Dairy prices have more than halved from record highs scaled in 2013, with Chinese buying dropping off dramatically after the world’s second-biggest economy built up excess supplies of milk powder last year just as the economy began to slow.

Fonterra, the world’s largest dairy exporter, has dominated the commodity milk powder sector for years and had been rapidly expanding its business in China.

But profits have been falling for nearly two years in the face of volatile dairy prices, which sank to a 12 1/2-year low at the latest global auction on Wednesday.

As a result, Fonterra said on Thursday it would cut more than 500 of its 16,000-strong global workforce, and warned more redundancies were likely as it reviews its operations.

New Zealand’s dairy exports to China have tumbled 69 per cent since the start of the year compared with 2014, official data shows, whittling Beijing’s share of the country’s total dairy shipments to roughly 16 per cent, from 37 per cent last year.

At the same time, a ban by Russia on foreign dairy products, imposed in response to sanctions slapped on the country over its role in the Ukraine conflict, has removed a major buyer of butter and other milk products.

Meanwhile, supply has ramped up as farmers in New Zealand, Europe and the U.S. have set up dairy farms in hopes of cashing in on a doubling in dairy prices between 2009 and 2013. Production in New Zealand, the world’s biggest dairy exporter, has reached record highs.

“It’s really both sides of the equation. We had a period of really high milk prices, and that encouraged additional milk production across the globe,” said Susan Kilsby, dairy analyst at agricultural consultants AgriHQ.

“There’s been… no reason to slow production anywhere as feed costs are low so there’s still a lot of signals to encourage milk production. That’s timed with the two largest buyers of dairy products buying less than usual.”

More room to fall

Industry sources say Chinese processors are still working through stockpiles of imported milk powder, prized over domestic offerings due to past safety scares, which is used in everything from confectionary to baby formula.

That has kept Chinese buyers out of the market since the start of the year.

“The optimistic view is that there is 150,000 tonnes of powder sitting in warehouses,” said David Mahon, managing director of Beijing-based Mahon China Investment Management, which focuses on China’s food and beverage sectors. “I think it’s well over 300,000 tonnes, but the mix is hard to know.”

Such a stash would equal roughly half the volume of milk powder New Zealand exported to China in the whole of 2014.

Analysts see the risk of prices falling further, with demand unlikely to pick up soon as Chinese processors work through their existing stocks.

Adding to the expected glut, New Zealand’s farmers are gearing up for the milking season beginning next month after the Southern Hemisphere winter.

“Often at this time of the year you see a faster increase in supply out of the Southern Hemisphere because supplies are tight, but we’re certainly not seeing that this year,” said Kilsby at AgriHQ. “There are certainly opportunities for prices to fall further.”

— Naomi Tajitsu is a Reuters correspondent based in Wellington, New Zealand. Additional reporting for Reuters by Adam Jourdan in Shanghai and Dominique Patton in Beijing.

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Fonterra said the subdued outlook amid sluggish demand would likely slow the pace of New Zealand dairy output growth, and kept its forecast payout price to farmers for 2015-16 below the long-term trend despite a rise from this year’s eight-year low.

Persistently low dairy prices have clouded the growth outlook in the agriculture-based economy where dairy products make up more than a quarter of total exports, and raise the possibility of an interest rate cut in coming months.

Fonterra increased its initial forecast for its farmgate payout price to NZ$5.25 (C$4.68) per kilogram of milk solids from NZ$4.40 this year, reflecting a recent slight lift in global prices which have tumbled around 50 per cent since 2014.

The forecast payout is still below a long-term average around $6.50, raising the risk that farmers may rein in the strong growth seen in the country’s “white gold” industry in the past decade and take on more debt.

“At these payout prices, I’m not expecting massive production growth next season,” Fonterra CEO Theo Spierings told Reuters.

“It could turn out to be a season of one per cent or two per cent growth,” he said, lower than average annual growth of around three per cent in past years.

Fonterra, which controls about a third of global dairy exports, expected only a limited pickup in global prices as demand from conflict-stricken countries in the Middle East and Africa continues to fall, despite some gains in top buyer China and Southeast Asia.

Spierings said prices for whole milk powder, New Zealand’s biggest export product, would likely average around $2,900 per tonne in the next 12 months, up from near-historic lows around $2,400 at present but well below highs of $5,200 in late 2013.

He was “cautious” about any pick-up in demand next year, and said an environment of lower global dairy prices would likely curb the company’s expansion plans and slow offshore investments, including in its dairy farms in China.

Low dairy prices also increase the risk that New Zealand’s farmers, already strapped for cash due to this year’s low payout, may take on more debt. The dairy sector accounts for around 10 percent of total borrowing in the country.

“Cashflows will continue to be very tight… it’s going to be tight for the majority of farmers over the next little while,” ASB Bank rural economist Nathan Penny said.

— Naomi Tajitsu is a Reuters correspondent based in Wellington, New Zealand.

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Both countries were among the top three exporters of beef to the U.S. last year as New Zealand and Australian farmers rushed drought-stressed cattle and dairy cows to slaughter.

But as pastures Down Under revive, 2015 exports could shrink five per cent and possibly more, according to some forecasts.

The culling of aging dairy cows should be finished by early July, “and then there will be a sharp pullback in New Zealand beef supply,” said rural economist Con Williams at ANZ Bank.

Australia’s cattle slaughter should diminish around late June, with July and August the time when cutbacks could pinch exports, Meat and Livestock Australia’s North America regional manager, David Pietsch, said in a recent TheBeefRead.com webinar.

Meanwhile, the U.S. herd is still near its lowest level in 63 years at 89.8 million head. Since it takes roughly two years for a calf to reach maturity, the first tangible rebound in domestic cattle numbers is not expected until 2016.

For 2015, the U.S. Department of Agriculture has forecast beef output to be down 0.2 per cent from 2014, and cattle market analysts foresee only a 0.2 per cent increase in 2016.

Demand slip may temper price gains

Despite scarce cattle supplies, analysts said it is likely that wholesale prices will struggle to move much higher than the record $263.81 on Jan. 14 and the previous high of $263.66 on July 31, 2014, at the peak of summer grilling demand (all figures US$).

U.S. exports have been hurt by the strong dollar, keeping more supplies at home, while record pork production offers a less expensive alternative to beef.

Agricultural research and advisory firm Sterling Marketing president John Nalivka expects wholesale beef to plateau around the mid-$260s.

For the week ending May 1, choice wholesale beef averaged $256.94/cwt, up $25.07 from a year ago and entrenched above $200, a price that prior to the severe U.S. drought of 2012 which trimmed supplies was thought prohibitive for supermarkets and food service buyers.

— Theopolis Waters and Naomi Tajitsu report for Reuters from Chicago and Wellington, New Zealand respectively. Additional reporting for Reuters by Colin Packham in Australia.

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The government on Thursday said medium-scale drought conditions were affecting the east coast of the South Island, which includes a major dairy region, adding that it would offer extra funding immediately through rural trusts.

“It’s clear that conditions are only going to get tougher as the seasons change and we need to prepare now,” Primary Industries Minister Nathan Guy said in a statement, adding that he was also monitoring parched regions in the North Island.

The announcement comes after a drier than average summer.

Drought was last declared in 2013, when it shaved about 0.3 per cent from real GDP in a country where farmers account for more than 55 per cent of exports.

Some analysts said the economic impact from the latest drought was likely to be smaller, given that fewer regions had so far been affected.

“It’s not clear where we’re going to finish up. Does it take 0.1 per cent off GDP? I don’t think it will be bigger than that at this point,” Deutsche Bank economist Darren Gibbs said.

However, industry experts said dairy farmers faced a bigger challenge in recovering from the current drought compared with 2013, as plunging global prices have cut cashflows.

Facing a benchmark payout of NZ$4.70 per kilogram (C$4.36/kg) of milk solids this year, the lowest since 2008, farmers have already have cut back on milk production and sent cattle to the slaughterhouse.

This is in stark contrast with 2013, when a record-high dairy payout in the following season enabled farmers to lift milk production to an all-time high.

“It’s a perfect storm with dry conditions and the lower payout,” said Virginia Serra, an advisor at industry body DairyNZ, which represents farmers in the drought-affected Canterbury-North Otago region.

“With last year’s NZ$8.40 payout, farmers had tools to deal with the previous season’s drought. But now, those tools are reduced. The margin to spend on expensive feed supplements and things like that just aren’t there this season.”

Dry conditions have spread throughout the Southern Hemisphere. Australian farmers have struggled with lower rainfall for more than two years, although favourable weather in recent weeks has eased some of the pain.

— Naomi Tajitsu reports for Reuters from Wellington, New Zealand. Additional reporting for Reuters by Colin Packham in Sydney.

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Years of low cattle supplies have kept U.S. beef import prices near a record high of around $3 per pound hit last September, according to agricultural data provider AgriHQ.

New Zealand is the third-largest exporter of the meat to the U.S., helping satisfy a surge in demand for ground beef from both long-established outlets such as McDonald’s and trendier “fast-casual” chains such as Shake Shack.

Farmers have cut back on milk production and sent aging cattle to the slaughterhouse, seizing on the demand for beef as global dairy prices have plunged to a five-year low.

Last month, Andrew Hoggard reduced the 550-strong milking herd on his farm in the North Island town of Fielding by 22, taking some of the cattle out of production so they need less feed but sending four less-than-prime cows to slaughter.

“There was one cow we got NZ$1,300 (C$1,188) for. She was big, but normally if you get $500-$600 you’re quite happy and $700 is a big deal,” Hoggard said.

Unfavourable summer weather has added to the dairy farmers’ woes, leaving the normally lush landscape so vital to the sector as dry as a crisp.

“If there’s one positive thing (about this season), it’s that those cows are getting good money,” Hoggard said, adding that he expected his milking herd to fall to 500 by the end of the season in May.

Meat accounted for 12 per cent of New Zealand’s total global exports in 2014, less than half of the 29 per cent contributed by dairy products, the country’s top export earner.

The country’s beef exports usually rise around February or March and stay high through May, when dairy production winds down for the season.

But frozen beef exports have been climbing since November as cash-strapped farmers have cut production and started culling herds earlier in the season than normal.

As a result, beef exports to the U.S. hit NZ$160.5 million (C$146.7 million) in December, Statistics New Zealand says, more than double the value of a year before.

Insatiable Americans

Demand for ground beef continues to rise in the U.S., where nine billion servings of burgers were ordered at restaurants and food outlets last year, up three per cent from 2013, according to U.S. market research group NPD.

Gourmet burger chains such as Shake Shack and Habit Restaurants are luring both hungry punters and investors away from the old fast-food chains. Shares in Shake Shack more than doubled on their debut on Jan. 30.

In New Zealand, older cows and those not expected to produce much the following season are sent to slaughter and processed into frozen lean beef cuts. Much of this is shipped to the United States, where it is minced and plumped up with additional fat to be made into hamburger patties for burger chains.

The drop in herd numbers has reduced dairy production in New Zealand, prompting dairy cooperative Fonterra to cut its milk collection forecast for the 12 months to May to 1.5 billion kg of milk solids, down 3.3 per cent from last season’s record high. It has also slashed its farmgate price forecast.

The culling will not pose a problem if milk demand picks up: farmers can lose up to 20 per cent of their cattle even in a normal year and have to replenish herds, and they can simply feed their cows more to push up output rapidly if needed.

For now, though, meat processors say business has been brisk since last month, with the latest weekly cattle cull numbers up 72 per cent in the South Island from a year before and nearly 27 per cent higher in the North Island.

“The low dairy payout, coupled with the dry weather conditions, has resulted in a dramatic increase in the number of cows being processed,” said Murray Behrent, general manager for livestock at processor Alliance Group Ltd.

“All processors are experiencing a backlog, and this will continue through May.”

— Naomi Tajitsu is a Reuters correspondent based in Wellington, New Zealand.

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