is expressed in dollars per kilogram of milk solids (kgMS), which is a blend of the underlying pricing of the fat and protein content of the milk.

The farm gate milk price is an important measure of the dairy industry's profitability and has a significant impact on the wider New Zealand economy. Dairy is New Zealand's largest export earner, accounting for around a third of the country's total exports. Additionally, many businesses in Taranaki, such as engineers, mechanics, trades, and services all rely on the dairy industry for a significant portion of their revenue.

The dairy payout in the last three seasons

In the past three years, the farm gate milk price from Fonterra, New Zealand's largest dairy processor, has risen year on year. In the 2019/2020 season, Fonterra’s final farm gate milk price for the season was $7.14 per kgMS - this was due to strong international demand for dairy products and was a welcome increase on the prior season's final payout of $6.35.

In the most recent season, the 2021/2022 season, the dairy payout increased to a record high of $9.30 per kgMS, reflecting a recovery in demand for dairy products. This was a welcome boost to the region's economy, with many farmers paying down debt and businesses that support the dairy industry also benefiting from the high payout.

The dairy payout in the current season

The current season’s dairy payout is uncertain, and recent developments suggest a decrease in income for the region.

According to DairyNZ herd statistics for the season-ending May 2021, the average herd size in Taranaki was 300 cows, with an average production of 417 kgs MS per cow, with a total of 1,553 dairy herds in the region producing a combined total of 194,312,592 kgs of milk solids from 465,896 cows.

The opening forecast for the season started strong with a mid-point announced by Fonterra of $9.50/kg MS in May of 2022. This was revised downwards to $9.25/kg MS towards the end of August 2022, with further revisions downwards to $9.00/kg MS and with the most recent downgrade in February 2023 moving the mid-point down to $8.50/kg MS. This most recent forecast revision means income of $92.65 million will no longer flow into the Taranaki economy between now and 30 September 2023 compared to what was forecast last month. This also means a total drop of $194 million from the opening start of the season forecast payout forecast mid-point ($9.50) to now ($8.50).

With Taranaki GDP at around $9,984 million in 2022, this drop of $194m represents almost 2% of Taranaki’s annual GDP. With annual growth in 2022 of 3.7%, a change of 2% makes for a significant impact on the region's economy and highlights the challenges faced by farmers and businesses in the dairy industry.

Interest rates have increased due to the official cash rate moving from 1.0% in February 2022 to now sitting at 4.75% post the latest rise in February 2023. And they are expected to rise again by another 0.50% to 5.25% at the next announcement on 5th April 2023. This has seen floating interest rates for farmers rise to between 7% and 9% with interest bills for the average farm in Taranaki growing by around $120,000 over the last 12 months. The full-year effect of high-interest rates is about to bite for the season ahead where interest rates are forecast to hold and stay high over the next 12 - 18 months.

High inflation in farm input costs - especially the 3 F’s of Fertiliser, Feed, and Fuel saw the average operating costs for dairy farms in Taranaki increase by around $1.10/kg MS between the 2021 season and the 2022 season, driven in part by logistics issues arising out of the Covid-19 pandemic. The full-year effect of these prices has bitten further in 2023 and while we are now seeing some easing of fuel and fertiliser prices, they are still well above pre-pandemic levels.

This has meant a fundamental change in the breakeven milk price for dairy farms.

According to Dairy NZ, the average break-even price for dairy farmers in Taranaki is now $8.66 per kgMS. This means that in order to cover their costs, farmers need to receive at least this amount for their milk. Last year's Fonterra final farm gate milk price was $9.30 per kgMS, which resulted in a cash profit for many farmers allowing many to repay some debt.

However, considering the higher interest rates and inflation that are currently impacting the economy, the current season forecast farm gate milk price of $8.50 per kgMS will mean many farmers are needing to pull back on normal capital maintenance and planned projects for the year ahead just to get through.

There is however some opportunity here as well. For instance service and repairs businesses may see an increase in demand as farmers choose to hold onto their plant and machinery assets for longer periods rather than renewing them, meaning replacing parts and servicing will increase.

Conclusion In the current year, the payout remains uncertain, with many farmers and businesses concerned about the impact of new regulations and rising input costs. Despite these challenges, the dairy industry remains an important part of Taranaki's economy, providing jobs and income for many in the region.

The impact of the dairy payout on Taranaki's economy is clear - a higher payout leads to increased revenue for farmers and businesses, while a lower payout has the opposite effect. Additionally, new regulations aimed at reducing greenhouse gas emissions and other environmental concerns are expected to impact the dairy industry in the coming years, which could further impact the region's economy. In the next 12 months, we can expect to see significant belt-tightening in terms of on-farm expenditure.

For those interested in Taranaki's economy and the dairy industry, it is important to keep an eye on developments in the sector, including changes in regulations, market trends, and input costs.

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