Dairy 2012 Situation and Outlook

Contents

Page no.

Executive Summary 3 Overview Glossary of terms 1

8 9

The international market 10 Current market developments Global economic settings Global market outlook Policy drivers

11 14 21 24

2 The Australian market 27 Current market conditions Australian market outlook

28 38

3

The industry value chain Ownership and consolidation Policy issues The farmgate market

40

41 42 45

4

The production sector Production trends People Production outlook Key regions at a glance

50

51 53 55 57

5

Production inputs and resources 58 Cow and heifer markets Outlook for feed inputs Water

59 61 66

This report has been prepared for the Australian Dairy Industry to provide participants and stakeholders with a comprehensive and objective assessment of the industry’s position and outlook, as a resource to the dairy industry for information and planning purposes. The work has been funded by Dairy Australia. The report has been written by Dairy Australia’s Strategic Analysis team with assistance from Freshlogic. The project has benefited from the input from dairy farmers, management of Australia’s major dairy companies, farm consultants and advisers, and Dairy Australia management and importantly the participants in the 2012 National Dairy Farmer Survey. While due care has been taken to ensure that the report is accurate and comprehensive, it is provided for information purposes. Dairy Australia accepts no liability if, for any reason, the information is inaccurate, incomplete or out of date. Parts of the report may be copied provided that it is not for commercial use and Dairy Australia is acknowledged as the information provider.

Executive Summary The industry in 2012 – rebalancing the supply chain The past couple of years have seen many farmers able to consolidate their business, and national milk production growth in 2011/12 was the highest for a decade. However, while the opportunities offered by growing international dairy demand are well understood, the short-term oscillations in returns and profitability continue to test the faith of dairy farmers and their commitment to future expansion and succession. Significant regional variation remains a feature of the Australian dairy industry in 2012. For most farmers in south-eastern Australia, the 2011/12 season has been one of consolidation. Slightly lower farmgate prices have been offset by lower feed costs. Generally favourable seasonal conditions and the return of plentiful irrigation water supplies to the northern Victoria and Riverina production region have underpinned expansion. In drinking milk regions – Queensland, New South Wales, Western Australia and parts of South Australia – intense retail competition, shifts in private label supply contracts and processor rationalisation have undermined farmer confidence and supply stability. Farmgate milk prices in southern exporting regions will finish the 2011/12 season down around 5% from the previous year. In drinking milk regions, average prices have also moved lower, as access to “tier one” supply for many suppliers has been altered and new lower contract prices have been negotiated, leaving farmers with limited alternative supply opportunities. In exporting regions, opening price announcements for the 2012/13 season are being developed in an operating environment characterized by surging global dairy supplies, solid demand and rapidly weakening dairy commodity prices. Butter prices have fallen over 30% from historic highs last year, while powder prices have declined more than 20%. The Australian dollar has stabilised around parity with the US dollar, but downward pressure is mounting. The outlook for indicative southern farmgate milk prices, based on current commodity price and exchange rate expectations is for an opening price range of $4.05 to $4.40 per kgMS down from an average opening price of around $4.75 per kgMS in 2011. This implies a full year average price range between $4.50 and $4.90 per kgMS down from $5.30 to $5.40 per kgMS in 2011/12.

While the forecast is indicative, it needs to be acknowledged that the range of pricing options available to farmers, as well as the variation in monthly pricing within the year, makes it difficult to be definitive about outcomes for individual farmers. The current weak export outlook puts pressure on opening prices, but the continued competition for milk supply will ensure that dairy companies open as aggressively as possible. In addition, prospects for a lower Australian dollar are a positive for export returns. In drinking milk regions, the balancing act between fresh supply and demand continues as processors adjust their intake requirements and pricing to meet the demands of a highly pressured retail marketplace. Where new supply contracts are being negotiated with farmers, prices are lower to reflect the pressure on processor margins and the changing requirements for milk supply. Confidence, as measured in this year’s National Dairy Farmer Survey remained relatively high nationally, as many farmers use the current favourable climatic conditions and seasonally higher prices to consolidate their balance sheets and fine-tune production systems heading into the 2012/13 season. However, significant regional differences in confidence and outlook remain as farmers face quite different pricing and market dynamics. World market International dairy demand has remained robust, despite the ongoing economic uncertainty centred on the US and EU economies. Led by China, south-east Asia and the Middle East, demand for dairy imports has remained strong, as milk deficit countries have achieved consistently higher economic growth rates, which support increased dairy consumption. Since peaking in 2011, just below the historic highs of 2008 in US dollar terms, dairy commodity prices have steadily fallen over the past year, largely in response to growing product availability. Southern hemisphere suppliers are currently clearing stocks in preparation for the northern hemisphere spring flush and the new 2012/13 season. Buyers are increasingly cautious, as recent more significant falls in spot commodity prices and increased supplies encourage more just-in-time purchases and less forward buying. Dairy 2012: Situation and Outlook 3

Executive Summary As dairy commodity prices have fallen there has been less incentive for substitution of vegetable-based oils and proteins. Rising oil prices, constrained supplies and biofuel policies are keeping substitute oil and protein prices stable – and the gap between dairy and plant ingredients is closing. A slightly improved economic outlook, together with lower commodity prices will support dairy demand from key emerging markets over the next twelve months, as the international market rebalances. World supply Favourable seasonal conditions have prevailed in most major dairy producing regions during 2011 and early 2012. This situation, combined with reasonable farm margins has seen milk output and export availability increase significantly. EU milk output was 2.1% ahead in 2011, as favourable seasonal conditions have combined with positive price signals. A mild winter has set the EU up for a good spring, with production forecast to increase by around 1% in 2012. In the United States, milk production increased by 1.8% in 2011, with herd numbers stabilizing and good seasonal conditions. Production growth is expected to strengthen in 2012, with the USDA forecasting an increase in output of almost 2.5%. New Zealand milk production growth is expected to finish the 2011/12 season between 8 and 10% higher than last year - well above initial market expectations. New Zealand exports are 9% up for the season to date, with much of the additional milk output exported as WMP, SMP and infant powder. Given the weakening export market, the new season payout forecasts are expected to be well down, providing less incentive for expansion. A return to more normal seasonal conditions could see New Zealand growth closer to its longer term average rate of between 3 and 5% in 2012/13. South American milk production continues to grow. However exports from the region were almost halved in 2011. Rapid growth in Brazil’s consumption absorbed supplies from neighbouring countries, resulting in limited export availability for markets beyond the region.

Australian market Growth in the Australian economy slowed in 2011, but is expected to strengthen in the short to medium term as monetary policy moderates. The multi-speed economy is apparent in business conditions, with the mining sector continuing to boom, while domestically-focussed and other exporting industries are struggling. Unemployment remains low, but concerns over cost of living increases and general global economic uncertainty are keeping consumers vigilant about their spending. In this environment the foodservice sector remains under pressure, as consumers look to home-prepared meals to cut food spending. Major retailers seeking to maintain or grow their market share are continuing to push the “value” button, and focussing on low-priced everyday staples such as milk and bread. One dollar per litre pricing for private label milk has been in place for over 12 months and appears to be part of the category landscape for the foreseeable future. Consumers have migrated across to the cheaper supermarket product, and while there has been some overall volume growth in the category, value and profit margins have been eroded. Nevertheless the domestic market continues to offer the industry a solid base for its product, with consumption growing around 1 per year - in line with population. The farm sector in 2012 Regional differences continue to characterise the Australian dairy industry – based on market and product mix, farmer confidence as well as current and future growth prospects. For most farmers in south-eastern Australia, 2011/12 has been a largely favourable season, with good rainfall, the best irrigation allocations for a decade and low feed prices. While a cold and wet spring proved challenging for Gippsland farmers, a dry second half year has hit western Victoria. The Murray Dairy region (encompassing northern Victoria and the Riverina) and Tasmania have been growth areas, and also the regions where farmer confidence - as measured by the 2012 National Dairy Farmer Survey - has been highest. In Queensland, central and northern New South Wales and Western Australia the industry is geared toward domestic fresh milk supply. Ongoing intensity in Dairy 2012: Situation and Outlook 4

Executive Summary retail competition, disruptions caused by changes in private label supply contracts and uncertainty surrounding processor milk requirements have undermined farmer confidence and stifled production growth. Nationally, a large proportion of farmers surveyed in the 2012 survey describe their business as being in a “steady as she goes” phase and are flagging limited expansion. Overall around 22% are growing their business, but the percentage of those “growers” is much higher amongst larger farms. While there are regional differences, national ABARES estimates indicate that 2011/12 farm cash incomes will average $136,000, down from $141,000 in 2010/11. Debt levels have retreated slightly to $660,000, an average fall of $3,800. The past couple of relatively stable years have offered the opportunity for many farmers to address short-term debt and stabilise balance sheets. Milk production outlook Milk production is expected to reach 9.45 billion litres in 2011/12 - up almost 4% on 2010/11 output of 9.1 billion litres. The outlook for 2012/13 is for growth to slow, to around 2% reaching between 9.6 and 9.65 billion litres, based on herd growth intentions, and normal seasonal conditions. Southern exporting regions will again lead growth; however lower prices may constrain output. Domestic supply regions will likely be flat, as reduced feed input costs partly offset farmgate price falls. Three-year growth intentions recorded in the 2012 survey were similar to the 2011 survey. Based on these expectations and assuming reasonable seasonal conditions and prices, milk production could range between 9.8 and 10.1 billion litres by 2014/15. Medium term prospects A key question for the Australian industry into the medium term is whether this rate of volume growth is sufficient to maintain relevance in an expanding global market for dairy products. A large proportion of current dairy farmers are signaling little appetite for growth as the pressures on management, cash flows and profitability remain. While the current fall in prices will test farmers who have managed through the challenges of the last decade, the medium-term prospects for the industry

remain positive. Demand for dairy products – the reason for positive sentiment amongst the farmers surveyed - remains a positive, and will continue to grow with the expanding middle class in emerging markets such as China, changes in diet and increasing urbanisation together with an rising global population. Dairy’s place as a premium source of fat, proteins and other nutrients, as well as a versatile food and high performing ingredient underpins demand, but is not assured as substitute products increase in sophistication. Dairy consumption must be supported with ongoing marketing and innovation, while consumer expectations around industry sustainability and production ethics will need to be met to maintain dairy’s favourable status. The challenges for the Australian dairy industry are to grasp the opportunities offered by the expanding market for dairy products in markets where Australia is already an established supplier - and maximize returns for the local industry. Policy settings will continue to play an important role in Australian dairy farmers continuing to be competitive and profitable into the future. At home the implementation of and adaptation to the carbon pricing scheme and access to water are key issues. Internationally, with no multilateral agreement on trade reform in sight, Australia’s ability to negotiate significant free trade agreements will be critical to maximizing returns for the industry. The bilateral agreements negotiated by competitor countries will also have an important bearing on trade flows and access to – and profitability in - markets of choice. EU and US policy reforms will also play a role in shaping future trade flows as the removal of EU production quotas and the likely development of a new US Farm Bill signal a new type of engagement with the international market for these two significant dairying regions. Australia’s ability to keep pace with growing demand and the need for production and product innovation, to ride out the inevitable ups and downs of a global commodity market will determine how many of the opportunities offered into the medium term will be realized by the industry. Central to the industry being able to grow and prosper into the future is its ability to attract and retain skilled people to support and develop the industry’s competitiveness and resilience.

Dairy 2012: Situation and Outlook 5

Executive Summary Rebalancing the supply chain Current industry operating conditions remain reasonably positive, but how will farmers respond to lower farmgate prices?

Exporters

Product manufacturers Production & resource inputs High global grain production and plentiful stocks keeping prices low High water allocations and carryover supplies mean short term security for irrigators but medium term policy concerns remain Limited supplies of milking cows and replacement heifers

Demand still solid led by China and south-east Asia Strong supply response from all major exporting regions as favourable seasonal conditions prevail Currency movements affecting competitiveness Preparation for policy changes in the EU and to some extent the US Stable competing (substitute) ingredient prices

Clearing stocks following higher than expected milk production Strong competition for milk supplies to maintain factory throughput Increased investment and restructuring activity amongst manufacturers

The Australian dairy industry value chain

Export

Water Feed production

Milk production

Processing / manufacturing Retail

Marketing

Supplements Imports

Dist’n

Food service

Milk production A “two speed industry” – different regional demands and outlook for milk supply Mostly reasonable seasonal conditions, but areas of difficulty Pricing signals reflect weakening export market in southern states Retail price discounting and company rationalisations undermining confidence in domestic regions

Fresh dairy processors Continuing to balance regional fresh demand and supply using sharper pricing signals Pressure maintained on domestic processor and manufacturer margins Increased size of private label milk contracts is adding to the disruptions caused by any changeover in supplier

Domestic marketers Consumers are value focussed as uncertainty about the economy remains Low food price inflation, as retailers continue to compete on price and focus on private label strategies Foodservice losing share to food retailers International competition increasing in industrial sector

Dairy 2012: Situation and Outlook 6

Executive Summary Fig E.1 - Drivers of the industry’s future

The scenarios for the future size and structure of the Australian dairy industry in the medium to long term will be shaped by a number of major primary drivers of change. The ultimate outcomes will be based on how well the Australian dairy industry responds to such future opportunities and risks affecting the industry’s competitiveness and sustainability. Outcomes are also determined by how well the sectors of the value chain align their response, as this will affect the industry’s capacity to adapt, innovate and differentiate.

Primary drivers…

Changing global economics

Climate variability

…have direct and indirect effects on… Developing economies driving economic recovery and food demand Challenges to competitiveness of agricultural production in first world countries Transition to low-carbon economy Costs of competing products influenced by biofuel demand Volatility of commodity markets in tight supply Adaptability & sustainability of proven production systems Increased complexity and need for long term resilience of business Increased competition for water Volatility of feed input supply and costs Uncertainty of policy settings affecting resource access and emissions

…future scenarios for the industry:

Future opportunities: Global dairy demand outpacing supply Changing economics for competing food ingredients Flexible and adaptable production systems Adopting technology for productivity gains Widening scope for product functionality Understanding and managing volatility

Advancing technologies

Need for accelerated adoption of new technologies to address production challenges Requirements for different skill sets Functionality of both dairy and its competing products Consumer acceptance of technology platforms

Transformational advances in plant & animal technologies Areas of industry risk: Vulnerable production systems Attracting and retaining skilled people

Changing trade and social policies

Consumer and community demands

High priority placed on food security Greater concern for environmental impact Varied societal empathy for farm sector Potential competition from emerging low-cost exporters Weakened appetite for multilateral trade reform – impacts of bilateral agreements on competitiveness Development of technical and ethical trade barriers Consciousness for enjoyment, wellness and healthy eating Concern for ethics in food production systems Compliance demands on farm and processing enterprises Acceptance of GM use in production inputs Affordable food as a policy priority

Producers operating on volatile production margins Reduced relevance as a reliable dairy exporter Threats to dairy’s ethical proposition Poor understanding of impacts and emissions of dairy Increased accountability and costs without effective measurement Moving too far away from competitive production base

Dairy 2012: Situation and Outlook 7

Overview What drives the returns to the industry? The Australian domestic market’s share of total industry milk production will slip a little below 55% in 2011/12 – with the export share just over 45% - due to the strong increase in milk production. The Australian market is effectively open to imports of dairy products, with a long standing free trade agreement with New Zealand and free access for most major dairy products. Imported product contributed an estimated 25% of domestic cheese consumption and 22% of domestic butter consumption in 2010/11.

Fig E.2 – Australian industry market mix since 1990 Australian industry market mix since 1990 Domestic

Export

Share exported (right axis)

12,000

60%

10,000

50%

8,000

40%

New Zealand is the major source of Australian dairy product imports – contributing 65% of total cheese imports and 91% of butter imports in 2011. The New Zealand share of cheese imports has fallen from 78% in 2009 to 65% in 2011; while the US share has lifted from 1% to 13% over the same period.

6,000

30%

4,000

20%

2,000

10%

The majority of wholesale dairy product prices in the domestic retail, foodservice and industrial markets are directly influenced by the international market. Due to longer term contracts, local retail prices do not reflect the short-term volatility of export commodity prices.

0

The transparency of world market prices, the open market for dairy imports, and the structure and practices of the retail grocery sector, mean there is no effective sustainable premium over time for sales into the domestic market compared to export returns, when all costs are considered.

0%

90/91

93/94

96/97

02/03

05/06

08/09

11/12 E

Fig E.3 - Australian industry product mix – 2011/12

Milk 25% Cheese 34%

As a result, farmgate prices - particularly in the regions of Victoria and Tasmania where the majority of milk is used in the manufacture of dairy products - are closely aligned to returns from exports. Supermarket pricing is clearly an important factor in setting industry margins in the drinking milk market, and therefore, pricing in regions that are largely dedicated to its supply.

99/00

other 6%

SMP/Butter 24%

WMP 11%

Dairy 2012: Situation and Outlook 8

Glossary of terms

ABARES

Australian Bureau of Agricultural and Resource Economics and Sciences

ABS

Australian Bureau of Statistics

ACCC

ASEAN

Australian Competition and Consumer Commission Association of South East Asian Nations (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam)

BRIC

Member countries Brazil, Russia, India, China

NDFS

Middle East and North Africa Murray Dairy region incorporating northern Victoria and the NSW Riverina National Dairy Farmers Survey conducted as part of the preparation of this study

CAP

EU’s Common Agricultural Policy

NSW

Central and Southern NSW (including the Hunter Valley)

CDIA

China Dairy Industry Association

NZ

New Zealand

CWT

Cooperatives Working Together

NZX

New Zealand stock exchange

DA

Dairy Australia

OPEC

Organisation of Petroleum Exporting Countries

DEIP

Dairy Export Incentive Program

PSA

Private Storage Aid

DFMC

Dairy Farmers Milk Co-operative

QSR

Quick Service Restaurant e.g. McDonalds, KFC

Doha Round

The round of WTO negotiations that commenced in 2001

RBA

Reserve Bank of Australia

EU

European Union

SA

FAO

Food & Agricultural Organisation of the United Nations

SDP

South Australia Sub-Tropical Dairy region incorporating Queensland and northern NSW

FAPRI

Food & Agricultural Policy Research Institute

TDP

Tasmanian Dairy Products

FTA

TPP

Trans Pacific Partnership

GCC

Free Trade Agreement Gulf Cooperation Council (Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and the United Arab Emirates)

TRQ

Tariff Rate Quota

GDP

Gross domestic product

UDP

United Dairy Power

GDT

GlobalDairyTrade online auction platform

US

United States

GHG

Greenhouse gas

USDA

United States Department of Agriculture

Gipps

Gippsland

WA

Western Australia

IDFA

International Dairy Foods Association

WCB

Warrnambool Cheese & Butter Factory

IMF

International Monetary Fund

WTO

World Trade Organisation

Intervention Mercosur MENA MD

A process whereby a government buys products from the market to reduce commercial availability A trade alliance between a number of South American countries including Brazil, Argentina and Uruguay

Dairy 2012: Situation and Outlook 9

Chapter 1 The international dairy market

Highlights Demand regions at a glance

18

Competing supply regions at a glance

20

Medium to long term outlook finely balanced

22

Changing policy landscape

24

Current market developments

The global dairy market has transitioned from demand-driven price rises to supply-driven price declines over the past 12 months. Following the 2008 global financial crisis and subsequent collapse in international dairy commodity prices, demand steadily recovered and commodity prices retraced steps toward historic highs achieved late in 2007. In response, farmgate prices improved across all major dairy exporting regions, and this combined with consistently good seasonal conditions has seen milk output steadily building throughout the past 12 months. While demand has remained solid, it has not kept pace with the surge in supply. Southern hemisphere suppliers are clearing additional end of season stocks, and buyers are currently watchful, meeting only immediate requirements, while they assess where prices will settle. While cost pressures are escalating in many key milk producing regions, there has not been a negative impact on milk production, particularly in the United States and to a lesser extent, Europe. Farmgate prices in the EU and US have remained high enough to support production growth during the northern hemisphere peak, although they have decreased rapidly in recent months. Milk production in the United States continues to grow despite escalating feed costs and declining farmgate milk prices. Additionally, US exporters are increasingly seizing opportunities in the global dairy market, and are now critical to the overall global market balance. Despite a shaky start, incredibly good seasonal conditions and attractive farmgate prices have seen a significant jump in New Zealand milk production. NZ milk production grew 8-10% in 2011/12. Since New Zealand exports approximately 95% of all milk produced, the additional production has been sold on the global market - primarily in the form of milk powder.

Longer term, there are questions surrounding the removal of production quotas in the EU by 2015 and its impact on EU milk production and the global market balance. The main factor preventing a rapid decline in commodity prices has been robust demand absorbing much of the supply growth in recent months. With ongoing economic uncertainty, demand is not expected to keep pace with supply growth in the next 12 months, and so milk prices are expected to drift lower. Attention will turn first to farmgate price signals in Australia and New Zealand for the 2012/13 season, as a proxy for production expectations. Pasture growth and production trends will be followed very closely to establish how much supply will enter the global market from Oceania. In combination with exchange rate volatility and potential economic fallout from the EU, risks are firmly weighted toward the downside of pricing.

Fig 1.1 - Spot commodity prices 6,000

US$ per tonne

Searching for market balance

5,000 4,000 3,000 2,000 1,000

SMP

WMP

Butter

Cheese

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11

Apr-12

The key factors driving the negative pricing environment over the next 12 months are economic problems in the United States and Europe, and strong supply growth in all major dairy production regions. Dairy 2012: Situation and Outlook 11

Current market developments Chinese demand China has grown to be the largest single dairy importing country in the world, with over 1.1mt of product imported in 2011, worth more than US$3.8 billion. Demand for imported products continues to be strong, with growth of retail products including UHT milk and infant formula products, and other products like cheese and butter for both retail and industrial uses. Import demand is driven by factors such as continuing concerns about the safety of domestic dairy products (spreading from infant formula to other products like milk during past 12 months), lower tariffs on dairy products from New Zealand, and the strength of the Chinese RMB relative to the US dollar. Due to high demand in mainland China infant formula products are increasingly being purchased in Hong Kong supermarkets by visitors from mainland China. A number of online and mail order businesses have emerged, dedicated to selling infant formula products. Some Hong Kong supermarkets have purchase limits of 2 tins per transaction while other retailers will sell a maximum of 100 tins of infant formula per day. A new Chinese Government regulation has came into force in mid-April 2012 – applying a 10% tariff on all purchases of infant formula products from Hong Kong exceeding the value of RMB5,000 (AUD$780). The intention is to limit grey market flow of products from Hong Kong to Mainland China. While Chinese imports of whole milk powder decreased in 2011, total dairy imports were up 20% compared to 2010. The largest import categories are in order of volume, whey powder, WMP, SMP and infant formula.

million tonnes, but Chinese authorities do not have to revert to the standard tariff rate when the initial 115,000t limit is surpassed. Australian exports to China declined by about 3% (by volume) down to 73,500 t in 2011, while only 0.7% down by value, according to Australian Bureaus of Statistics. The major category affected was WMP – down by 65% - reflecting the commercial advantage that NZ enjoys with its FTA. The major growth categories were cheese (for both retail and food service), liquid milk (mainly as UHT milk for retail sales), SMP (mainly for industrial uses) and infant formula (for retail sales).

Fig 1.2 – Chinese dairy import composition 2007-11 100%

WMP

90% 80%

Whey Powder

70%

SMP

60%

Milk

50%

Lactose

40% 30%

Infant Powder

20%

Cheese

10%

Butter

0% 2007

2008

2009

2010

2011

New Zealand is the largest supplier of dairy ingredients and receives an advantage over Australian dairy imports because of a preferential free trade agreement. New Zealand can export the first 115,000t of milk powder at 6% compared to the 15% tariff that would be charged on Australian origin milk powders. The 115,000t limit is small compared to total Chinese dairy imports of one Dairy 2012: Situation and Outlook 12

Current market developments Gulf Cooperation Countries demand remains strong, despite unrest Despite widespread unrest in parts of the Middle East, dairy exports to Gulf Cooperation Council (GCC) countries for 2011 dipped to 1,250,000 tonnes. The impact of recent unrest (Arab Spring) has mainly been limited to specific countries in the wider region (Bahrain and Syria), and has been offset to some extent by movement in business to other markets such as the United Arab Emirates and Saudi Arabia. European traders working within the Arab Spring affected countries report that while demand for dairy products remained, there were challenges for locals to get access to trade finance to facilitate international business.

The largest declines were in the powder category with SMP, WMP and whey powder imports all declining by over a third, while butter and buttermilk products and yogurt saw growth in imports compared to 2010. Challenging market conditions within Russia has contributed to growth in counterfeit dairy products (dairy products ‘extended’ with vegetable fat). Official Russian data suggests 150,000t of vegetable fat was used to substitute milk fat in 2011, but a futher 80,000 tonnes was estimated to have been used illegally to produce low quality products. Weaker global markets are driving Russian domestic milk prices below 12 Rouble per kilogram (AUD$0.37/litre), with expectations of further declines in coming months.

Exports to one of the largest GCC dairy importers, United Arab Emirates, were up 7%, driven by an increase of 21,000t in WMP imports. UAE is reportedly taking steps to liberalise trade in a number of areas – including dairy – in order to combat rising food prices and monopolistic behaviour by importers and distributors. Year to date dairy imports for GCC countries are down 44% on 2011 in volume terms – likely due to a combination of healthy stocks and the anticipation of easing commodity prices. Russia demand stable Russia and the wider CIS region have been affected by spill over from the Euro area crisis, which has dampened export growth into this market and resulted in significant capital outflows as investors seek safe havens. However, demand is likely to be supported by a third non-consecutive term of Vladimir Putin’s Presidency. Given some of the domestic unrest during the election campaign earlier in 2012, President Putin will be keen to reinforce his economic credentials. After a large increase in dairy imports in 2010 due to drought, Russian imports eased 9% to 550,000t in 2011 as domestic production capacity recovered.

Dairy 2012: Situation and Outlook 13

Global market outlook Global economic settings Economic conditions have an important bearing on demand for dairy products, particularly in emerging markets where food expenditure represents a higher proportion of income, and consumption of less traditional foods such as dairy is highly sensitive to changes in price or income. The latest International Monetary Fund (IMF) World Economic Outlook released in April described slightly better prospects for the global economy. Improved financial conditions, easing monetary policies, a similar pace of fiscal tightening as in 2011, and continuing reconstruction activities in Japan and Thailand will drive the reacceleration of growth by 2013.

Fig 1.3- Year on year changes in GDP (%) -2 Global Advanced economies US Japan Eurozone

For emerging economies, modest negative impacts from the Euro area are expected to be largely offset by monetary easing and reduced fiscal tightening. European economic recovery is not yet assured, with a new government in France, challenges on agreeing to austerity measures in Netherlands and Greece backing away from previously agreed austerity measures. China’s growth has progressively slowed since mid-2011, allaying concerns about a potential hard landing which would be detrimental for global economic growth. The slow down has been carefully managed by Chinese authorities, and projected growth rates appear more measured and sustainable.. In Latin America, financial conditions and commodity markets remain favourable. Recent fiscal tightening will slow activity, however prospects are expected to improve in 2012, and unemployment rates are likely to remain low.

2

4

6

8

10

12

2010 2011 2012 2013

Emerging economies China

Improved US economic activity and better policies in the Euro area have reduced the threat of a sharp global slowdown. However the IMF does expect global GDP to grow 3.5% in 2012, down compared to 2011, with advanced economies expanding just 1.4% year on year. Emerging economies continue to outpace the global economy and are forecast to grow by 5.7% in 2012, slightly down on 2011. While recent policy responses have eased the risks, the global economy remains vulnerable. The two most immediate risks are renewed escalation of the Eurozone crisis and heightened social and political unrest in the Middle East which could trigger a sharp increase in the price of oil.

0

ASEAN India Brazil Russia Source: IMF World Economic Outlook April 2012

Oil prices Rising oil prices remain a significant risk to the global economic recovery. Oil importing countries in Asia are particularly vulnerable; generally speaking higher prices would increase inflationary pressures and reduce discretionary consumption. Global oil demand was lower than forecast in 2011 because of weaker than expected economic activity. However disruptions to supply have maintained upward pressure on prices. Oil production has recovered in Libya - in February production was 80% of the pre-unrest level – but fell in other Organisation of Petroleum Exporting Countries (OPEC) producers while non-OPEC output remained weak. The risks posed by social unrest and uprisings – currently centered on the Islamic Republic of Iran have boosted oil prices. The EU’s oil import embargo, other countries’ tightening sanctions and Iran’s partial oil export embargo, make lower Iranian supply almost inevitable. While other producers will probably increase supply to fill the gap, there remains a real possibility of supply disruptions. Dairy 2012: Situation and Outlook 14

Global market outlook With these risks unlikely to subside soon, precautionary demand for oil stocks has increased. Demand growth - related to increasing economic activity – and only a modest increase in non-OPEC supplies, mean that oil prices will ease slowly, but remain above 2011 prices. Futures markets suggest oil prices will recede to around US$110 a barrel in 2012 and 2013. Currency movements Since most international dairy trade is carried out in US dollars the exchange rate is important in determining how international prices will translate to local returns. Currency movements for other dairying regions and markets are also important in determining the competitiveness of Australia’s exports and the affordability of dairy for importers.

Fig 1.4- Crude oil price (US$ /barrel) 160 140 120 100 80 60 40 20 0 Apr-07 Dec-07 Aug-08 Apr-09 Dec-09 Aug-10 Apr-11 Dec-11

The Australian dollar has been reasonably stable in the past couple of months, trading in a narrow range between 102 and 104 US cents, after peaking at 107 US cents in July 2011. Easing local interest rates and signs of improvements in the US economy were the key driving the Australian currency lower against the US dollar. More recently, weaker economic data out of China has also weighed on the Australian currency. With further cuts to official rates expected over 2012, and a more subdued outlook for commodity prices and demand, most forecasters expect limited upside for the local currency. While this is good news for Australian exporters, the Euro is also weaker as markets are again focusing on the recession, weak banks and fragile debt dynamics at play in Europe. The weaker currency will make EU exports more competitive. By the end of the calendar year the four major Australian banks have a forecast range for the Australian dollar of 104-110 US cents, but short term depreciation is expected due to renewed concerns about Greece exiting the Eurozone and the resultant flight to US safe havens. A Bloomberg survey of 45 financial institutions forecasts the dollar to trade between US$0.95 and US$1.15.

Dairy 2012: Situation and Outlook 15

Global market outlook Demand factors Demand for dairy products has remained solid, and has absorbed much of the increased supply over the past 12 months. China and Russia remain key demand regions in balancing the international market. Regions such as southeast Asia have maintained demand in the face of global economic uncertainty, and imports continue to grow in value. While global economic uncertainty remains an important factor determining the demand for dairy products in the short to medium term, the past 12 months show that key emerging markets have been relatively unaffected by the global economic slowdown. With a slightly improved economic outlook, demand from these regions is expected to remain strong into the foreseeable future. Furthermore, easing dairy commodity prices are likely to support short term demand growth, as products become more attractive to price-sensitive ingredient users and more affordable for consumers. In China a strong preference for imports remains – especially infant formula and other nutritional products. Affluent middle class consumers are prepared to pay a premium for products they know are safe and of a high and consistent quality. For the local Chinese processing sector, licensing crackdowns - in the wake of the melamine contamination scandal - have generally affected low-value, lowquality producers leading to a higher concentration of processors. Increased processing costs, driven in part by stricter regulations, are adding to the pressure for rationalization of the local processing sector. These changes within the Chinese industry are expected to see strong ongoing demand for imported dairy ingredients, with local production focused on meeting demand for higher value fresh dairy products. Dairy consumption is likely to remain stable in the key regions of the EU and US. Local consumption within these two massive production zones is critical, because only around 10% of production is exported, and their domestic markets are each larger than total world dairy trade. Despite economic woes, EU and US dairy consumption has been fairly steady. US retail milk sales decreased 4% during Q1, 2012 (compared to last year), but foodservice sales improved - Starbucks reported Q1 same store sales growth of

Fig 1.6 – Major importers by volume (‘000 tonnes) 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0

2007

Sth East Asia

Africa

Middle East

Greater China

2008

Japan

2009

2010

Russia

2011

Mexico

8% in the Americas. US food service sales have been strong, indicated by McDonalds sales increasing 8.9% in the USA, while same store sales for Q1,2012 increased 6% for Taco Bell, 5% for Pizza Hut and 2% for KFC. Dairy tends to do well in recession as shoppers trade down to more staple products that can be consumed at home. In the EU, cheese consumption in France, Germany and the UK has also increased modestly (between 0.4%-2.0%) helping to offset the 3.2% increase in EU milk production during December. But economic pressures are affecting some mid-level brands as consumers save money by switching to private label products. Brazil has emerged to become an important nation in balancing the global dairy market at the moment. Strong economic growth has underpinned higher disposable incomes and a jump in local dairy consumption. Growth forecasts for Brazil indicate that after struggling in the second half of 2011, demand is showing signs of a rapid rebound. Real wages have increased 4.5% from 2011 and inflation is not expected to become a problem until 2013. This has come at an opportune time given strong milk production growth this year in Argentina, Chile and Uruguay. Milk production growth from these countries has been absorbed by Brazil to meet rising demand rather than creeping into the global market to be absorbed by countries that may have traditionally purchased from Australia, New Zealand or the EU.

Dairy 2012: Situation and Outlook 16

Global market outlook Developments in market exchanges and instruments

The NZX Dairy Futures have now also expanded to include SMP and AMF futures contracts, but dairy product futures markets in general still have a long way to go before they achieve the same liquidity as in successful grain or cocoa futures markets.

3500 3000

GDT spot price

2500 2000

Dairy Australia range of spot prices

1500 1000 500 0

Fig 1.8- GlobalDairyTrade product offers 70,000 60,000

50,000 40,000 30,000 20,000

WMP

SMP

AMF

BMP

Casein

Cheese

Jan-12

Oct-11

Jul-11

Apr-11

Jan-11

Oct-10

Jul-10

Apr-10

Jan-10

Oct-09

0

Jul-09

10,000 Apr-09

By comparison CME International SMP futures and Eurex butter and SMP futures have been in operation since May 2010, but significantly less volume has been traded on these exchanges – one lot for CME International SMP Futures and less than 5,000t of butter and SMP contract volumes on Eurex. NYSE Liffe SMP (established in Oct 2010) has also traded around 500t of contract volumes.

4000

Jan-09

Greater sales volumes and the inclusion of more sellers adds to GDT’s credibility as a settlement price for NZX Dairy Futures, which have been one of the more successful of the dairy futures instruments released in recent years. Interest in NZX Dairy Futures (WMP launched in October 2010) has accelerated, initially taking around 12 months to trade the first 10,000 lots, but five months to trade the next 10,000 lots.

4500

Oct-08

Movement in GDT prices has been relatively modest as more frequent events and increased familiarity with the auction have enhanced its role in increasing market transparency. More recently, as larger volume offerings have met with low buyer participation, auction price movements have been greater and have highlighted the weakening wider commodity market.

5000

Jul 09 Aug 09 Sep 09 Oct 09 Nov 09 Dec 09 Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Nov 10 Dec 10 Jan 11 Feb 11 Mar 11 Apr 11 May 11 Jun 11 Jul 11 Aug 11 Sep 11 Oct 11 Nov 11 Dec 11 Jan 12 Feb 12 Mar 12 Apr 12

Cheddar cheese and Milk Protein Concentrate (MPC70) have been added to the products offered on the GlobalDairyTrade (GDT) online auction platform. New sellers have joined GDT, including Arla Foods, Murray Goulburn and Dairy America. Around 788,000 tonnes of product have been sold on the platform over the past 12 months, representing under 9% of world trade in all dairy products. However for whole milk powder (WMP) the GDT share is just under 25% - representing a significant share of trade for this product.

Fig 1.7 - GlobalDairyTrade prices vs. Australian export prices (USD/tonne)

Jul-08

While the market has been less volatile during the past 12 months than in previous years, the availability of risk management instruments has expanded significantly - although uptake varies across the different products.

MPC

Dairy 2012: Situation and Outlook 17

Global market outlook Fig 1.9 - Demand regions at a glance China Russia The IMF forecasts growth in the Russian economy will moderate from 4.3% GDP growth in 2010 and 2011 to around 4.0% in 2012 and beyond. Continued growth supported by high oil and commodity prices. Demand for dairy products is expected to remain stable in the near term, with food service and hospitality channels the likely sources of growth. After a large increase in dairy imports in 2010 due to drought, Russian imports eased 9% to 550,000t in 2011 as domestic production capacity recovered. There are signs of production growth in early 2012.

Based on information from the China Dairy Industry Association (CDIA) and Chinese Customs, total dairy imports in 2011 increased nearly 20% by volume (up to 1.1 million tonnes), and 33% by value (to US$3.8 billion) - making China the world’s largest dairy importer. Local production is adjusting to tighter regulations implemented in the wake of the melamine contamination, and becoming more concentrated. The high demand for imported dairy products is likely to be maintained in the foreseeable future, with significant growth expected for imported retail products including infant formula, UHT milk, cheese and even pasteurized milk and yogurt, on top of ingredient products like SMP, WMP and whey powder for industrial uses.

South East Asia Dairy exports to the region were over 1.6million tonnes in 2011, up 4% on 2010. Confidence in demand growth is high despite challenges in individual countries. Growing food service penetration is increasing demand for dairy used in coffee, on pizza and in baked goods.

Latin America Imports to the region totaled 480,000 tonnes in 2011, up 13%. Growth in dairy consumption has been supported by high rates of economic growth in the region. This is particularly the case in Brazil, which has become a net importer, absorbing production growth other Latin American countries. Brazil is now an important market in terms of maintaining global supply and demand balance. The outlook for dairy demand in the region is highly dependent on the continued economic expansion of Brazil, both as the economic engine of the region and an importer of product from other Latin countries.

Middle East An estimated 1,250,000 tonnes was exported to the region in 2011, down from 1,380,000 Saudi Arabia and UAE are the most important markets (43% of volume). But Iran, Turkey, Kuwait and Oman are becoming increasingly important to trade in the region. Iraq is also a large market for imports, purchasing 220,000 tonnes in 2011.

Demand for dairy continues to grow (though at varying pace between individual countries) driven by improved education, government programs encouraging consumption, and economic growth. The markets have progressed from being basic commodity markets to more sophisticated high-value product markets. Resilience of demand and the value of imports is improving as dairy has become more entrenched in the diet.

Year to date dairy imports for GCC countries are down 44% on 2011 in volume terms – likely due to a combination of healthy stocks and the anticipation of easing commodity prices. The economic outlook remains steady despite ongoing social unrest in region. Business is adapting – shifting to less troubled parts of the region. Higher oil prices will drive the region’s economy and underpin ongoing dairy demand.

Dairy 2012: Situation and Outlook 18

Global market outlook Competitor products The supply dynamics for substitute products are becoming increasingly complex as vegetable fats and proteins are used in a wider variety of food and animal feed products. As vegetable fat and protein filled products are pitched at the lower end of the pricing spectrum, many industrial users are very flexible in ingredient requirements and have a range of recipe options that can be used based on the economics of ingredient prices – be it soy or dairy, to maximise profit margins. This is especially the case for animal feed producers who can switch between different animal and plant fats and proteins because of less restrictions around labelling requirements. At the same time, the growing prevalence of renewable energy policies and biofuel subsidies to support the transition of feed crops to fuel crops are limiting supplies of vegetable proteins in some countries. Soybean production is forecast to fall by 28 mt in 2012 as the South American production outlook deteriorates due to crop damage. China has also undertaken an aggressive purchasing regimen, and markets are concerned that the Brazillian government may ban soy exports to protect local producers. Global palm oil markets are also expected to tighten in coming months as Malaysian palm oil yields are down significantly on record production volumes achieved last year. Indonesial palm oil production is ahead this season but insufficient to cover shortfalls in Malaysian production. World production of the 17 major oils and fats increased markedly in late 2011 and early 2012, yet growth rates are set to moderate over the remainder of 2012 because of competition from cereal crop plantings.

Fig 1.10 - Dairy protein price premium vs soy meal (US$/kg protein) $14.00 $12.00 $10.00 $8.00 $6.00 $4.00 $2.00 $0.00 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12

Fig 1.11 - Butterfat price premium vs palm oil (US$ per kg fat) $6.00 $5.00 $4.00 $3.00

$2.00 $1.00 $0.00 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12

The EU 2012 cereal crop is expected to grow by 1.2% in 2012 to 288mt. However, economic uncertainties are reducing new season plantings and frost kill has been a concern over winter.

Dairy 2012: Situation and Outlook 19

Global market outlook

Fig 1.12 – Competing supply regions at a glance

United States US milk production rose 1.8% in 2011 as the nation’s dairy herd stabilised and milk yields per cow continued to increase. Another strong season is predicted with the latest USDA forecasts for 2012 milk production indicating just under 2.5% growth on last year. Some farms appear to be positioning themselves for life post US Farm Bill by expanding their production base. Mild weather in many dairying regions and significant rates of culling have seen per-cow production remain high as less productive animals are removed from herds. US exports of most commodities continued to grow in 2011, albeit at a reduced rate to that seen in 2010. SMP exports climbed 13% to 435,000t whilst cheese was up 29% to 224,000t. Butter exports increased by 16% to 52,000t and lactose grew 13% to 311,000t. Whey powder exports remained almost static at 451,000t. Significant culling later in the year could dampen further production growth into 2013, but will be offset by the large US dairy heifer population (the largest in 15 years according to the USDA) providing a steady stream of replacement milkers.

Latin America Collectively the South American countries exported 108,000t of WMP beyond the local region in 2011. This was up 4.5% on 2010. Trade within South America is expected to continue to grow as domestic consumption – particularly in Brazil – grows. The Chilean domestic market also remains strong. Argentina continues to grow strongly – but at a slower pace than last year (35%) Brazilian milk production for 2011 was up 2%, and is expected to grow at a similar rate in 2012. However, internal consumption growth is retaining all of this milk for the domestic market Uruguay production is up around 24% for Q1, but minimal product is making the global market as Brazil is purchasing any exportable surplus. Brazil accounted for one third of Uruguayan exports by value in January 2012.

European Union Good weather conditions, robust demand and strong milk prices encouraged EU27 milk production growth of 2.1% in 2011. EU milk output is forecast to rise slightly in 2012 with growth of around 1.3%. Growth is currently running at 3.3% but is expected to slow given rising feed costs. While the EU has enjoyed generally favourable weather conditions to date, cuts to farmgate prices and rising costs are expected to dampen growth over the remainder of 2012. Cheese production is absorbing most of the surplus milk – with little increase in SMP and butter volumes likely. In 2011 export volumes fell by 8%. EU SMP exports were up 15% to 434,000 - the only growth category for exports. Cheese exports were down 14% to 572,000t, while WMP exports were down 17% to 319,000t. Butterfat exports were 31% lower at 106,000t. The European Commission’s Private Storage Aid (PSA) program had accepted 55,000 tonnes of butter at the end of April. The PSA program subsidizes storage of product during times of high seasonal stocks, for release into the market during the Northern Hemisphere winter.

New Zealand Milk production expected to finish up between 8 and 10% for the 2011/12 season – well above expectations. Reasonable farmgate prices, combined with excellent seasonal condition have combined to boost milk output. New Zealand dairy exports totalled over 2.5 million tonnes in 2011, 8% up on the previous year. WMP remains the largest NZ dairy export product, with 1.1 million tonnes exported in 2011, a 17% increase. New Zealand exports were up 12% for the first two months of 2012. For 2012/13 milk production growth could return to more a more “normal” 3-5% is expected, assuming climate is less idyllic and price signals are less positive in line with a weakening international market.

Dairy 2012: Situation and Outlook 20

Global market outlook Supply factors Global milk production is forecast to grow by almost 3% in 2012. A “perfect storm” of favourable seasonal conditions has prevailed across most major exporting regions, allowing for reasonable profit margins and expansion in 2011.

Fig 1.13 - EU and US milk supply % changes on same month of prior year 6% 4%

Since early 2011, prices for US cull cows have remained at historically high levels. With the recent “pink slime” controversy causing a reduction in the ability of beef processors to use treated beef trimmings as filler in low-grade ground and processed beef products, increased animal requirements to fill the gap are likely to see cull cow demand remain strong. Production yields per cow are likely to improve as less productive cows are replaced with young stock from the record dairy heifer population (the largest in 15 years according to the United States Department of Agriculture) providing a steady stream of replacement milkers.

0% -2% -4% US

EU 27

Jan-12

Nov-11

Sep-11

Jul-11

Mar-11

May-11

Jan-11

Nov-10

Sep-10

Jul-10

Mar-10

May-10

Jan-10

Nov-09

Sep-09

Jul-09

May-09

-6% Jan-09

Expectations of a slowdown in US milk production resulting from a reduced profit margins has not materialized. The US government Milk Income Loss Contract (MILC ) program has been reactivated (for the first time since April 2010) as a result of increasing feed costs.

2%

Mar-09

This synchronized growth in milk production around the world has been met by solid demand, but as northern hemisphere dairying regions gear up for 2012, it is becoming increasingly apparent that the tight demand and supply conditions that have characterized the international market have significantly eased.

Fig 1.14 - Incremental change in milk production (yearon-year, millions of litres) 3,000 2,500

2,000 1,500 1,000 500

In the European Union, decreasing export commodity prices have been slow to flow through to farmgate prices, supporting production growth. However, dairy processors are now beginning to lower farmgate prices. Good weather in the five largest EU dairy producers, France, Germany, UK, Italy and the Netherlands is supporting production growth of 2 to 3% during the seasonal production peak. In New Zealand , almost ideal pasture conditions have led to a significant increase in milk production in the 2011/12 season of between 8 and 10%. Lower milk prices and potentially less favourable weather conditions should see the pace of NZ milk production growth to slow considerably.

(500) (1,000) (1,500)

EU-27

US

2008

NZ

2009

Aust

2010

2011

Argentina

Brazil

2012(f)

Dairy 2012: Situation and Outlook 21

Global market outlook Medium to long term outlook EU post-quota outlook The removal of production quotas in 2015 will have a significant medium term impact on the dairy sector within Europe, and also the global dairy supply and demand balance, as the region adjusts to an unencumbered production future. Many European firms are looking at export growth to absorb the expected increase in EU milk production post 2015, as they do not expect significant growth in internal EU demand. Some manufacturers are using the interim period before quotas are removed to build market presence in Asia and grow brand awareness for products they intend to export more of post 2015. While many organizations are currently planning for change, for some there are still too many variables to fully commit to a course of action. Particularly in light of the financial and economic issues facing the Eurozone, and potential threats to the Euro itself as a single currency. This is presenting problems for investment in processing infrastructure. Given the large volume of EU milk that is processed into cheese, it is likely that new production infrastructure that will be built to cope with post-quota removal milk supply growth will centre on milk powder drying. There is widespread acknowledgement that current EU processing capacity is insufficient to handle any significant growth in seasonal peak milk flows. Many processors are currently grappling with oversupply during the seasonal peak and end up on-selling partially dried ingredients (skim milk or whey concentrates) to third parties for further processing. Some processors have clear plans in place for plant expansion, most of which is destined to flow into drying plants rather than new cheese investments. It is generally accepted that the EU member states struggling to remain within existing production quotas will be the most likely regions for milk production growth post 2015. These countries are, France, the Netherlands, Denmark, Ireland and Germany. However each will face challenges in growing production.

Country (growth region)

Challenge for growth

Germany

Environmental measures and insufficient funds available for investment in capacity growth. Long term returns in biofuels has diverted potential investment funds for dairy.

(north west)

New processing capacity limited to powder driers. The Netherlands (inland)

Public perception of dairy farming, due to environmental and animal welfare concerns. Tightening regulations around fertilizer application could constrain growth. Home grown feed supplies unlikely to be sufficient, risks associated with importing feed.

France (north west)

Widespread community support for smaller farms as part of the national identity will slow efficiency gains and industry transition. Restrictions on movement of production quotas and production capability to regions where milk is the cheapest to produce.

Denmark

Highly leveraged industry already – finance for growth unlikely to be forthcoming in current economic environment.

Ireland

Irish growth plan is for 50% growth in milk production between 2009 and 2020.

(southern)

Ireland requires investment in processing plant to be able to convert increased supply into products for the global market. Local producers already producing large volumes of export cheese for UK market, but if new WMP plants are built how do they compete on global market? Highly seasonal production curve complicates processing infrastructure investment, but challenge is to broaden shoulders of production curve without eroding too much of low production cost benefit.

Dairy 2012: Situation and Outlook 22

Global market outlook

Global demand for dairy products will continue to rise in the long term with the growing importance placed on dairy’s nutritional value and functional diversity, but more significantly with the projected improvement of household incomes and living standards in developing economies. The long-term supply and demand chart on this page describes a scenario for future trade in dairy products. This scenario shows how total export demand in 2021 may be met by the total growth in milk equivalent supply from major exporters. In past Situation & Outlook reports, a theoretical gap between demand and supply has been postulated based on detailed demand and supply assumptions using the latest information and outlook projections from various forecasters. However, a more relevant way to look at the long term is to consider the likely pressures on sustaining a balanced global dairy market over time. The chart on the right shows one potential outcome over a 10 year period from 2011 to 2021. Major assumptions as to the expansion in export supply from exporters and consumption of dairy in all major markets that affects trade underpin that result. Export volumes from these exporters would, in this scenario, grow by 16bn litres. While the world market balance is fragile, the expectation is that supply will struggle to maintain pace with potential demand, supporting a trend line of firming world prices. A “balanced market” scenario is highly sensitive to a number of factors as shown in the table on the right. The greatest threats to long term balance are: the import demands of the Chinese market as it improves local supply chains yet faces ongoing rapid growth in nutritional food needs by expanding urban populations, EU’s ability to maintain a balanced internal market after the removal of production quota limits in 2015, the impact of climatic patterns on pastures and crops used in milk production, balance in the US internal market, affecting available exports of milk powders and cheese.

Clearly the tight balance and sensitivity of the outlook to changes in key production and demand variables lends itself to ongoing price volatility.

Fig 1.15 Changes in major exporter volumes 2011 to 2021 (million litre milk equiv.) 55,000 50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 -

2011

Base assumption in the above scenario

EU

NZ

US

Aust

Latins

Other

2021

Sensitivity of “market balancing” in 2021 (assuming no other changes)

Context

US production growth of 1.4% p.a. EU production growth of 0.4% p.a.

This is consistent with the past 5 years’ compound growth This aligns with European Commission latest views on the EU outlook

Chinese milk supply grows by 8% pa

Current growth is faster, but resource limits may curtail future growth

Chinese liquid milk demand grows 6.5% pa NZ milk output grows 2.5% pa

Current growth is faster, but incomes may curb expansion Expansion over 5 years to 2010/11 was 3.3% pa

If growth is 2% p.a., added supply of 5.2bn litres would be available. If adjustment to deregulation is harder and the EU does not grow, a shortfall of 5.1bn litres would be apparent If growth is 1% pa slower, a shortfall of 4.0bn litres would be apparent If demand is 1% pa faster, an additional 3.9bn litres would be required If growth is 1% pa faster, added supply of 2.5bn litres would be available

Dairy 2012: Situation and Outlook 23

Policy drivers

International policies While policy settings have long had an important influence on world dairy markets, the interaction between policy developments and international market opportunities and outcomes is likely to intensify during 2012/13. The US and European Union are both nearing crucial decision points on the future shape and direction of their domestic support policies for dairy and other agricultural sectors. While the nature of support may change significantly in both countries, one objective of policy will be to maintain (and in the case of the US expand) their dairy export capabilities over the next decade. The failure of the WTO Doha Round has seen a renewed push for bilateral deals. o

Several third party deals could significantly affect the competitive position of Australian exporters in key markets in future years.

o

Australia is also seeking agreements with a number of trading partners. But, in several cases negotiations are being complicated by nonagricultural issues.

Some countries are using the emerging “food security” debate to justify an increase in protectionist policies and actions to limit trade and support local firms. Continued pressures on manufacturing employment in a number of developed economies (so-called “jobless recoveries”) are similarly encouraging shift in sentiment towards greater protectionism. Collectively these developments are, and will add further to, the complexity of Australia’s dealings in world dairy markets in the next few years.

European Union The next two years will see some major decisions made about the direction of EU agricultural support. In late 2011 the EU Commission published parallel draft proposals on possible reform of its Common Agricultural Policy (CAP) and on the future funding of EU and CAP budgets. These proposals will be debated over the course of 2012

between the Commission, the Ministerial Council and the European Parliament which now has “co-decision” rights over major policy reforms. The new policies are expected to be finalized early in 2013. The core elements of the proposed CAP reforms are: o

Budget funding for CAP programs to be frozen at 2013 levels from 2014 to 2020 - effectively a real decline in funding over time.

o

Continuation of the current basic structure of direct income payments to farmers (Pillar I) and decoupled Rural Development funding (Pillar II), and

o

Further reductions in public intervention and private storage aid mechanisms, but the provision of a new cross-sector safeguard clause that will allow the Commission to respond to “general market disturbances”.

Some elements of the broader CAP proposals that may have implications for future dairy production (and will require further assessment) include: o

A shift to make payments to farmers more uniform per hectare (rather than based on historic production levels) and across member states and regions with convergences across all sectors by 2020;

o

The “greening” of payments by tightening the rules covering 30% of direct payments that are linked to farmers undertaking specific environmental and climate related activities on farm;

o

Capping of payments for large farmers, and redirection of funding in favour of small and “active” farmers.

The CAP reform proposals do not deal in detail with dairy where previously agreed reforms, such as the annual increase in milk production quotas prior to their removal by March 2015, continue to be implemented. In February, the Ministerial Council and European Parliament agreed to some additional legislative reforms for dairy - the ‘Milk Package’. These measures aim to boost the position of dairy producers in the supply chain as the sector moves to a more market-oriented, post-quota environment. It provides for written contracts between farmers and milk processors, the right for producer

Dairy 2012: Situation and Outlook 24

Policy drivers organizations to collectively bargain on behalf of farmers and new obligations on firms to provide government with milk intake information. The recent downturn in dairy prices within Europe has seen renewed calls from some sectors and governments for the reintroduction of export subsidies (which are still allowed in the absence of a WTO Doha deal). However, at this stage, the Commission is holding firm against such requests. United States The current five year US Farm Bill, The Food, Conservation, and Energy Act that regulates commodity support, environment, conservation, research, market access, farm services and food assistance (for disadvantaged households) programs will expire on 30 September 2012. The forthcoming US Presidential and congressional elections in November are making members of Congress cautious about major policymaking particularly in view of the budget deficit and the pressing need to make spending cuts to existing programs. The House Agricultural Committee leadership has proposed cuts of US$23 billion per annum while the Obama Administration sought US$32 billion in savings. The National Milk Producers Federation (NMPF) which represents producers and producer cooperatives favours a margin insurance program. To offset the cost, NMPF are proposing to eliminate the ineffective dairy product price support program, the Dairy Export Incentive Program (DEIP) that allows for export subsidies, and the counter-cyclical Milk Income Loss Contract (MILC) program. The MILC program mainly benefits smaller producers and is triggered when the monthly average milk price is below a threshold level, with the payment adjusted for movements in the price of feed. The International Dairy Foods Association (IDFA), is adamantly opposed to supply management. The basis for the IDFA opposition is that supply management could adversely impact milk production and therefore supply availability for exports in addition to causing negative repercussions for domestic demand if a tightening of supply pushed up wholesale prices, which in turn could then encourage more imports. IDFA has thrown its support behind a margin insurance program.

Some industry changes and output growth appear to be occurring already in anticipation of margin insurance and supply management, which could be based on 2012 production. If a joint bill is not agreed by the August recess then the November elections will likely prevent finalization until 2013. With Congress and Administration some way from agreement, it is likely the existing Farm Bill will indeed be extended for another year. Directions for trade policy The long running WTO Doha Round negotiations failed another crucial hurdle in late 2011 when a planned “final” Ministerial meeting in Geneva broke up without reaching agreement on key reforms to international trade rules. A key stumbling block in the agriculture talks was ongoing division on the type and scale of concessions to be provided to developing countries in any final deal. However, there were also fundamental differences in positions in other key negotiations including trade in services and manufactured products. Importantly, the meeting failed to establish an agreed pathway or timetable for finalising negotiations during 2012. Some countries, including Australia, have started a series of parallel negotiations to see if they can reach agreement on various subsets of the Doha reform agenda (e.g. export competition, trade in services). Even this more limited process faces challenges with some key developing economies such as India expressing reservations about supporting any subdeals. The timing of negotiations will also overlap key election processes in countries like the US, further reducing the likelihood of significant progress before late 2013. With no clear WTO deal on offer, many countries have shifted their trade policy focus to negotiating new bilateral and regional free trade agreements (FTAs) with key trade partners. Some of these deals have the potential to significantly impact on Australia’s competitive position in key markets in coming years (see table on page 26).

Dairy 2012: Situation and Outlook 25

Policy drivers Australia is also seeking to finalise FTAs and cooperation treaties with a range of key trading partners in the Asia-Pacific and Middle East regions. Some of these negotiations are very advanced. Australia and Malaysia are expected to announce agreement on an FTA in the first half of 2012. Hopefully an agreement with Korea can be also finalised before the end of 2012.

Fig 1.16 - Competitor Trade Agreements and their status Trade Agreement EU-Korea

Negotiations continue with Japan, China, the GCC, Indonesia and India on bilateral trade agreements, but none of these are likely to reach a conclusion in 2012. In the case of China, negotiations started in 2006 but have been held up by divisions on issues outside agricultural trade (including motor vehicle access). Recently the Australian government announced it is pursuing a new approach that may allow agreement on agricultural trade access to be brought forward while leaving other sensitive access issues to be resolved later. Australia is also one of nine countries engaged in the Trans-Pacific Partnership (TPP) negotiations which is seeking to establish a framework that will enhance trade between the members (including the US) and allow for the future entry of additional countries (such as Japan) to the framework. There are significant challenges posed to Australian dairy trade by third-party trade agreements which are currently operating or being finalised.

US-Korea (KORUS)

GCC – New Zealand China-New Zealand

Status Provisionally applied since 1 July 2011 while final ratification is taking place. EU agreement includes provisions on geographical indications (GI’s) that could impact on trade in specific cheese varieties to South Korea (such as fetta). Implemented in March 2012. This agreement will phase in duty free or reduced duty access for US exporters on a range of key dairy products such as milk powders, butter and butter oil, cheese and powder preparations. The public and political reaction to KORUS within Korea was one factor that stalled progress in Australia’s FTA with Korea. Negotiations have concluded, but the agreement has not been ratified into law. FTA came into effect in 2009. Under this agreement China is gradually reducing tariffs on dairy imports from New Zealand to zero. Despite the existence of a Special Safeguards provisions, the FTA provides New Zealand with considerable commercial advantages in the Chinese market. One indication of this benefit is that New Zealand’s market share (by value) in China rose from just over 20% in 2008 to over 40% in 2011.

Dairy 2012: Situation and Outlook 26

Chapter 2 The Australian dairy market

Highlights A review of each major dairy product category

30

Aggressive supermarket competition continues

34

Loss of market share for non-grocery sector as consumers cut food spending

36

Current market conditions The Australian food market The retail food and beverage market was estimated to be worth $144bn in annual turnover for the 2010/11 financial year. There are several major channels, but sales are dominated by the grocery sector (which comprises major chains and independent stores) with 63% of sales.

Fig 2.1 - Retail food and beverage sales Other takeaway 3%

QSR 9%

The retail food market is made up of a diverse number and type of outlets, as well as distribution structures between food producers and manufacturers and the retail outlets servicing consumers. Consumer trends Australians remain cautious in spending on household essentials as well as reduced outlays on discretionary or “premium” items. A sustained attempt to increase savings aimed at warding off exposure to a declining housing market and employment risks have contributed significantly to this setting, along with increased and less avoidable household costs of energy and transport. Retail sales remain flat as consumers continue to be cautious and valueconscious. While consumer confidence has recovered somewhat following the sharp decline in mid-2011, it remains below its long-run average. Sentiment is affected by developments overseas, falls in asset prices and the softening in the labour market. Spending on food The sustained price-based competition in the Australian grocery sector has helped to reinforce consumers’ cautious behaviour by maintaining consumers’ attention on price and attempting to build trust in their retail brands. A significant portion – close to a third – of food spending in grocery is on promotion. Freshlogic’s tracking of household spending shows a continuing value shift in spending by consumers between major channels. Through 2011 and in early 2012 there has been continuing pressure on the share of spending on “eating out”; favouring a higher share spent in supermarkets and specialist food stores. The preference for convenience remains an underpinning fixture – not only in how people shop, and how meals are prepared, but also how people choose and receive takeaway food and where they dine out.

Dining out 19% Grocery 63%

Specialists 6%

Fig 2.2 - Table of key indicators Consumer

Below average confidence, spending growing 3.25% in real terms

Housing

Prices down 4-5% in capitals, approvals declining in past quarter

Savings

Household savings at 9-10% of income, slightly down on past 2 years

Retail sales

Growing close to 3% in total over past year, food sales growing 4-5%

Inflation

Declining over past year, lowest in 3 years

Business

Confidence is close to long-term average, but falling in 2012

Fig 2.3 – Total food spending – share between eating at home and eating out ($/household per week) $250

$200 $150 $100 $50

Eating out

Eating at home

$Q1 08

Q2 08

Q3 08

Q4 08

Q1 09

Q2 09

Q3 09

Q4 Q 1 Q2 09 10 10

Q3 10

Q4 10

Q1 11

Q2 11

Q3 11

Q4 11

Q1 12

Dairy 2012: Situation and Outlook 28

Current market conditions Dairy market snapshot

Fig 2.4 - Retail value of dairy categories in 2011 ($m)

Highlights

Key influences of category demand and value

Domestic sales volumes (in milk equivalents) were steady in overall terms with the previous year. Wholesale value increased nearly 3% to an estimated $6.4 billion – due to stronger commodity prices reflected in non-grocery and industrial prices - for the four major consumer categories. Domestic per capita consumption for key dairy categories fell by 4 litres to 297 litres in milk equivalents in 2010/11. Market Structure The supermarket channel accounted for approximately 50% by volume (in milk equivalent terms) and 61% by wholesale value for major consumer dairy categories of milk, cheese, dairyspreads and yogurt in 2010/11. In 2011, the level of penetration of private labels increased across the major dairy product categories – by 4% to 54% in milk; by 1% to 31% in cheese; by 6% to 34% in dairyspreads; but slipped from 6% to 4% in the yogurt category.

Milk

Consumer response to retailer promotional activity including discounting. Households eating more meals at home, increasing demand for meal ingredients Reduced spending on premium or discretionary food purchases in supermarkets and delicatessens due to constraints on household spending. Healthy-eating consciousness and preferences for “natural” foods.

Promotional activity The volume of grocery promotional placements has fallen in the past two years as retail competition has intensified, but the category focus of activity has narrowed and price reductions generally increased. Freshlogic’s tracking of promotional activity across the grocery sector showed an increased incidence of dairy products being promoted in advertisements. Activity has been strongest in cheese and ice-cream rd since the 3 quarter of the 2011 calendar year.

Cheese

14

104

12

103

10

102

8

Fig 2.7 - Weekly printed promotions of dairy products by grocery chains

Spreads

Cheese Butter / Blends Cream

QTR growth

Yogurt

MAT growth

Dairy desserts Custard

Dairy blends

200

Butter

Cheese (kg)

Butter/Blends (kg)

Yoghurt (kg)

Milk (litres RHS)

Yoghurts

Cheese

15-Apr-12

15-Mar-12

15-Jan-12

Butters & spreads

15-Feb-12

15-Dec-11

15-Oct-11

15-Nov-11

15-Jul-11

Ice Cream

15-Sep-11

2010/11

15-Aug-11

2009/10

15-Jun-11

2008/09

15-Apr-11

2007/08

15-May-11

UHT milk 15-Mar-11

99

15-Jan-11

TOTAL MILK

0 15-Feb-11

50 15-Dec-10

2006/07

2%

4%

6%

8%

10%

QTR growth MAT growth

P/Label milk

100

98 2005/06

0%

Branded milk

15-Nov-10

-

-2%

Fig 2.8 - Supermarket volume growth – year to March 2012 Dairyspreads

100

2

$341

Milk

250

150

4

$1,560

Fig 2.5 - Volume growth of sales – year to March 2012

300

101

6

$1,972

Fresh dairy & cream

-4%

Fig 2.6 - Estimated per capita consumption of major products

$1,920

Fresh milk -6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

Index

Dairy 2012: Situation and Outlook 29

Current market conditions Milk category Highlights Market remains under extreme price pressure due to the pricing differentials between private label and branded products. Growth in the drinking milk market was 3.1% in the 12 months to March 2012, taking annual consumption to 2.38bn litres. In value terms, the total milk category lost 1.3% in supermarkets, with average price per litre across all products down 8c per litre to $1.54 per litre. Niche products continue to grow despite the competitive price pressure. A2 Milk has reported 32% increase in sales in the first quarter of 2012.

Major market dynamics Private label pricing of 2 litres for $2 has been the biggest influence in the category, used by grocery chains as a driver of shopper traffic. Uniform product has lifted the share of fresh milk sales held by modified milk products, but has also taken considerable value out of these products. Non-grocery sales volumes are flat due to the grocery price competition and weak consumer spending UHT milk volumes have lost share of the total drinking milk market due to lower fresh white milk prices, but are staging a recovery early in 2012. Effective brand promotion and distribution support of fresh flavoured milk in non-grocery channels has driven stronger growth of 4.6% in 9 months.

Leading Supplier Brands

Fig 2.9 - Comparison of average retail prices for 2 litre branded milk (January 2010 to March 2012)

Market Structure Supermarket share of total milk sales was 52% in the year to March 2012. Private label penetration of all fresh white milk sales is about 32%, but the share of sales in supermarkets is 63%. Flavoured fresh milk has grown to 10% of all milk, of which 62% is sold in non-grocery outlets.

$4.50 $4.00 $3.50

NSW Qld Vic WA

$3.00 $2.50 $2.00 Jan-10

Prices for branded products are different between states due to the relative intensity of competition.

Consumer trends With the population growth rate slowing to less than 1.5% in the last year, this implies a further increase in per capita consumption rates in the current season. A very high proportion of adults (86%) consume milk weekly, this is consistent across age groups. 40% of adults drank milk on its own in 2011.

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Fig 2.10 - Share of supermarket sales held by brands (January 2010 to March 2012, national) 60.0%

50.0% Brand modified Brand full cream

40.0%

30.0% 20.0% 10.0%

0.0% Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Fig 2.11 - Major private label contracts by region Woolworths*

Coles

Qld

Parmalat

Lion

NSW

Parmalat

Sth NSW, Nth Vic

MG

Vic

Lion

Lion

SA

Lion

Lion

Tas

Lion

Lion

WA

Lion

Harvey

Fig 2.12 - Share of milk sales by type (9 months to March 2012) Fresh flavoured 10%

Lion Modified p/label 14%

UHT 8%

Full cream p/label 23%

Full cream brand 26% Modified brand 19%

*A tender process is underway at the time of this report Dairy 2012: Situation and Outlook 30

Current market conditions Cheese category Highlights The retail market remains subdued due to a squeeze on discretionary consumer spending. Domestic sales volumes fell by almost 1% in the year to March 2012. Sales volumes to non-grocery customers improved with strong performance by the “value” component of quick-serve restaurants. Sales of the dominant type - cheddar – sales fell by 2.6% in the year to March 2012 – featuring a 3.6% fall in sales into the grocery channel. Average per kilogram grocery prices across the category lifted by 2.9% to $14.38 in 2011 despite a tight retail market. Supermarket sales volumes for all cheese types increased marginally by 0.5% in 2011 to 137,100 tonnes, as consumer looked to more home prepared meals rather than eating out.

Major market dynamics Weakening export prices will pressure wholesale values for in the coming year. Major changes have occurred in contract supply for private label in the case of Coles – Bega replacing Fonterra with a 5-year agreement. Foodservice sales volumes have been underpinned with value segment of the QSR market. Increased competition from lower priced imports.

Leading Supplier Brands

Market Structure The grocery channel holds a 48% share of sales for the overall cheese category. Private label products represented 24% by value and 35% by volume in grocery sales in the 2011 calendar year. Cheddar is the major cheese type with 64% of sales in the 2011/12 year to March. The emergence of exclusive grocery co-branding lines occurred as Warrnambool Cheese & Butter signed a five-year supply contract with Coles to establish a new consumer brand, Great Ocean Road, for a minimum of 4,000 tonnes annually into Coles’ Victorian stores.

Consumer trends Sales of product type in grocery outlets show a steady trend towards sliced products in preference to block cheese sales. Consumers pay more for convenience – average retail prices for sliced and grated products exceed block prices. 86% of adults consume cheese on a weekly basis. The consumption frequency is higher in the 60+ year age group, lowest in the 18-24 year age bracket.

Fig 2.13 - Share of cheese sales in % terms by volume and value in 2011 Other

6.4 15.7

Volume Value

25.1

Sliced

24.1 28.9

Grated

29.5 35.2

Block

30.7

Fig 2.14 - Average supermarket retail prices for block cheese (2011 v 2009 in $/kg) $16.84

250g

$16.19 $13.14

500g

$14.40 $10.88

750g

2011 2009

$10.80

$11.17

1kg

$11.30

Fig 2.15 - Sales by cheese type in volume (9 months to March 2012 Semi hard 5% Mould 2% Hard 4% Fresh 12%

Stretched curd 13%

Cheddar 64%

Dairy 2012: Situation and Outlook 31

Current market conditions Dairyspreads category Highlights

Fig 2.16 - Mix of total product sales into the Australian market in 2011/12 by volume

Market Structure

Supermarket sales of dairyspreads have lifted almost 7% in the first quarter of 2012, and by 5% over the preceding year.

The grocery channel holds a 76% share of sales volumes for the overall butter category (butter and blend products).

While butter sales are up 5.2%, blends have lost ground by 4.6% over the year. In the past quarter blends have recovered a little ground.

Private label penetration in supermarket sales for dairy spreads reached 34% in the year to March 2012, much of which is in butter products. Manufacturer brands dominate sales of dairy blends.

Over the year to March 2012, average supermarket retail prices rose 5%.

“Taste” and “natural” are the primary drivers of preference for butter, although saturated fat levels are a concern for consumers.

Branded products have come under greater pressure in the first quarter of 2012.

The trend to in-home cooking and baking has supported higher butter sales.

Non-grocery sales volumes were marginally lower in the year to March 2012.

40% of adults consume butter weekly. This has fallen from 49% in the last 2 years.

Butter products were a feature of the deepdiscounting campaigns by grocery chains. Strong competition from margarine has kept dairy blends under price and volume pressure. Foodservice sales volumes affected by a decline in dining out and increased cost-sensitivity of food service outlets. Higher wholesale prices in 2011 have probably led to some substitution with vegetable oils.

Leading Supplier Brands

Butter 62%

Consumer trends

There have been limited gains in unit selling prices in the grocery category in 2012, with the exception of private label prices for butter packs.

Major market dynamics

Butter oil 1%

Blends 37%

Consumption frequency is lower for the under-40 age groups where it is down to 33% Acceptance of innovation in the “better for you” functionality of vegetable oil spreads has provided stronger competition in the premium end of the category.

Fig 2.17 - Average supermarket prices 2012 v 2011 in $/kg

9.6%

Butter in Non-grocery

-0.5%

Blends in Grocery

-0.4%

$12.03

$6.35

P/Label butter

Qtr 1 2012

$5.54

Qtr 1 2011

$9.18

Branded blends

$9.02

$6.70

P/Label blends

$6.93

Fig 2.19 - Mix of supermarket sales into the Australian market in 2011 by volume

Fig 2.18 - Changes in sales volumes (year to March 2012 v prior year) Butter in Grocery

$12.03

Branded butter

Blends 22% Butter 21%

Margarine 57%

Dairy 2012: Situation and Outlook 32

Current market conditions Fresh dairy category Highlights Fresh dairy products (yogurt and desserts) were worth $1.263 billion in grocery sales in 2011 and grew 6.7% in total value, after only 2% growth in 2010. Cream sales in grocery were $299 million in 2011, which increased just 1.7% on the prior year. A mix of of value and convenience influenced product mix in the year. There has been a strong increase in the share of sales through 1kg pack size in yogurt, which grew 11% on the prior year to 41% of yogurt sales and represented more than half the growth in the total category. Despite greater competition, and the shift to larger pack and unit sale prices, average prices rose 2.7%. A large portion of remaining growth came from multipack products which grew sales value by 19% in 2011. Dairy snacks lost volume in 2011 but grew total value by 5.5%.

Major market dynamics Brand dominated categories of yogurts and desserts are important brand platforms for processors. Fresh dairy is a highly competitive category, with a number of major brands (Ski, Yoplait, Dairy Farmers, Vaalia) and a set of local second tier brands (Bulla, Jalna, Gippsland).

Market Structure Grocery share for the overall yogurt category is close to 90%.

Fig 2.20 - Share of yogurt pack types by value (2011 year) multipack 24%

Private label penetration in the yogurt category is low – measured at 3.4% of value in 2011.

other 2%

singles 14%

twin 8%

500g 11%

1kg 41%

The grocery share of sales of cream products was 54% in 2011. Private label held 41% of sales value in that year.

Consumer trends Convenience and healthy snacking are the keys underpinning demand drivers in the yogurt category. There is ongoing acceptance of consumers of diversity in innovation in product flavours, styles and types, with an increasing focus given to health benefits of yogurt consumption. Strong uptake of “better for you” products ahead of traditional product styles. 57% of adults consume yogurt on a weekly basis. Consumption is higher in the 60+ group due to the greater concern for their well-being and awareness of the health benefits of products.

Fig 2.21 - Unit prices per kg of yogurt by product type (2011 year) singles

$9.60

twin

$7.20

500g 1kg

multipack

$6.78 $5.08

$4.90

Leading Yogurt brands

Danone has re-entered the market through a joint venture with Murray Goulburn to further add to competition. A new brand - Chobani was launched by Agro Farma following its purchase of Bead Foods. Yogurt products have increased their penetration of a range of meal and snacking occasions. Dairy 2012: Situation and Outlook 33

Current market conditions Supermarket sector

Q3 12

Q2 12

Q1 12

Q4 11

Q3 11

Q2 11

Q1 11

Food CPI

Q4 10

Q310

Q210

Q110

Q409

Q309

Q209

Q109

Coles

2.23 - Dairy product sales by channel – 2010/11 Supermarkets

Other

100% 90%

Both major chains claim to have won increased shopper numbers and higher sales volumes in most categories over the past year. Both have reported deflation in food prices after the effect of promotions – in fact the promotional campaigns have contributed to lower priced food across the grocery sector.

80%

As a result several sectors of the food service market exposed to discretionary spending, such as restaurants and cafes, have purchased lower volumes of dairy products and ingredients.

30%

Coles still has a long way to match Woolworths’ operational profitability. In fact, Woolworths is probably widening its lead in the profitability stakes despite operating in a price deflationary environment, aided to a large extent by the price pressure from the retailers themselves. Relative retailer profitability suggests Woolworths would be in a much stronger position to see off Coles’ retail price discount program into the medium term.

Q408

In this time, the recovery and improved performance of Coles has been a major driver of change in the grocery sector. Coles’ more effective promotional tactics have attracted a larger number of customers but has been aided by a weaker performance by Woolworths’ in its new store openings and refurbishments. Although Coles is smaller than Woolworths, it operates with lower productivity of retail selling area, generating narrower trading margins.

Woolworths

Q308

The strong focus of promotional campaigns on deep discounting of staple lines has increased supermarket shares of food spending by consumers. The battle for the perception of “retailer with the cheapest groceries” has remained intense, with a variety of tactics across categories. Dairy products were included in those campaigns from January 2011.

10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% -2% -3% Q208

Retailers are responding to weaker consumer sentiment by promoting cheaper products and a value proposition to enable consumers the opportunity to save on food staples.

Fig 2.22 – Retailer changes in same store sales v food inflation

Q108

Intense price-based competition between the two major supermarket chains has been sustained in 2011/12 as household spending on food has remained flat and a higher portion of meals are typically being consumed in the home.

70% 60% 50%

40% 20%

10% 0% Milk

Cheese

Butter

Yogurt

Dairy 2012: Situation and Outlook 34

Current market conditions The major chains have increased market share at the expense of independent stores, affecting also the wholesale and retail activities of Metcash, which has announced a restructure of its wholesale business and an exit from involvement in some IGA retail groups and food service activities. Discount store operators such as Aldi and Costco, which operate vastly different store models, continue to expand their business networks and take a greater share in the available growth of the retail food market. The expansion of these groups – Aldi in particular – has been a major determinant of discount price points on staple food lines and the expansion of the private label presence by Woolworths and Coles. Costco, the US membership based bulk retailer is planning to open a further two stores in 2013 in Sydney and in Brisbane, bringing their total number of outlets to five. The rate of expansion has been limited by the ability to find parcels of land suitable for the scale of their operations. Private label v brands The expanded use of private label lines is a key component of retailer strategies. Their use has had a profound effect on milk, cheese and spreads categories in the past few years, increasingly since the first half of 2011 these products have been used as key staple lines in deep-discounting campaigns. The impacts on the milk category of the use of deep-discounted private label lines since January 2011 have been: o A lift in sales of cheaper private label products, weakening the overall wholesale returns to processors. This has occurred within the grocery store, and at the expense of convenience and food service outlets. o Overall, branded milk has lost around 5% share to private label in supermarket sales from around 50% to 45%. o Sharply lower sales of branded modified milk products which target a health-related proposition for consumers, increasing the pressure on performance of marketing and product innovation. o Downward pressure on farmgate prices for producers supplying white milk processers in NSW, Queensland and WA, where the leverage of firm

2.24 - Brand shares within supermarkets – year to Dec 2011 Branded

Private label

Yogurt Dairyspreads Cheese Fresh regular milk Total Milk 0%

10%

20%

30%

40%

50%

60%

70%

80%

90% 100%

2.25 Estimated annual changes in modified milk sales (based on 9 months to March 2012, millions of litres) -1.0

Vic

NSW Qld

24.8

-5.9

27.3 1.3

SA

6.2

Brand

0.2

WA Tas

23.4

-4.0

-2.9

9.7

Private label

3.3

international product prices (which have prevailed for the 2011/12 season) has limited influence on farmgate prices. o Alterations in contract supply arrangements have changed market access for milk producers on a regional basis, who face varying exposures to lower-priced tier 2 milk prices. The impact on average retail sales and, ultimately on wholesale returns has varied state-to-state, due to the differences in retail prices, brand and sales channel mix between states.

Dairy 2012: Situation and Outlook 35

Current market conditions Non-grocery The most important segments of the market outside the grocery sector for dairy products are: o sales of cheese into the fast food or Quick Service Restaurant (QSR) market;

Fig 2.26 - Total Food Spend per week - average for households 4 quarters to March 2012 Specialist Food Stores, 12.6%

Breakfast, 1.4% Lunch, 8.1%

Supermarkets, 64.2%

Dinner, 10.1%

o sales of ingredients into food service establishments;

Snacks, 3.6%

o sales of milk into convenience retail and high-turnover food service outlets such as cafes and takeaway food stores. Freshlogic’s analysis of its Mealpulse panel suggests the share of food spend by households in non-grocery channels has been steadily falling since 2008/09, from 39% of outlays to 35% in the four quarters to March 2012. Foodservice Foodservice consists of an estimated 52,000 outlets (including takeaway, dining and event/leisure) with estimated sales of $39 billion per annum. The heaviest concentration in foodservice in terms of sales-per-outlet is in the QSR sector, where average sales per outlet are estimated at about $1.7 million. The remaining 45,000 foodservice outlets are competing for about $28 billion in sales, through varied and complex distribution channels, where the value added to meal preparation includes significant labour costs. These channels represent a different proposition for dairy products – rather than the sale of products to be consumed in final form, in the main the a range of ingredients are required for prepared meals and drinks. This requires distribution and marketing engagements with customers which are entirely different from servicing the grocery or specialist retail channels. The more successful marketers base their models on tailored distribution, packaging and solutions in product form. Household spending on meals and snacks consumed out of the home are driven by a number of factors, including lifestyle, household structures, working week routines as well as changes in and pressures on disposable incomes.

Fig 2.27 - Food spending by Channel as % of total weekly food spend (Sept Qtr 2011) NSW VIC

62%

13%

59%

25%

12%

QLD

70%

SA

67%

WA

69%

Supermarkets

29% 12%

12%

21%

12%

Specialists

18%

19%

Eat Out

Fig 2.28 ABS retail sales – eating out (% change on prior year) 14.0% 12.0% café/restaurant

10.0%

takeaway

8.0%

6.0% 4.0% 2.0% 0.0% -2.0%

Jan-11

Mar-11

May-11

Jul-11

Sep-11

Nov-11

Jan-12

-4.0% -6.0%

Dairy 2012: Situation and Outlook 36

Current market conditions In recent years the overall food service sector has come under pressure as sales have fallen, and share has been lost to take home retailers. The tendency to eat out varies however across segments of the consumer market and regions. While the Australian Bureau of Statistics (ABS) data suggests growth rates of 6% and 11% in takeways, cafes and restaurants respectively, Freshlogic research and industry’s own data on volumes suggests little or no consistent net growth in these channels during 2010/11.

Fig 2.29 - Dairy sales into non-grocery channels (9 months to March 2012) Butter Cream

However the performance of the QSR sector has been patchy. Some companies have been less successful in capturing and holding customers, and the growth history and stated future intentions of these groups reflects their relative abilities to deal with the evolving consumer market. Consumers have also supported emerging chains promoting higher-quality or gourmet meal options (such as Crust Pizzas and Grill’d burgers) which are quickly growing their store networks despite offering meals at higher price points.

-4.4%

Cheddar Stretched curd cheese

1.3% -6.9%

Milk

Some large QSR chains such as Domino’s Pizza have reported strong growth in “same store” sales, targeting the “value” proposition, increasing the convenience of ordering home-delivered meals through smartphone and other online tools; as well as pitching to a range of ethical values. The combined value and convenience appeal, and constant refreshing of menu options remain key drivers of increased volumes through this channel. An increase in online sales has facilitated this quest for value, as consumers can easily shop around and compare value offerings for pizza.

-1.9%

1.0%

Fig 2.30 - Store networks of major QSR groups (early 2012) Number

Domino McDonalds Eagle Boys Burger King KFC Nandos Oporto Pizza Hut Subway

470 780 335 308 605 250 140 280 1254

Added p.a. last 5 years 9 7 33 (57) (22) 26 11 1-2 55

Expansion planned p.a. 24 5-10 40-50 ns ns 25-30 10-15 25-30 ns

Dairy 2012: Situation and Outlook 37

Australian market outlook Overall Activity in the Australian economy slowed in 2011 but is expected to recover in the short to medium term, provided there is continued easing in monetary policy, stability in growth in the market for resources and no further major financial crises. Growth in consumption expenditure is expected to remain relatively subdued while households face rising household costs, a weak housing market, uncertainty stemming from the situation facing the European financial system, and employment risks. The diversity in business conditions facing different sectors is evidenced by growth in mining and services, while a number of domestically focused industries exposed to soft consumer spending and a strong Australian dollar retail, wholesale, construction and manufacturing – are expected to continue to struggle. The RBA’s forecast for the Australian economy remains for around trend GDP growth over 2012 and 2013. Employment growth is expected to remain fairly subdued in the near term, with a small increase in the unemployment rate forecast over 2012, before the unemployment rate declines again over the later part of the forecast period. Underlying inflation is forecast to remain within the RBA target range over the next few years; declining slightly in the near term before drifting gradually higher to be in the upper half of the target range by 2014. This excludes the potential effect of the carbon price on business costs. With the inflation outlook having improved in late-2011, the RBA lowered the cash rate by a cumulative 0.5% in November and December - after having maintained a mildly restrictive stance on monetary policy through most of 2011. These reductions in official interest rates were largely passed through to borrowers, so that most lending rates in the economy are now close to their medium-term averages. The RBA lowered the cash rate by a further 0.5% in early May. The rate cuts have generally not been passed on to borrowers in their entirety despite a number of banks lifting interest rates independently of the RBA in recent months. Further RBA rate cuts are a possibility later in 2012.

Fig 2.31 - Key economic & dairy indicators Latest

Medium-term

Australian GDP growth (Dec 2011)

2.5%

3% to 4%

RBA official cash rate

3.75%

4% to 5%

Underlying inflation rate

2.0%

2.5% to 3.0%

(1.3)%

+1.0%

Per capita dairy intake growth Challenges for the category

The overall consumption of dairy products is expected to continue to increase with population growth. Some category segments will remain exposed to cautious consumer spending. Dairy has four secure pillars on which to base its continued appeal and presence in the Australian diet – health and nutrition, convenience, taste and indulgence. Underlying any short-term variation in trends in dairy consumption in Australia is the fact that dairy products are available in a range of forms and applications, and are well placed to capitalize on on-going consumer lifestyle trends regardless of the sales channel to the consumer. The outlook in the short to medium term is for a continuation of intense retail and wholesale competition in the Australian grocery market. While the cautious household sentiment is unlikely to significantly affect the overall volume of dairy products consumed, it may impact on the preference for the channel in which consumers spend their food dollar, and their willingness to spend money on higher-value products. Weakness in consumer spending will provide continuing support for private label products and price-promoted branded lines through the supermarket channel. Intense supermarket competition will remain a major feature of the retail market for at least the short-term until economic prospects lead to an improvement in discretionary spending. It appears to be in the interests of

Dairy 2012: Situation and Outlook 38

Australian market outlook both major retailers to maintain their financial performance and to lift sales and sustain margins in the interests of appeasing investors.

such as carbon footprints, environmental impact, animal welfare standards following the lead of US and European retailers.

Pressure applied by retailers as a result of continuing to compete for the mantle of “cheapest for the consumer” will ensure sustained discount campaigns and an increased amount of shelf-space devoted to private label products. Woolworths has recently nominated an ambitious target for the share of sales in private label, based on penetration rates achieved by grocers in other mature retail markets such as the UK and Europe, albeit over long term periods of slow growth.

A potential increase in ethical requirements of retailers may affect the dairy category in future but to date change in this area has been slow compared to other categories and other countries.

Fig 2.32 - Comparative recent retailer performance Coles Woolworths Food & liquor sales growth*

+4.1%

+2.9%

Same store sales* Food price inflation* EBIT to sales margin 6 mths to Dec 2011

+2.7% (2.6%) 4.4%

0% (4.4%) 6.9%

EBIT growth on last year Return on capital employed (Dec 2011)

+14.1% 8.2%

+6.3% 77% (est)

14

16.1

2

Sales per m in grocery ($000)

#

Some of these efforts will involve initiatives that attempts to build some consumer loyalty through direct “line-of-sight” exclusive arrangements with food producers (such as that developed with Warrnambool Cheese in 2011/12) as has been the case in several fresh food categories to date. Sustained pressure on the foodservice sector will ensure a continued focus is applied to meal and ingredient costs. Operators will continue to look for lower-cost but functional products. Growth in local cheese sales has been affected by this, with lower-priced US “filled cheese” being imported from the US in the past two years.

rd

*3 quarter 2011/12 financial year #

estimated by Citigroup in March 2012 based on half year results to December 2012

The continued expansion of Aldi and Costco will sustain pressure on the two major retailers to offset the loss in market share to new stores from these competitors. These factors will affect scope for further recovery in growth in volume and unit value of dairy products over time, without corresponding investment in innovation, brand support and development. The greater commoditization of the milk sector which may be a feature for the medium term is forcing changes in the roles that private label contracts and branded milk products play in processors’ business models. There is likely to be an increase in the ethical requirements sought by retailers requiring product-label information to establish points of difference in response to consumer concerns. These will increase in scope covering issues Dairy 2012: Situation and Outlook 39

Chapter 3 The industry value chain

Highlights Policy developments affecting the dairy industry

42

Strategies of individual companies driving farmgate prices

45

How do Australian prices compare with New Zealand?

48

Farmgate market – by state

49

Ownership and consolidation Ongoing change in the processing sector Major developments affecting the ownership of dairy businesses in the Australian industry over the past 12 months were: o The public listing of Bega Cheese, retaining a shareholder cap of 5% for the first two years, thereafter lifting to 10% for three years. As part of the change, Bega purchased the remaining 30% stake in Tatura Milk Industries. o Lion sold two of cheese plants located in South Australia to United Dairy Power (UDP). UDP also acquired the Caboolture brand; and will contract pack a number of Lion products at the sites, including Le Rice, Pura sour cream and mozzarella cheese. o Hastings Dairy in NSW went into administration and was purchased by Sungrow. o Murray Goulburn expanded into Tasmania via a joint venture with

Tasmanian Dairy Products (TDP). o Victorian dairy products manufacturer Bead Foods - manufacturer of Gippsland Dairy organic yogurts and specialty creams - was sold to US company Agro Farma. Agro Farma produces Chobani, claimed as the leading Greek yoghurt brand in the US. Agro Farma is spending $20 million expanding production capacity at the Dandenong factory.

The company has simplified its management structure, and is targeting improved operational efficiency and dairy food innovation, including building a bigger brand presence. It has targeted $100 million worth of cost savings, which it says will be returned to suppliers, equating to about 3.0 cpl based on 2011/12 expected milk volumes. Other developments since the change in leadership include: o An investment of $3.5 million to expand annual cream cheese manufacture at its Kiewa plant by an extra 10,000 tonnes was announced. The extra production would largely be aimed at increasing Japanese market share. o New offices slated to open in Dubai, Singapore (as a south-east Asian region headquarters) and Vietnam; o A new packing plant is planned in Qingdao, China as demand for the company’s specialty nutritional products has outgrown its existing facility; o The milk powder drying operation at its Rochester plant was closed from the end of April due to the loss of milk production volumes in the region. Lion Dairy & Drink Division The performance of the group will come under further pressure with the sustained deep-discounting of private label milk products in supermarkets.

o Chinese food group Bright Food purchased a 75% stake in Manassen Foods from UBS and CHAMP Private Equity. About 70% of Manassen’s sales come from owned brands including dairy brands Margaret River Cheese and Lemnos cheese, and 30% from imported agency or licensed brands such as Castello, Fromageries Bel and Laughing Cow.

Lion’s owner, Japanese brewing and drinks conglomerate Kirin wrote down the value of the dairy business by a further $1 billion in 2011 – following a writedown of $832 million in 2010 – blaming low consumer confidence and spending, poor weather and natural disasters, high input costs, and a “challenging price environment” for its white milk business.

o Parmalat Australia became a subsidiary of French group, Lactalis, after securing 83.3% of Parmalat SPA. Parmalat will remain an independent entity with its own legal structure and stock market listing.

Lion has expressed the need to significantly improve its performance by focusing on higher value branded products and quitting unprofitable business, as well as its dissatisfaction at the returns available from fresh milk processing.

Murray Goulburn Sweeping management changes have been implemented at Murray Goulburn since the appointment of a new CEO in Gary Helou, formerly the managing director at grower-owned Sunrice.

New entrants TDP announced plans in mid-2011 to buy a Gunns Ltd sawmill plant in Smithton in the north-west Tasmanian dairying region – subject to various preconditions – to develop into a milk processing plant to produce a range of milk Dairy 2012: Situation and Outlook 41

Ownership and consolidation powders to be exported to Asia and the Middle East. The investment is said to be worth some $50-$70 million, using 100 – 150 million litres of milk per year. Murray Goulburn will hold a majority stake in the joint venture, and market all the products from the factory; TDP will independently operate the site. The plant is designed to produce high specification milk powders and planned to come into operation in the second half of 2012. A2 Corporation increased its production capabilities in Australia - with the opening of a new processing facility in Sydney commissioned in early-2012. Pactum – a subsidiary of Freedom – announced plans for a new UHT plant based in Western Sydney which will produce for the Chinese market Other investments Longwarry Food Park commissioned a new UHT plant in late-2011, for products aimed at both domestic and international markets. Longwarry are also investing in infrastructure for additional drying capacity. At full capacity the plant will require some 20 to 30 million litres, about 10 to 15% more milk than is currently purchased from farmers.

Policy issues Carbon tax After an extended policy debate that stretches back to the Shergold review of 2007, the Australian dairy industry will operate with a price imposed on carbon dioxide (CO2) emissions from July this year when the new Clean Energy Program takes effect. The program aims to ensure that Australia can reduce CO2 emissions by 5% by 2020 through the combined effects of a direct tax on emissions and incentive schemes that will encourage the adoption of low emission technologies into future production systems. On one level, dairy is not significantly affected by a tax on carbon. Direct CO2 emissions from dairy farm operations (e.g. enteric methane produced by cows) are not subject to the new tax. These exempt emissions account for about 80% of estimated dairy emissions. Even so, the new tax will have some significant impacts on dairy cost structures in coming years.

Fig 3.1 - The causes of electricity price increases

Bulla Dairy Foods is investing $8 million in innovation centre and office facility in Colac to focus on research and development, sensory testing and pilot plant capability for new and emerging products. Further changes The scope for Australian dairy manufacturers to be acquisition targets is limited, despite the fact that there exist a number of diverse businesses within the Australian industry. The removal of shareholding limits applicable to WCB, and the floating of Bega Cheese on the share market may add to that interest, although limitations apply to any significant acquisition in the latter for a period of five years.

Dairy 2012: Situation and Outlook 42

Policy issues The price of key farm inputs (such as electricity) will rise under a carbon tax. Treasury estimates electricity prices will rise by around 10% at the initial tax rate of $23 per tonne. As electricity is a major energy source on dairy farms, the industry is more exposed to this expected rise in electricity prices under a carbon tax than other sectors of agriculture. Dairy manufacturing costs will also be affected by the new scheme. Input prices for electricity, natural gas, packaging and chemicals are all likely to rise. While many dairy firms are highly exposed to world markets under the planned rules no dairy firm or product line will qualify for relief from the tax as an Emissions Intensive, Trade Exposed activity. The cost of a carbon tax will vary between firms, with those involved in milk powder drying and cheese production facing relatively higher costs per tonne. However, all dairy companies are expected to face real challenges recovering any of these tax costs from downstream customers. This suggests that, a large share of the carbon tax costs in dairy will be borne at the farmgate. The introduction of carbon pricing will impact differently on individual farms and companies, but poses a challenge for all suppliers to maintain margins and cost competitiveness. It will strongly encourage all industry participants to review their energy usage and to explore ways to improve their energy sourcing and the efficiency of their energy use. Dairy companies may be able to secure government funding under the Clean Technology Food and Foundries Program to support investment in new lower emission production technologies. Funding support for farms is less clear, the industry is working to secure government funding to support a broad range of farm energy efficiency audits that can help farmers identify possible actions to reduce energy use and the cost increases arising from carbon pricing. International comparisons There has been limited progress towards multilateral agreement on emissions reduction policies. Implementation of carbon pricing or emissions trading schemes varies across the world in terms of design and scope. In the absence of a global agreement these differences will affect the costs associated with producing traded commodities and therefore the competitiveness of different exporting nations.

Fig 3.2 - Comparing emissions trading schemes in different countries Country New Zealand

Tax/ETS Yes

European Union

Yes

USA

No

Canada

No

Latin America China Korea

No No Yes

Comments ETS in place since 2010 (modelled on CPRS). Currently operates with fixed carbon price ($25NZ/t to 2012). Dairy companies covered and obliged to pay one unit of tax per 2 tonnes of emissions. Direct farm emissions to be included from 2015 (dairy firms point for obligation for collection). Recent review will see transition period for firms before full (1:1) coverage extended to 2015 Fixed price to remain to 2015 (or later), Future price ceiling aligned with Australia New review to decide future coverage of agricultural emissions (to report in 2014). ETS in place since 2005. Phase 3 commences 2013 Most licenses allocated freely to covered firms. Direct agricultural emission excluded. Expanded auctioning of licenses from 2013 to 2020 Milk powder drying activities allocated free permits to 2020 (to prevent carbon leakage) Previous national ETS legislation defeated – no scheme on policy horizon. Voluntary Chicago Climate Exchange wound up. California has legislated to implement regional cap and trade scheme from 2012 (initially with free permit allocations to affected firms). No national scheme. Four provinces - British Columbia, Manitoba, Ontario, Quebec – seeking to implement regional ETS in partnership with Canada Only Quebec has regulated for this to occur to date.

Piloting of regional ETS schemes from 2012. Legislation passed in 2012, details are unclear.

Dairy 2012: Situation and Outlook 43

Policy issues

Australian Food Plan The Australian Government is developing Australia’s first ever national food plan which will ensure that the government’s policy settings are right for Australia over the short, medium and long-term. The aim of the plan is to foster a sustainable, globally competitive, resilient food supply that supports access to nutritious and affordable food. The national food plan will be developed through a green paper/white paper process. An issues paper was released in June 2011 and was followed by 10 weeks of public consultation. The next step, a green paper will outline the government’s vision and approach to food policy and canvas potential changes to policy, programs and governance arrangements. The green paper is still under preparation and will provide stakeholders with a chance to contribute before a white paper is prepared. Food regulation Food policy and regulation is an important area for the industry. Dairy’s platform as a healthy and nutritious product is a key driver of consumption, and considerable industry effort is put into protecting and promoting dairy’s role as part of a healthy balanced diet. Government policy aimed at curbing the “obesity epidemic” and influencing consumption has the potential to adversely affect the industry by over-simplifying nutrition messages and failing to recognise the holistic benefits of dairy products. The industry continues to advocate for health promotion strategies, consistent with relevant policy principles that focus on increasing consumption of nutritious core foods such as dairy as opposed to focusing on reducing individual nutrients such as saturated fat, salt and sugar. Of greatest concern to the industry amongst the recent food labelling law and policy review recommendations were related to front of pack ‘Traffic Light’ labelling, which may have the effect of discouraging consumption of ‘core’ nutrient rich foods, such as milk, cheese and yoghurt. The industry’s response has outlined the lack of evidence to support that this type of labelling improves health outcomes, the evidence that increased dairy consumption is associated with better health, and the industry costs of implementation.

The government response did not support mandatory Front of Pack Labelling, but recommended a working party of industry and public health representatives be convened to reach agreement on a format for voluntary Front of Pack Labelling aimed at reducing consumer confusion from conflicting or inconsistent nutrition messages. The working group work will provide an update the next Food Regulation Forum meeting in June 2012, with expected completion in December 2012. The proposed Food Standard Australia and New Zealand (FSANZ) health and nutrition related claims draft standard was recently released for consultation raising similar issues as the Front of Pack Labelling recommendations, combined with unnecessarily restrictive requirements that are not consistent with current evidence or the ‘Health Claims’ policy principles. Competition policy In January 2011, the federal Senate’s Economics References Committee was tasked with enquiring into the impact of major supermarket chains deciding to significantly discount private label products on the dairy industry. In particular the Committee examined the impact of $1 per litre pricing for milk. In its November final report, the Committee made the point that market outcomes such as a shift away from branded to private label product resulting from discounting is not a matter for government. The Committee also observed that nationally, few dairy farmers would be significantly impacted, as international prices are the key driver of returns, and drinking milk a relatively small share of production. However, the Committee acknowledged there would potentially be greater impacts in states where milk was primarily used for drinking. The Committee’s recommendations were: improved transparency and stability in farmgate pricing, government commissioned studies of the most affected regional dairy industries, reviews into the competition provisions of the Competition and Consumer Act 2010, and the effectiveness of collective bargaining laws and the Produce and Grocery Industry Code of Conduct. In response, the federal government is looking at effective ways to support the dairy industries in Queensland, New South Wales and Western Australia.

Dairy 2012: Situation and Outlook 44

Farmgate market Changes in the farmgate market Fig 3.3 - Summary of milk supply arrangements offered by major dairy companies Full-year pricing or option

Growth incentive

Notes

2.8

Y

Y

Y

Y

Y

4

Fonterra

1.7

Y

Y

Y

Y

Y

3

Competition for milk between dairy product manufacturers remains intense in southern production regions, given the persistent demand from export markets; and the generally slow growth in milk supply volumes. Sustaining optimum milk throughput in plants remains a priority to ensure better fixed overhead recoveries.

Lion

In the past couple of years, the entry and/or expansion by a number of smaller processors and manufacturers (such as Burra Foods and Longwarry Food Park), and the changes in ownership of a number of plants (purchases by Agro Farma and UDP for instance) has added to this pressure. Fresh milk processors, under stronger margin pressure in the milk category, are also seekinga closer greater matching of milk supply volumes to their monthly processing needs to avoid costs associated with handling surplus milk volumes. Victorian manufacturers There has been limited change in the past year in the structure of milk supply arrangements offered by manufacturers. In 2011/12, Warrnambool Cheese & Butter (WCB) introduced a variation in their payment structures to cater for suppliers producing a flatter profile of milk supply, which was in part a response to similar schemes on offer from competitors.

(DFMC)

1.6 (0.9)

WCB

0.8

Parmalat

0.5

Y

Bega Group

0.5

Y

UDP

0.2

Y

Two-tiered pricing

Optional pricing structures

Competition remains intense

Productivity incentive

Step-up payments

Murray Goulburn

Murray Goulburn remains by far the largest farmer-owned manufacturer operating in southern production regions, and accordingly plays a critical role in setting the farmgate value of milk in those regions, with which other milk buyers compete.

Use of individual contracts

Milk volume direct supply 2011/12 (billion litres)

While more than half of national milk production is processed into products sold on the domestic market, the returns available from dairy products sold in domestic markets such as cheese and butter are governed by export market prices. As a result, the returns to more than 70% of milk production are set by world markets.

Y

Y

Y

Y

2

Y

Y

Y

Y

Y

2

Y

Y

Y

Y

Y

Y

Y

Y

Y

Y Y

Y Y

1 Y

5 Y

Y

Notes: 1. Contracts are used by WCB for a portion of its supply base 2. Lion refers to direct milk supply agreements. DFMC (LionCo’s supplier cooperative) offers separate milk pricing and incentive structures to the direct milk supply contracts offered by the LionCo itself. 3. Fonterra offers a range of options to suppliers which include the use of full-year prices. 4. Murray Goulburn makes share deductions from milk prices. 5. Parmalat offers different contract structures across Queensland, NSW and Victorian regions. Two-tiered pricing applies in the Queensland and Northern NSW supply base.

Fresh milk processors Stability and uncertainty for fresh milk processors and their milk suppliers has been adversely affected by changes in private label contractual arrangements between suppliers in milk and cheese, and the reduced contract periods. Milk bottling contracts for private label milk products are set for each regional capital city market, with contract periods that are now less than two years in

Dairy 2012: Situation and Outlook 45

Farmgate market eastern Australia. Cheese packaging arrangements apply for longer periods, as is the case with new arrangements between Bega Cheese and Coles.

The challenge for fresh dairy processors and domestic dairy product manufacturers will be to improve margins to overcome the erosive effect of the former use of two different systems – PDA and POPS – in the case of Parmalat, which had evolved since deregulation in 2000.

Significant supply chain disruption has been caused by recent changes in private label suppliers by grocery chains in some regions. The impacts on wholesale and farmgate returns have been greatest in Queensland and central/northern NSW, where retail prices of branded lines are lower than other regions (due to the intensity of brand competition) and farmgate prices typically higher than in southern states reflecting higher costs of year-round milk production.

To fulfil its expanding NSW presence after securing private label supply to Woolworths, Parmalat has secured a significant direct milk supplier base from central NSW regions.

Fig 3.4 – Monthly regional milk sales and production in Queensland and Nth NSW (million litres)

Milk producers contracted to Lion (through direct supply contracts or milk supply co-operative DFMC) currently suffer from the combined effects of a rationalization of Lion’s processing requirements in dairy products (other than fresh milk) and the loss of private label volumes.

65

Production

Sales

60 55

Milk volumes in NSW as a whole remain higher than fresh milk processing plant requirements. In southern Queensland however the monthly milk sales and production volumes are much closer (as reflected in Fig 3.4) with seasonal shortages of supply in late summer and autumn months, amplified by the effects of floods on milk supply through much of 2011. In 2012, a recovery of production volumes is likely to increase the surplus of milk available in spring.

50 45

Two-tier pricing systems are used by both major fresh milk processors to limit their risks of exposure to potential changing product returns mix, and to send clear signals as to the size and value of the available market volumes required.

Mar-12

Nov-11

Jul-11

Mar-11

Nov-10

Jul-10

Mar-10

$5,000

$7.00

$4,500

$6.00

$4,000

$5.00

$3,500 $3,000

$4.00

$2,500 $3.00

$2,000 $1,500 $1,000 $500

$2.00 Average commodity price $A/t Murray Goulburn net farmgate price $/kgMS

$0

$1.00 $0.00

Murray Goulburn price $ per kg

The changes in the product mix of the Lion business is, over time, having the effect of reducing the proportion of milk volumes that attract Tier 1 prices offered by the company, an impact that varies region-to-region and between individual suppliers, as the portion of their milk production achieving a lower marginal milk price may vary significantly due to their own production history and circumstances.

Fig 3.5 – Average export returns and Murray Goulburn milk prices (1990 to 2012)

$A/tonne

In the case of Lion and Dairy farmers Milk Cooperative (DFMC), Tier 1 milk prices are paid on milk supply volumes representing an allocation of the fresh packaged milk requirements (“anticipated full demand” or AFD) of the regional Lion operations. Individual supply volumes in excess of these contracted Tier 1 volumes attract Tier 2 prices.

Nov-09

Jul-09

40

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

years 1989/90 to 2011/12

Dairy 2012: Situation and Outlook 46

Farmgate market Farm gate prices in 2011/12 A summary of milk prices paid across the regions of the industry is set out on page 49. Milk prices in southern regions opened lower in 2011/12 due to a weakening international market, but were nonetheless followed by step-up payments into the season as competition for milk supply was sustained. Farmgate prices for southern producers will finish the 2011/12 season marginally weaker than the prior season, and are expected to average in the vicinity of $5.30 to $5.40 per kgMS. Milk prices in NSW and Queensland have been lower than those in the prior year for most producers due to: o the reduction in Tier 1 prices by Lion, o the reduced access to Tier 1 contract volumes by that business, and o the introduction of a new contractual structure by Parmalat which brought a reduction in average milk prices. However, there is now much wider variation in the payments to individual suppliers than in prior years by these dairy companies due to the different exposures to Tier 1 and Tier 2 pay rates. Forecast milk prices in 2012/13 Southern regions The 2012/13 opening farmgate milk price announcements will be critical signals for farmers assessing short-term decisions and their longer term future in the industry. Good seasonal conditions in all regions other than Western Victoria and relatively low bought-in feed costs provide a physical operating environment that will assist many producers to weather the flow-on effects of a weaker world market for dairy products. Given the uncertainty as to the duration of weak market conditions for dairy products until a rebalancing of the global dairy supply chain occurs, and the uncertainty about currency values, full year farmgate milk prices in southern Australia are forecast to be significantly lower than the final 2011/12 payments.

The different exposures to world market conditions and company strategies may widen the range of milk prices. Full year prices are forecast to be in the range of $4.50 to $4.90 kgMS, implying opening prices are in the range $4.05 to $4.40 kgMS. This outlook is based on the following assumptions: dairy product prices realising the spot price levels prevailing in mid-2012, the Australian dollar valued between US$1.00 to 1.05, dairy market fundamentals remaining weak through 2012 due to the abundance of milk supply from major product exporters, no financial shocks that would significantly disrupt commodity trade and threaten economic growth. The forecast is an indicative range as the proliferation of pricing options available to farmers, as well as the variation in monthly pricing within the year, makes it difficult to be definitive about outcomes for individual farmers. Wile the current weak export outlook will put pressure on opening prices, however the continued competition for milk supply will ensure that dairy companies open as aggressively as possible. Northern regions Prices remain under downward pressure in Queensland and NSW regions as regional milk flows exceed fresh market demand requirements which may be reflected in lower Tier 1 volumes offered by Lion; Tier 2 milk values will fall in line with southern prices; and intense the retail competition that is reducing processing margins. The influence of farmgate prices available to Parmalat suppliers under new contractual structures may mitigate the extent to which prices are reduced by other companies in 2011/12. A large percentage of Parmalat’s Queensland milk supply is now contracted at fixed prices until the end of 2014.

Dairy 2012: Situation and Outlook 47

Farmgate market NZ price outlook Australian farmgate prices have held up better than those in New Zealand in 2011/12. Fonterra have announced an estimated full-year milk payout for the 2011/12 production season of NZ$6.05 per kgMS – down 20% on last season’s final payment of NZ$7.60 per kgMS. The expected “distributable profit” of 40 – 50 cents will be available for the payment of a dividend, which is in turn expected to be NZ 25 -30 cents, with the balance being retained within the cooperative.

Fig 3.6 - Aust v NZ farmgate milk prices in nominal $A kgMS $8.00

Australia

$6.00 $5.00

$4.00

Fonterra is currently suggesting to its suppliers that the 2012/13 payout will be significantly lower than the final 2011/12 amount, at NZ$5.50 per kgMS.

$3.00

Prices between Australia and New Zealand differ year-to-year because of:

$1.00

o product mix between major commodity products and co-products,

New Zealand

$7.00

$2.00

$0.00 2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012 E

o market mix between domestic and export markets, o management of currency exposures,

Fig 3.7 – Average export mix 2006-2012 – NZ vs Aust

o business models operated by dairy companies, o profit retention practices by dairy companies, o treatment of protein measures in quoted milk prices, and o the extent of competition in each market.

50% 40% 30% NZ 20%

Aust

10% 0%

Butter*

Cheese

SMP

WMP

Dairy 2012: Situation and Outlook 48

Farmgate market This map reflects the varying farmgate market prices and dynamics affecting milk supply and competition in each of the major regions.

Western Australia Farmgate prices 2011/12: 40-42cpl 2012/13: flat 0-1 cpl Key dynamics Milk supply expected to fall marginally in 2012/13 Supplier redistribution following loss of Challenge Cooperative Some processors looking at expanding export opportunities from the region

South Australia Farmgate prices 2011/12: $5.20 – 5.40/kgMS (38-40cpl) 2012/13: down 10-15% Key dynamics Milk supply expected to increase by 1% in 2012/13 Slow supply growth in Western Victoria and export market demand will ensure sustained farmgate competition Volumes dependent on regional climate, water allocations and feed input costs

Queensland and North NSW Farmgate prices 2011/12: 45-53cpl 2012/13: reduction for suppliers exposed to changing processor liquid milk market. Most supplying Parmalat are locked into agreements until 2014 Key dynamics Milk supply expected to remain flat in 2012/13, with lower feed costs partly offsetting falls in mik price The region has been over-supplying local milk market at times of the year Uncertainty over future access to Tier 1 milk prices will affect producer sentiment and investment

Central NSW Farmgate prices 2011/12: 45-51cpl, for majority of producers 2012/13: 43-49cpl with variation due to different exposure to changes in liquid milk market access (affecting % of Tier 2 prices) Key dynamics Milk supply is likely to be flat in 2012/13 in response to pricing signals Increasing influence of over-supply at times of the year affecting milk value/returns Weaker southern milk prices will lower Tier 2 milk prices Uncertainty over future access to Tier 1 milk prices will affect producer sentiment and investment

Tasmania Farmgate prices 2010/11: $5.20 – 5.30/kgMS (38-40cpl) 2012/13: down 10-15% Key dynamics Milk supply expected to increase by 3% to 5% in 2012/13 Production growth has slowed in Autumn Additional processing capacity coming on line in the region, requires strong growth in milk supply and will see competition for milk supply increase

Victorian regions Farmgate prices 2011/12: $5.30 – 5.40/kgMS (40-41cpl) 2012/13: down 10-15% Payments for suppliers to fresh processor prices will be adjusted to reflect change in export prices Key dynamics Milk supply expected to increase by 2% to 3% in 2012/13 Lower opening price will increase pressures in Western Victoria in particular, where conditions have been dry Despite lower prices on offer, companies will still be competing strongly for milk to maintain factory throughput

Dairy 2012: Situation and Outlook 49

Chapter 4 The production sector

Highlights Profitability and finances for dairy farmers

52

Short and medium term production outlook

55

Key regions at a glance

57

Production trends The production sector in 2011/12 Like the national economy, the dairy industry continues to be characterised by “two speeds” – growth and consolidation in exporting regions, contrasted with faltering confidence and contraction in domestic milk regions. Generally favourable spring conditions in south-eastern Australia have resulted in the strongest improvement in national milk production for a decade. Milk production is forecast to reach almost 9.5 billion litres in 2011/12, up around 4% on the 2010/11 season. While farmgate prices were slightly down, good rainfall and positive irrigation allocations, combined with lower feed costs have provided adequate margins. Increasing costs of other inputs - in particular energy, and fodder harvesting costs in the first half of the year, have maintained pressure on cashflows. Gippsland experienced overly wet conditions in spring, and pastures have dried off in western Victoria and Tasmania, slowing autumn production. Flooding affected farmers in north-east Victoria and northern New South Wales, however there was limited impact on production overall. In northern states there has been a partial recovery from the widespread flooding of 2010 and 2011, however retailer strategies and negative pricing signals from processors continue to weigh on confidence and willingness to reinvest. Western Australia has experienced another dry year. This combined with ongoing uncertainty regarding milk requirements from processors has seen production fall in 2011/12. Herd expansion remains limited Additional milk output has largely been a result of improved per cow yields flowing from favourable seasonal conditions rather than a significant expansion in cow numbers. The National Dairy Farmer Survey (NDFS) indicates culling rates are in line with those reported in 2011, as are the average number of heifers on hand. High cow prices have limited the ability of some producers to quickly build up numbers.

Fig 4.1 – Monthly national milk production (million litres) 1,200 1,100 1,000 900 800 700 600

2010/11

2011/12

500 400

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun This year’s survey results reveal that just 22% of farmers describe themselves as being in an expansion phase. Almost two thirds of the farmers interviewed in the 2012 survey described themselves as being in a “steady as she goes” phase, either because they are satisfied with the business as it stands (48% of respondents) or they are unable to expand at present (17%). Further analysis indicates that larger farms – those milking more than 500 cows - are significantly more like to describe themselves as being in an expansion phase. While smaller farms are significantly more likely to be winding down. This suggests that a proportionately greater percentage of milk is on farms that are in an expansion phase. However, there remains significant cautiousness amongst farmers to extend themselves financially and physically, as many remain highly geared. In a number of favoured regions, where land prices are high - out of reach of many younger, less established farmers. Vendors are reluctant to reduce prices resulting in little movement in real estate, and hampering the reallocation of land from those who wish to exit to those that might take production forward.

Dairy 2012: Situation and Outlook 51

Production trends Profitability ABARES Farm Survey estimates for 2011/12 indicate average farm cash incomes fell to $136,000 – down 4% from the 2010/11 average of $141,000, but around 30% up on the preceding ten-year average – with 12% of farms with a negative farm cash income (up marginally from 11% last year). Although little change is reported nationally, regional changes are more significant and inconsistent. Incomes in the Murray Dairy region and Tasmania are estimated to be up considerably in 2011/12, reflecting improved production and lower feed costs. Incomes in South Australia and Gippsland are expected to be down significantly due to lower milk receipts and increased fertiliser, energy as well as repairs and maintenance costs

Fig 4.2 – ABARES farm performance (avg per farm) $250,000

2010/11 $200,000

2011/12 E

$150,000 $100,000 $50,000

Tas

WA

SA

NSW

SDP

WV

Nat

MD

Gipps

$0

In drinking milk regions – Queensland, central and northern New South Wales and Western Australia incomes continue to slide, as farmgate prices fall. Financial position ABARES farm survey data indicates a small reduction in average debt from $663,800 in 2010/11 to an estimated $660,000 in 2011/12.

Fig 4.3 Composition of average farm debt - ABARES

The composition of farm debt has changed significantly over the past decade as farmers have struggled to deal with successive drought years and market volatility. Working capital has increased from 17% of debt in 2001/02 to 26% in 2010/11, while the share of reconstructed debt – the consolidation of loans into longer term debt - has fallen fairly consistently over the period.

80%

15

16

15

13

21

19

20

21

17

70% 60%

18

8 6

50%

7 3

7 3

4 6

6 3

9

12

11

11

11

19

14

20

23

26

4 2

5 3

6 3

5 4

4 4

reconstructed debt working capital machinery

40% 30%

53

48

50

54

56

63

64

57

buildings

57

53 land purchase

20% 10%

3

2004/05

2005/06

2006/07

2

2

1

3

2010/11 (p)

3

2009/10

1

2008/09

2

2007/08

2

2003/04

land development

1

2002/03

0%

2001/02

On the other hand, Department of Agriculture, Forestry and Fisheries (DAFF) data on Farm Management Deposits (FMDs) shows a significant recovery in these funds from the end of last season. While not quite up to the peak levels generated by the 2007/08 commodity price boom, the drawdowns through the first half of the current season have been the lowest for many years.

90%

% debt

This trend appears consistent with more anecdotal reporting of the difficulties in managing cashflow across the year, which is increasing farmers’ reliance on short term borrowings with correspondingly higher average interest costs.

100%

Consequently, the total value of FMDs as at December 2011 of over $211 million – up 15% on the previous year - is virtually the same as four years ago. Dairy 2012: Situation and Outlook 52

People Industry confidence

Investment on-farm

The National Dairy Farmer Survey measures industry confidence as the proportion of farmers who are positive about the future of the industry. In 2012, 66% of surveyed farmers were positive – down from 69% in 2011. The survey results highlight the very different levels of confidence between dairying regions.

The proportion of surveyed farmers intending to invest on farm has declined from 50% in 2011 to 38% in 2012. However, while a large proportion of last year’s investment plans were aimed at repairing flood damage to track and fencing, this year’s investments are focused on potentially more productive areas such as dairy and irrigation plant.

Tasmania remains the industry’s most positive region, with 91% of farmers positive about the industry’s future compared to 75% in 2011. A high proportion of these farmers (23%) describe themselves as very positive about the future.

Not surprisingly, 62% of farmers whose farms are currently in an expansion phase are planning investments in the coming 12 months.

In Victoria confidence fell in both the western and Gippsland regions, while Murray Dairy farmers were marginally more positive than in 2011. In South Australia, confidence improved significantly from 45% in 2011 to 62% in this year’s survey. Demand for dairy products remain the most cited reason for confidence in the future, while improved prices and weather conditions were also mentioned.

Comparing regions, Tasmanian farmers are the most likely to be planning investments (51% of respondents), mostly in irrigation plant (17%) as well as dairy plant and shedding (11% for both categories). Investment intentions were lowest in south-east Queensland and northern New South Wales, where higher rates of investment have been required to repair flood damage over the past 12 months, and the largest proportion of farmers describe themselves as “winding down”.

At the other end of the spectrum, confidence is lowest in south-eastern Queensland and northern New South Wales, where just 45% of farmers describe themselves as being positive about the future. Low prices and increasing production costs were the drivers of negative attitudes for surveyed farmers.

Fig 4.4 - Attitude to the future of the national industry 100% 90% 80%

Challenges faced

Very negative

70% % farms

Although concerns have eased somewhat since the 2011 National Dairy Farmer Survey, farmgate milk price remains the greatest future challenge with 43% of farmers mentioning it in 2012 compared to 51% last year.

Fairly negative

60%

Neutral/unsure

50%

Fairly positive

40%

Very positive

Concerns about input costs – such as fuel and electricity - have risen to 15% compared to 12% in 2011.

30%

Carbon tax was mentioned by 4% of farmers as their greatest future challenge: 69% of survey respondents were interested in becoming more informed about the carbon tax, with just 32% feeling they had a good knowledge of the impacts for dairy.

10%

20% 0%

2004 2005 2006 2007 2008 2009 2010 2011 2012

Dairy 2012: Situation and Outlook 53

People People in dairying

Feed input costs

Tas

WA

SA

NSW

SDP

Gipps

WV

Irrigation water

Labour

ETS/Carbon

Fig 4.6 – Employment intentions for coming 12 months (% of farms)

Tas

WA

SA

Recruiting

NSW

Laying off

SDP

35% 30% 25% 20% 15% 10% 5% 0% -5% -10% -15%

Gipps

Around 19% of farmers expect to employ people over the coming 12 months, while 21% of farms are planning to let staff go. The most common reason for shedding staff was that workers will want to leave (34% of respondents), while 27% of respondents are looking for better skills.

Climate

WV

An estimated 12% of farms employed a trainee or apprentice in 2012, with the highest participation rates in South Australia (22% of farms with trainees), Western Australia (17%) and Tasmania (17%). In Victoria, just 10% of farmers surveyed were employing a trainee or apprentice.

Milk price

MD

Extrapolating survey data, the total number of people working on farms was estimated to be around 31,000. The estimated number of people employed in paid roles on dairy farms across the industry was over 13,000 in 2012. Approximately 31% of these people had started their current roles in the past 12 months, while 15% of workers were completely new to the industry. Turnover rates were highest for assistant farmhands, but significantly lower for managers.

MD

Nationally, some 68% of farms operate with paid roles up from 64% in 2011. An estimated 32% of paid staff are employed on larger farms (comprising 301 to 500 cows), which represent 24% of all dairy farms across the industry

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

AUST

The 2012 National Dairy Farm Survey (NDFS) results continue to paint the changing picture of farm management and labour structures. The proportion of dairy farms operated by a single person only, or with a partner was 29% in 2012 compared to 43% in 2007.

Fig 4.5 – Main challenge faced in the future (% farms)

AUST

Dairy farms have become increasingly more challenging to manage over time. As farms grow in size, reporting and compliance requirements increase, and technology plays an expanding role in milk production the nature of the people required to successfully run a dairy farm are changing.

In terms of perceived future challenges for the dairy industry, 20% mentioned labour as a challenge (significantly up from 11% last year) – 7% saw labour as the main for the future of the enterprise. Specific issues associated with labour and people are availability, mentioned by 20% of surveyed farms, and succession/young people dairying 7%.

Dairy 2012: Situation and Outlook 54

Production outlook

2012

1.0% 2.4% 4.3% 2.0% -8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

Fig 4.8 –% of farms increasing production from past year 60%

50% 40%

The national herd has remained stable at 1.6 million for around five years. The increasing proportion of heifer exports and uncertainty about climatic and market conditions has prevented any significant re-building of milking cow numbers for most of the past decade.

30%

Culling rates in the 2012 survey were similar to 2011 at 17%, while the proportion of heifers sold was double at 10%. There were significant differences in heifer sales by region, with surveyed farms in Western Australia and Tasmania reporting the highest rates at 20% and 18% respectively.

0%

Overall, the change in the number of cows milked by surveyed farmers is in line with the 2011 survey at around 2%. Surveyed farmers in the Murray Dairy region and Western Australia were planning the most significant increases in cows milked at 4.3% and 4.5% respectively. Farmers in south-eastern

2011

1.8%

20%

2005

10% 2012

Herd numbers

-6.5%

2011

Dairy Australia’s forecast for milk production in 2012/13 is for an increase of 2% to 9.65 billion litres, based on the views of the major dairy companies across Australia and corroborated by analysis of the outcomes of the NDFS.

4.8% 2.5%

2010

According to the 2012 National Dairy Farmer Survey (NDFS), 46% of farmers intend to increase production in the coming 12 months, while 40% expect production to remain stable. While 8% of farmers weren’t able to provide estimates, a further 6% were planning lower production next season.

1.6%

2009

On the positive side, availability of irrigation water will be high heading into the 2012/13 season, and low grain prices will assist in protecting margins and supporting output.

Tas WA SA SEQ NSW Gps WV MD Nat

2008

In addition, negative price signals for the opening of the 2012/13 season may take some of the momentum out of production growth, particularly if additional supplementary feeding is required.

Fig 4.7 - Projected changes to herd numbers next season – comparing surveys

2007

The settings for 2012/13 are mixed. While many regions have experienced favourable seasonal conditions and have good supplies of conserved fodder, a number of southern dairying areas are experiencing a very dry autumn.

2006

2012/13 production outlook

Queensland were expecting to milk significantly fewer cows in the coming season. These results suggest that herd numbers will not change significantly in the 2012/13 season.

Dairy 2012: Situation and Outlook 55

Production outlook

Medium term outlook Over much of the past decade, Australian dairy farmers have concentrated on responding and adapting to increased climatic and market uncertainty. Expansion has not been on the agenda, despite a widespread understanding opportunities offered by an expanding global market for dairy products. The challenges of managing volatile incomes, dealing with or having succession within the business and accessing suitable labour are proving difficult hurdles to overcome for many farmers, and the appetite for expansion remains relatively low. In addition, uncertainty concerning the future implementation of carbon and water policies is clouding the ability or willingness for the industry to profitably expand. These factors are important considerations driving the medium term outlook for Australian milk production. Assuming a return to reasonable seasonal conditions, three year intentions from this year’s survey indicate a scenario for milk production in 2014/15 of between 9.8 and 10.1 billion litres. This outlook reflects a slightly lower proportion of survey respondents intending to increase output in three years’ time. This has been offset by stronger potential performance from the growers based on their last two years of demonstrated growth. This page provides some possible scenarios for medium term Australian regional milk production based on future intentions of respondents to the 2012 National Dairy Farmers Survey. Surveys provide indicators of intention and sentiment towards future farm production, rather than an aggregation of firm commitments. The scenarios provided show the difference in outlook between moderate and optimistic outlook views, based on the previous growth rates. The 46% of milk on farms that are intending to produce the same volume in three years time is the largest proportion in the eight years of the survey.

Fig 4.9 – Scenarios for medium term Australian milk production Segments of the production sector

Range of outcomes 2014/15 Production intentions in 3 years time

(billion litres)

Growing

49% of milk production growing by 4-7%

5.5 to 5.7

Static

46% of production is on farms that expect similar production

4.3

Declining

1% of production is on farms that expect lower production

0.1

Leaving

4% exiting

-

Total 2014/15

9.8 to 10.1

Fig 4.10 – Milk production 2012/13 to 2014/15 -100

-50

-

50

100

150

200

250

300

Murray Dairy West Vic Gippsland SEQ/Nth NSW moderate

Cent NSW

optimistic

SA WA

Tas

Dairy 2012: Situation and Outlook 56

Key regions at a glance This page includes data from Dairy Australia’s regional forecast milk production and outcomes from the 2012 and 2011 NDFS.

South Queensland/Nth NSW

Western Australia Key facts

2012

2011

Milk production (ml)* Average farm output (ml) Average herd size % change in herd next year % plan more output in 3 yrs % positive* % plan investment next year

341 2.313 334 4.8 46 54 41

362 2.313 388 -0.3 43 47 38

Murray Dairy Key facts

2012

2011

Milk production (ml)* Average farm output (ml) Average herd size % change in herd next year % plan more output in 3 yrs % positive* % plan investment next year

2,167 1.792 253 4.3 48 77 43

1,866 1.615 287 5.2 58 74 54

Key facts

2012

2011

Milk production (ml)* Average farm output (ml) Average herd size % change in herd next year % plan more output in 3 yrs % positive* % plan investment next year

608 1.110 185 -1.0 38 45 30

608 1.044 177 -1.7 44 50 52

Central Southern NSW Key facts

2012

2011

Milk production (ml)* Average farm output (ml) Average herd size % change in herd next year % plan more output in 3 yrs % positive* % plan investment next year

765 1.930 253 1.7 42 53 36

720 1.866 205 -5.4 44 46 42

Key facts

2012

2011

Milk production (ml)* Average farm output (ml) Average herd size % change in herd next year % plan more output in 3 yrs % positive* % plan investment next year

2,115 1.918 284 1.0 49 71 40

2,149 1.820 267 4.5 42 80 53

South Australia Key facts

2012

2011

Milk production (ml)* Average farm output (ml) Average herd size % change in herd next year % plan more output in 3 yrs % positive* % plan investment next year

568 2.285 315 2.5 44 62 33

572 2.126 288 3.8 50 45 37

Gippsland

Tasmania

Western Victoria Key facts Milk production (ml)* Average farm output (ml) Average herd size % change in herd next year % plan more output in 3 yrs % positive* % plan investment next year

2012 2,094 2.353 312 2.3 44 63 33

2011

Key facts

2012

2011

2,084 2.135 300 0.3 42 74 52

Milk production (ml) Average farm output (ml) Average herd size % change in herd next year % plan more output in 3 yrs % positive* % plan investment next year

792 2.373 394 1.6 53 91 51

722 2.220 370 1.1 47 75 40

*% of respondents positive about the future of the national industry *milk production estimates refer to seasons 2010/11 and 2011/12

Dairy 2012: Situation and Outlook 57

Chapter 5 Production inputs and resources

Highlights Trends in cow and heifer sales

59

Feeding trends and the outlook for prices

61

Water developments affecting the dairy industry 64

Cow and heifer markets

60,000

50,000 40,000

30,000 20,000 10,000

0

2006

2008

2009

2010

2011

2012

Fig 5.2 –Heifers sold in 2012 (% of milking herd) 25% Domestic

Over the last decade some 500,000 head have been exported to around 30 countries. Many farmers now regard export heifer sales as an integral part of their dairy business.

20%

Cull cow sales for the three months to March down 7% on last year and down 12% on the 9-year average - as farmers retained cattle where possible to take advantage of relatively stable milk prices and positive seasonal conditions around most of the country.

10%

Export

15%

5%

Tas

WA

0% SA

Over the twelve months to March 2012, cull cow sales volumes fell 10% below last year – which was 13% down on the previous year - and down 17% on the 8-year average of data available.

2007

NSW

While Victoria is the largest source of export dairy heifers in absolute numbers – due to the size of the industry - the proportion is highest in Western Australia with 19% of heifers on hand sold for export.

70,000

SDP

According to the 2012 National Dairy Farmer Survey (NDFS), 31% of dairy farms sold heifers – with 10% of the total heifer herd being sold. The split between export and domestic sales was 80% to export and 20% domestic sales.

80,000

Gipps

While the recent slowdown in export heifer volumes is a positive sign for the rebuilding of the local herd – down 30% in the three months to February – recent reports suggest that a lot of cattle have come onto the export market in the last two months with farmers concerned over next season’s milk price.

90,000

WV

The largest markets over the past twelve months have been China with 76% (up from 66%); Russia with 12% (down from 15%); and the Middle Eastern region with 3% (down from 9%).

Fig 5.1 – Live dairy cattle exports (12 months to February)

MD

Dairy heifer exports for the twelve months to February 2012 fell 8% to 70,300 compared to the same period last year- for a value of $A158 million. With the national herd at approximately 1.6 million cows, live export heifers would now account for about 4.3% of milking cows - a welcome retreat from the record high of 4.8% at this time last year.

AUST

Cow and heifer trade

According to the 2012 NDFS, 15% of the milking herd was culled – the same level as last year – and ranged from lows of 12% in Gippsland and 13% in northern Victoria and Tasmania, up to a high of 19% in Western Australia. Dairy 2012: Situation and Outlook 59

Cow and heifer markets Beef market With the two wettest years on record across the key cattle producing regions of Australia underpinning female retention and herd growth, supplies are anticipated to increase in the second quarter of 2012. Assuming an increase in cattle supplies in the coming three months, there is expected to be additional downward pressure upon cattle prices. If the current malaise for Australian beef in export markets, especially Japan and Korea – flat per capita consumption and increasing competition from the US - continues, the pressure upon prices could be magnified – despite the expectation for demand from the US to remain positive. Nevertheless, producers have the flexibility to hold on to cattle if prices are deemed unfavourable, given that most would be flush with feed and water. In view of the much improved conditions, ABARES is forecasting a gradually increasing herd size over the next two years, combined with a moderate increase in Australian beef exports. Consequently, the much improved pasture conditions, combined with beef prices drifting slightly lower over coming years, are expected to reduce the demand for feed grains from the feed lot sector – at least for the next couple of seasons.

Dairy 2012: Situation and Outlook 60

Outlook for feed inputs Feed usage According to the 2012 National Dairy Farmer Survey (NDFS), an estimated 95% of Australia’s dairy herd of 1.62 million milking cows consumed an average 1.74 tonnes of grain, mixes and concentrates in 2011/12 for a total feed grain requirement of around 2.8 million tonnes. National average usage per cow is up slightly on last year’s 1.66 tonnes over 95% of the herd. This ranges from a low of 1.30 tonnes in Tasmania, to a high of 2.31 tonnes in south-east Queensland.

Fig 5.3 – Average grain usage per cow per annum (tonnes) 2.5

2006

2007

2008

2009

2010

2011

2012

2.0 1.5

1.0

Better seasonal conditions again meant that a lower proportion of farmers purchased hay and silage this season – down from 61% in 2010 to 53% in 2011 to 47% in 2012. Purchased feed is the largest single cost item for dairy farmers – representing an estimated 25% of average of dairy farm cash costs in 2011/12 according to ABARES analysis – falling from 27% last season, 30% the prior season and from over 37% in 2007/08. In dollar terms, the fall has been from an average farm expenditure of $185,000 down to $108,000.

0.5

Tas

WA

SA

NSW

SDP

Gipps

WV

MD

0.0 AUST

Analysis of the survey findings shows that yield per cow rises substantially with the amount of grain fed; with purely pasture fed herds producing an average of 4,800 litres per cow last year compared to 7,450 litres per cow for herds fed over 2.5 tonnes per cow per year. An estimated 42% of farms now feed their cows more than 1.5 tonnes grain per cow per year (up from 37% in 2011) – and are estimated to produce 61% of the national milk volume. Higher average grain feeding rates, despite better seasonal conditions suggest farmers were seeking to maximize per cow productivity, and possibly reflects the higher proportion of farmers seeking to flatten supply curves through the year to access higher payments.

This ratio improves significantly over the season as higher second half milk prices take effect – lifting from 1.65 for feed wheat during the first six months of 2011/12 to an estimated 2.03 for the current six months. Similarly, barley has lifted from 1.63 to an estimated 2.08 over the season. Global feedgrains market World prices for grains and oilseeds eased in 2011/12 from the peaks of 2010/11, primarily due to favourable growing conditions around much of the world delivering large production volumes and leading to increased stock-touse ratios.

This figure has fallen markedly in recent years due to much better seasonal conditions across the large southern dairying regions and a fall in feedgrain prices from the highs of four years ago.

Industrial and fuel use demand for coarse grains and oilseeds fell with policy changes in the US which saw both the ethanol blender subsidy and an import tariff on foreign ethanol expire in December 2011. Oil prices were relatively benign during 2011, but have started to move up in recent months with increasing political uncertainty in the Middle East.

Analysis of the current season indicates a ‘milk price to feed grain price ratio' improving from 1.66 to 1.86 for feed wheat - the best figures in over a decade; and steady at 1.86 for barley.

The International Grains Council is forecasting a fall in wheat production of 15 million tonnes, or 2%, in 2012/13 to 681 million tonnes from this season’s record high. Smaller crops in Australia, Kazakhstan, Morocco and Ukraine are

Dairy 2012: Situation and Outlook 61

Outlook for feed inputs likely to be nearly offset by lifts in North America and Russia. Consumption is forecast to grow modestly – with gains in feed and industrial usage expected to be offset by falls in feed demand. Consequently, carryover stocks are forecast to fall by only 2 million tonnes to 208 million at June 2013. With a comfortable stocks-to-use ratio of nearly 31%, ABARES has forecast a US$20 fall in world wheat prices to US$275/t. The USDA forecast is for US wheat plantings to increase 3% - particularly for high protein wheat in response to higher prices caused by last year’s volume shortfalls. Early April US planting conditions remain favourable, with very warm weather meaning soil temperatures are on the rise and in some regions warm enough already to germinate corn. Current conditions are ideal to maximize potential corn crops. The USDA reported that 61% of the winter wheat crop was rated good to excellent – compared to 36% last year – and just 10% rated poor to very poor – compared to 36% last year. Elsewhere, European spring rainfall continues to be 25% below average, causing some concern; while further east, Russia, Kazakhstan and China are still experiencing bitterly cold conditions which might hamper early sowing dates for corn and spring wheat. Australian market ABARES’ February 2012 Crop Report reported that growing conditions for winter crops were generally favourable across Australia and therefore national winter crop production was estimated to have been the highest on record. Western Australia experienced a recovery from very dry conditions the previous season and more than doubled production volumes; while the eastern states experienced a second successive favourable season. Despite eastern state volumes being down 17% due to lower yields, it remains the

Fig 5.4 – Victorian grain price trends - $/tonne

second largest winter crop on record in the eastern states. Total winter crop production was estimated to be up 7% to 45.4 million tonnes in 2011/12. Wheat production is estimated to have increased to a record 29.5 million tonnes – 55% above the five-year average; and barley production is estimated to have increased to 8.6 million tonnes – 21% above the five-year average. Despite early-2012 flooding in the central north and north-west regions of NSW and south-west Queensland, yield prospects for most summer crops remain favourable due to near record levels of both upper and lower layer soil moisture profiles. While upper soil layer moisture levels vary with seasonal conditions, lower layer soil moisture will provide a deep store of moisture for east coast winter crops in the year ahead. WA soil profiles are drier but tend to be sandy soils more reliant on in-crop rainfall anyway. While the proportion of down-graded wheat this season was considerably lower than last season, volumes remain very high. Nevertheless, it has been reported that demand for lower grade wheat from Australia is strong as east Asian customers look for alternatives to higher-priced US corn to meet the growing demand from the livestock sector in line with increased consumption of livestock products in that region. ABS data to end-March reports 7.3 million tonnes of feed wheat in bulk grain handler storage – compared with 8.5 million tonnes at the corresponding time last year. With large domestic grain stocks and a third consecutive large winter crop looking likely at this early stage, domestic prices will be relatively stable throughout 2012. The range of forecasts for the 2012/13 Australian wheat crop is currently between 24.7- 26.1 million tonnes and for the barley crop at 8.1 to 9.1 million tonnes. ABARE is forecasting a fall in prices – down from $A268 to $A257/t - leading to a fall in the area planted to wheat of 3% in 2012/13. The ASX grain futures price (delivered Sydney) for January 2013 wheat stands at $235 /t; while January 2013 barley was $199 /t.

$500 $400 $300 $200 $100

Barley VIC

Wheat VIC

Mar-12

Sep-11

Mar-11

Sep-10

Mar-10

Sep-09

Mar-09

Sep-08

Mar-08

Sep-07

Mar-07

Sep-06

Mar-06

Sep-05

Mar-05

$0

Dairy 2012: Situation and Outlook 62

Outlook for feed inputs Fodder

Medium term outlook World grain stocks are expected to remain relatively tight in the medium term as growth in production is broadly matched by increased consumption, ensuring that volatility remains a feature of the grains market landscape. Growth in incomes of consumers around the world is expected to continue being a major demand factor affecting feed grain and oilseeds markets. As diets in developing regions continue to diversify in favour of livestock products, use of grains for stockfeed is expected to rise at a more rapid pace than in recent years. Meanwhile, the rate of increase in direct consumption of grains as human food is likely to slow. Increases in industrial uses of grains and oilseeds such as biofuels are expected to moderate from the rapid rates of the past decade. In particular, industrial maize consumption in the US is forecast to rise 2% annually to 2017, compared to 12% in the last five years as ethanol market growth levels out in the wake of the expiry of the US ethanol blenders’ credit and removal of ethanol import tariffs on 31 December 2011.

$500 $400

$300 $200 $100 Colac

Shepparton

Sale

Jan-12

Jul-11

Jan-11

Jul-10

Jan-10

Jul-09

Jan-09

Jul-08

Jan-08

Jul-07

Jan-07

Jul-06

Jan-06

Jul-05

$0

Jan-05

When winter crop hay production closed in late-2011, many contractors reported that they had only baled 25 to 50% of what they normally do – as low hay prices and reasonably positive grain prices back in mid-2011 encouraged growers to choose grain crops. Consequently, the supply of cereal hay to the domestic market may be limited during the autumn and winter months – particularly following increased floodinduced demand in some regions - increasing the risk of a feed gap developing in the months ahead. On-farm stocks remain high from last season – although, like last year, generally of lower quality due to difficult hay-making conditions during another wet southern spring. ABS data indicates that hay exports totalled 770,000 tonnes in 2011 – down 11% from 2010.

Fig 5.5 – Victorian pasture hay price trends - $/tonne

Major areas of production growth are expected to be Latin America and the Black Sea region, where extra land is available to bring into production, and yield improvements are readily within reach. In Australia, margins have come under pressure in a major competitor for feed grain supplies – the beef feedlot industry. Since the breaking of the drought, a combination of ample grass in paddocks, a high Australian dollar and increased consumer demand for grass-fed beef have greatly reduced the profitability of lot feeding cattle. In the absence of resumption in dry conditions across major beef areas, it is expected that a higher proportion of livestock will be fed on pasture, reducing feed grain demand. Fertiliser Fertiliser is a significant cost item for dairy farmers – representing an estimated 8.3% of average dairy farm cash costs in 2011/12 according to ABARES analysis – lifting from around 7% over the previous three last seasons. Costs have been pushed up by increased usage associated with the much improved pasture growing conditions, rather than unit cost increases. In some regions, paddock renovation following flooding would have also contributed to increased fertiliser costs.

Dairy 2012: Situation and Outlook 63

Outlook for feed inputs

Both Rabobank and the National Australia Bank (NAB) expect fertiliser prices to be driven by a lift in demand from the northern hemisphere as planting conditions remain broadly positive and commodity prices firm enough to support increased usage. Fertiliser prices are expected to show a “modest but steady” recovery from recent lows over coming months. Irrigation water usage The 2012 National Dairy Farmer Survey (NDFS) reported that 27% of all dairy land was irrigated, down from 31% in 2011. Nationally, 30% of the land used for the milking herd was irrigated, but this varied significantly by region. In the Murray Dairy region 59% of land was irrigated during 2011/12 but this was significantly down from 69% of land irrigated in 2010/11. Nevertheless irrigated land represented 59% of the land used to support the milking herd in the region. At the other end of the spectrum, in western Victoria, just 4% of the land used to support the milking herd was irrigated in 2011/12 – similar to the previous year.

80% 70% 2011

60%

2012

50%

40% 30% 20%

10%

Tas

WA

SA

NSW

SDP

Gipps

0%

WV

Rabobank is reporting that global benchmark prices for key nutrients have remained soft through the early months of 2012. Cautious buyers expect further easing in prices and so trading activity is limited. However, as northern hemisphere spring planting approaches buyers will need to re-enter the market.

Fig 5.6 – % of milking land irrigated

MD

With manufacturers and traders keeping inventories low, price risk has effectively been pushed down to the farm end of the supply chain. More volatile fertiliser pricing has changed the demand pattern with retailers and farmers adopting ‘as needed’ buying and hence carrying a delivery timing risk as well. For dairy farmers, these changes add another layer of complexity in the management of one of their smaller, but still significant, input costs.

On farms with more where more than 50% of grazing land was irrigated, stocking rates were significantly higher than farms where less land was irrigated.

AUST

Globally, the strong agri-commodity prices of 2010/11 triggered higher fertiliser demand but prices didn’t respond anywhere near as much as in 2007/08 and there was an avoidance of panic-buying at extreme prices and hence no build-up of excessive inventory. However, with inventory levels now much lower across the supply chain, product availability may be hampered if and when fertiliser demand spikes again.

Water availability in the southern dairying regions A second consecutive strong La Niña event has lead to all the Murray-Darling Basin water catchments having their wettest two-year period in four decades and second wettest in the 110 years of records. As early as mid-November 2011, Goulburn-Murray Water (GMW) and Murray Irrigation Ltd had both announced 100% high reliability water share (HRWS) allocations across all the Goulburn and Murray systems - for the first time since 2001/02. Once again, consistent rainfall throughout the season meant that storage volumes were very high during the year. With water deliveries at record low levels for many months, there will be large volumes of water held in storage to be carried over into the 2012/13 season in all systems. Combining the low water usage this year, high water storage levels and large volumes of carryover water, it has been said that there is probably at least Dairy 2012: Situation and Outlook 64

Water two, and maybe three, years of water availability ‘in the system’ in northern Victoria / southern NSW providing more certainty on this input for many years. Water trading volumes for the March quarter were up 155% on last year as farmers boosted autumn pastures – before the excess of rain in early-March. By late-March prices were down at just $9 /ML – and only $5 /ML across the border in the Murray Irrigation system.

However, sea surface temperatures around Australia remain warmer than normal and the tropical wet season remains active; maintaining the potential for increased rainfall over the continent. The Southern Oscillation Index has fallen from +1 at end-Feb to - 4 at earlyApril - and remains well within neutral ENSO values. A positive SOI is historically correlated with wetter conditions in the eastern states.

Water levels in the Goulburn-Murray (GM) system in northern Victoria have continued to improve this season - even on last season’s already high levels – with Eildon at 91%, Dartmouth at 81% and Hume at 89% at the end of March. The total GM system was at 83%. GMW released its first outlook for 2012/13 seasonal allocations in midFebruary 2012. The Goulburn, Loddon and Murray systems should receive seasonal allocations on 2 July 2012 regardless of prevailing inflow conditions over winter – with all the northern Victorian systems expected to have seasonal allocations of 100% HRWS by mid-February 2013 under average inflow conditions. Assuming average rainfall and inflows, the initial outlook is to deliver a 37% allocation on the Goulburn and a 19% allocation on the Murray on 2 July 2012 – only the second early-July allocation in over a decade. The early outlook for mid-October 2012 is for 97% allocation on the Goulburn system and 80% on the Murray system - rising to 100% on all systems by mid-February 2013. Rainfall outlook The national outlook for rainfall over June quarter (April to June) shows large parts of eastern Australia more likely to have a wetter than average; while the key dairying regions of south-east SA, western and central Victoria, and Tasmania more likely to have a drier than average season.

Fig 5.7 – Goulburn Murray Water allocations % of High Reliability Water Shares 2006/07

2007/08

2008/09

2009/10

2010/11

2011/12

100%

80%

60%

40%

20%

0% 1 Jul 1 Aug 1 Sep

1 Oct 1 Nov 1 Dec

1 Jan

1 Feb

1 Mar

1 Apr

This is combined with a maximum temperature outlook favouring cooler day temperatures across eastern Australia; but warmer days across southern Australia. The 2011/12 La Niña event has ended - with key indicators returning to neutral levels. Climate models surveyed by the Bureau of Meteorology suggest that neutral conditions will persist into the southern hemisphere winter.

Dairy 2012: Situation and Outlook 65

Water Water policy developments Murray Darling Basin The draft Murray Darling Basin Plan was released in November 2011 for community consultation. Submissions closed on 16 April 2012. The Basin Plan is intended to: o

Set and enforce sustainable diversion limits (SDLs) on surface and groundwater use.

o

Set Basin-wide environmental, water quality and salinity objectives.

o

Develop efficient water trading regimes.

o

Improve water security for all users.

The draft Plan requires 2,750 GL to be recovered in the form of ‘held’ entitlements (that is, irrigator entitlements) or ‘planned’ environmental water. According to the Murray Darling Basin Authority, this will result in a 30% reduction in water diversions for agriculture. The dairy industry in its submission points out that shrinking the collective pool for irrigation, trade and carryover will drive up prices for allocation trade, particularly in droughts when allocations are low. Less water delivered through shared irrigation districts will also put water companies under intense pressure to increase charges to cover the costs of maintaining and operating the system. The Basin dairy industry will struggle to sustain its current size, much less grow and prosper in future, in the face of these cost pressures. In turn, fewer farmers will be left in the NSW Murray and Victorian irrigation districts to share the higher costs of modernised systems. Socio-economic modelling for the MDBA predicts reduced dairy production under the draft Basin Plan will affect processing plants in Rochester and Cobram, Stanhope and Echuca and Tatura, and drive a 12.9% ($88.2 million a year) fall in the gross value of production in the Goulburn-Broken valley in the long term. This is one of the highest percentage changes of all the Basin Plan regions.

The MDBA recognises similar or better environmental outcomes could be achieved with less water if more sophisticated modelling was undertaken to account for other options. Such options include environmental works and measures, improved river operations and upgrading the barrages. The draft Basin Plan suggests this more sophisticated modelling and analysis will be undertaken to inform the 2015 plan review, with the prospect that the SDL could be adjusted, and therefore the volume of water recovered could be reduced. However, changing the Basin Plan to adopt such a recommendation requires a repeat of the current, lengthy process of consultation, ministerial council consideration, ministerial approval and parliamentary endorsement. The draft Plan envisages that the review process and any resulting changes to the Basin Plan would not be finalised before 2017. In the meantime, between 2012 and 2017, water buybacks would likely continue to be the Government’s investment priority as the cheapest means of recovering water in the form required by the Basin Plan. The dairy industry remains actively engaged with State and Federal Governments and the MDBA to develop a better Plan for the Basin. The industry’s key recommendations for Plan revisions include: o

Environmental water holders demonstrate they can use the water already recovered effectively, efficiently and without unacceptable third-party impacts or negative environmental outcomes, before more water is removed from productive use.

o

The water recovery target be revised at the level required to meet catchment SDLs (1636GL).

o

Downstream objectives be achieved using the available environmental allocations in conjunction with improved river operations, environmental works and other efficiency measures.

o

The Plan actively direct Government investment into environmental works and measures, and improved river operations as a priority.

Dairy 2012: Situation and Outlook 66

Water o

The remaining buyback and infrastructure funding be pooled, and the Government commit to investing in a package of environmental works, improved river operations and other measures as the priority.

o

The 2015 review assess progress in achieving downstream objectives in light of the investment in a package of environmental works, improved river operations, and other efficiency measures.

o

The costs for the Basin Plan’s management, monitoring, evaluation and reporting regimes must be shared among all Australians – not just passed on to those who live and work in the Basin itself via higher water bills.

o

Clear delineation of the respective regulatory and other roles played by different agencies, to avoid duplication with agencies more expert in water trade matters than the MDBA.

The Basin Plan is scheduled to be finalised later in 2012. The States are expected to implement the SDLs in their next State Water Resource Plans, which are expected to be aligned to come into effect in 2019.

same time, a farmer succeeded in a court case to align groundwater management in the border zone with Victoria with the SA water management framework. These developments have broken the impasse in developing the Limestone Coast Water Management Plan, which will deliver greater certainty of supply to dairy farmers. Victoria’s Western Sustainable Water Strategy was finalized and released in November 2011. Dairy representatives on the consultative committee succeeded in achieving a more practical approach to managing groundwater dependant ecosystems, an extension for s51 water use licences from 15 to 20 years, and a process to address third party impacts of plantations on water availability for the first time. In Tasmania, the evolution of water management plans is being monitored, to ensure that the pain of any adjustment does not fall unfairly on dairy’s shoulders. In the Ringarooma catchment in north-east Tasmania, for instance, dairy may be denied access to water for prolonged periods to maintain minimum environmental flows over summer, when plantation expansion has contributed to flows being less than they were 20 years ago.

The dairy industry in May 2012 has also lodged a submission on the Commonwealth Environmental Water Holder’s discussion paper on trading environmental entitlements and allocations. How much water the CEWH ultimately controls depends on the final Basin Plan, but the CEWH is already the largest single owner of water with 11% of entitlements in the southernconnected Basin as of February 2012, including as much as 17% of high reliability entitlements in northern Victoria. How the CEWH behaves in the water market, and its use of risk management tools such as carryover, may ease or worsen socio-economic impacts arising from the Basin Plan’s implementation. The industry’s submission on the discussion paper proposes protocols and measures to ensure that the CEWH trades responsibly. Other catchment developments After many years of lobbying, dairy and other farmers in southeast South Australia were rewarded with a Parliamentary vote in late 2011 to bring water use by plantation forestry within the water management framework. At the

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ISSN 2200-6206 (online). Published by Dairy Australia Limited. Whilst all reasonable efforts have been taken to ensure the accuracy of the Dairy 2012 Situation and Outlook, use of the information contained herein is at one’s own risk. To the fullest extent permitted by Australian law, Dairy Australia disclaims all liability for any losses, costs, damages and the like sustained or incurred as a result of the use of or reliance upon the information contained herein, including, without limitation, liability stemming from reliance upon any part which may contain inadvertent errors, whether typographical or otherwise, or omissions of any kind. © Dairy Australia Limited 2012. All rights reserved.

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