Cows eating
April 11, 2016

Oversupply Could Speed Consolidation

Top Story  |   |  By: Tom Bailey

The past few decades, the U.S. has seen a rise in the number of dairies with herds of more than 1,000 head. This trend was recently examined in a report on dairy consolidation in the U.S. released by the Rabobank Food and Agribusiness Advisory Group.

This consolidation has brought postive change to the U.S. dairy industry, including reduced environmental impact through efficiency of production. It has picked up speed the past ten years, as market volatility and industry changes made dairy farming a more challenging but—if done right—more profitable practice, particularly for well-managed, large, and efficient producers.

The increasing rate of change has boosted consolidation of U.S. milk production, putting increasing influence in the hands of large farms and sending ripples throughout the U.S. dairy industry. With large farms likely accounting for the majority of growth in the coming years, U.S. dairy producers and processors alike should be considering the potential impact of this change.

Milk Supply Drives Global Markets. Milk supply has continued to expand despite very low milk prices for most producers and a very bearish pricing outlook for the coming year. The driver of this supply has been the European Union (EU), which was up 2.2% for all of 2015 and saw an additional 3.2 million MT of milk introduced to the market. The main supply growth has come from the Netherlands, which was up 7%, Ireland, which was up 13%, and Poland, up 3%. In 2016, EU supply is showing few signs of slowing, with Dutch production up 15.5%, Ireland up 19%, and Poland up 7.5% for January.

The reason for the EU growth has been the removal of the EU quotas that placed milk supply caps on the market for the past three decades. In the build-up to the removal of the quotas, the market saw record-high milk prices, which drew in significant investments at the farm gate in anticipation of the removal of these quotas. As a result, the post-quota period has seen very rapid growth in milk-supply.

European milk supply will take time to slow as milk prices remain well above breakeven for many producers, since processors are able to pay a higher milk price due to profitability in their value-added product categories.

New Zealand’s story is much different. Fonterra has again reduced its milk price, now at $3.90/kg of milk solids for the 2015/2016 season (around $8/cwt). This puts the majority of New Zealand dairy farmers below breakeven. This will add further pressure on New Zealand’s milk supply, which was down 2.1% in January.

Consolidation to Continue. As we study the U.S. dairy industry, we are more convinced than ever that producers and processors alike need to consider how continued consolidation would impact their business. The profitability of large dairy farms is driven by economies of scale, leading Rabobank to believe the long-standing trend of consolidating milk production is here to stay. The bottom line: the global market is oversupplied, and has been oversupplied for more than 12 months now. We at Rabobank believe the laws of supply and demand will sooner or later prevail, and prices will eventually fall to a level, or remain low long enough, that it will mean production will slow to rebalance the global dairy market.