Drought drives dairy prices up

Worsening New Zealand drought conditions helped drive international dairy product prices up by 10.4 per cent at the latest global dairy trade auction, putting upward pressure on Fonterra's dairy payout forecasts for 2013/14 and beyond.

Prices are now up 23 per cent from a year ago and a full 54 per cent above their mid-May 2012 lows. Over the same period, the New Zealand dollar has increased in value by about 7 per cent.

While the dairy price improvement was a positive sign, it needed to be seen in the context of lower volumes thanks to the worsening drought, the Bank of New Zealand said in a commentary. Auction volumes were down 14 per cent compared to forecast, it said.

"Contracting supply, set against solid demand, should see prices continue to push higher in future," the bank said.

Westpac economists said they had revised up their 2012/13 season payout forecast from our earlier forecast of $6.00/kg to $6.10/kg.

This compares to Fonterra's forecast for the 2012/13 season payout of $5.90-6.00 per kg.

Westpac increased its 2013/14 payout forecast by 20c to $6.40 a kg.

"This forecast offers some respite this season as farmers struggle with drought conditions, but for many this increase will not be enough offset falling milk production volumes," Westpac said.

"Our upgrade to the 2013/14 payout forecast hints at recovering farm incomes next season, particularly if growing conditions return to normal over the winter months," the bank said.

Westpac's forecast upgrade reflected the fact that dairy commodity prices have spiked higher as New Zealand supply has tightened rapidly, owing to drought conditions in key dairy-producing regions.

Whole milk powder prices - the most important product for New Zealand dairy producers - broke through the US$4,000 tonne barrier for the first time since March 2011, while all the major categories recorded increases of 4.6 per cent or more.

"In the short term we expect the local drought conditions to drive world dairy prices higher, with the record March 2011 level under threat,' Westpac said. "While we see this development as temporary, the longer-term outlook remains positive with the world economy set to improve over 2013 and growth centred in the hungry part of the world," Westpac said.

These factors will underpin world dairy prices for the 2013/14 season, but Westpac expects a high exchange rate to cap the payout at around $6.40. "With world growth improving further and a depreciating dollar over the 2014/15 season, we expect the payout to increase to $6.70," the bank said.