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Published February 20, 2012, 11:22 AM

Size of the prize

SIOUX FALLS, S.D. — The U.S. dairy industry seems to have a bigger opportunity in expanding world markets than it did two years ago, but the window of opportunity is temporary.

By: Mikkel Pates, Agweek

SIOUX FALLS, S.D. — The U.S. dairy industry seems to have a bigger opportunity in expanding world markets than it did two years ago, but the window of opportunity is temporary.

“There’s an opportunity for the United States to jump through that window, but if we’re not proactive and aggressive in pursuing it those opportunities will begin to close,” says Clinton Anderson, a partner in the Dallas office of Bain and Co., speaking at the I-29 Dairy Conference in Sioux Falls, S.D., on Feb. 8.

The time length of the opportunity will depend on the global economy, and how quickly new consumers become more affluent, Anderson says.

Bain and Co. led a globalization study for the industry in 2009, looking ahead 10 to 15 years, and underlined seven broad policy initiatives needed to take advantage of global opportunities. But the study was updated in 2011 because of wild swings in agricultural markets. The study was funded by check-off dollars on behalf of Dairy Management Inc. and the Innovation Center for U.S. Dairy.

Some argue the window of opportunity is open for only three years. Some say it’s open up to 20 years, Anderson says.

Anderson’s personal view is that if nothing is done in the mid-term of five to seven years, there’s no problem, but there is a need to prepare for the long term, which is 15 to 20 years out. “I think that if we don’t have it figured out by then, we’ll have missed the opportunity,” he says, adding, “Our inaction will in fact cause the window to close more quickly than it otherwise might.”

Three, seven, 20 years?

The U.S. dairy industry still has big opportunities in a world of expanding consumption because of increased world demand. The study suggests that U.S. dairy policy should move the country less toward supply management and more toward a free market system with supports or tools to avoid the pitfalls and pain of volatile ag markets.

One area of “heavy criticism” with global clients is that the U.S. dairy inputs are there in good times, but not always in bad times, compared with European and New Zealand suppliers, for example, he says. The U.S. domestic market always will be the “core,” but the world market provides expansion potential. “If we don’t keep pushing for change, we’ll miss out on the opportunity,” he says.

Economics suggest the current, complicated federal milk marketing system should be replaced with futures market tools that — like in other ag sectors — allow producers and buyers more than a month’s assurance in setting supplies, Anderson says. The Dairy Security Act, proposed last September by U.S. Reps. Collin Peterson, D-Minn., and Mike Simpson, R-Idaho, would hurt U.S. competitiveness in global markets, because it would insulate the industry from market trends rather than allowing the industry to see the trends and react quickly.

The key statistic is that the world will add 800 million new consumers in the next 30 years in developing markets, Anderson says. China, India, Brazil and Turkey, are among “emerging markets,” where people are increasing dairy consumption because they are becoming wealthier, moving from consuming plant-based protein, to animal-based protein — especially pork, poultry and dairy.

800 million new mouths

It has become clearer in the past two years that China won’t increase dairy production to equal its increasing demand, fueled by its vibrant economy and a shift toward western-style food service. China’s economy had been growing 10 percent annually, but has backed off to 7.5 to 8 percent annual growth during the economic downturn, Anderson says. Regardless of any global economic cycles, or European recessions, “China is still coming,” Anderson says.

China will increase pork and poultry production, but won’t increase dairy production because of a shortage of labor in dairy-producing regions. Fonterra, a multinational company owned by 13,000 New Zealand dairy farmers and the world’s largest exporter of dairy products, is among those increasing Chinese dairy development, but it is insignificant in the big scheme. The value of the domestic Chinese dairy will be high-priced, high-quality in context of security and safety issues highlighted by the melamine scare in 2008, the study says.

Chinese milk consumption is increasing 5 percent annually, but the amount of imported milk roughly will double in the next decade, the study shows. A growing gap between demand and supply will go unmet, especially if consumers “don’t know that they want it.” Indonesia, the Philippines and Malaysia have an even bigger collective opportunity. They produce less than 10 percent of their own milk needs because of production challenges there, including heat and disease.

The study offered an in-depth look at world competitors, including the U.S.

Who will supply?

“Russia continues to struggle,” Anderson says. “They try to be self-sufficient. They bring in a lot of product from Belarus, Ukraine.”

Mexicans are consuming more dairy, including drinkable yogurts and long term will be a large importer of U.S. milk, even though their herds are increasing significantly. The Middle East markets are increasing: Saudi Arabia, Egypt and Algeria combined import as much milk as China.

India has more dairy cows than any country, but relatively low productivity. India’s market is “growing like crazy.” “It’s a very immature market in the supply chain,” he says, with limited retail space and refrigeration. Milk is delivered daily to homes and used within a day. Almost half of the milk produced there spoils before it gets to market.

New Zealand farmers shifted to dairy when wool and lamb subsidies went away. A lot of production shifted to pasture-based dairy, first in the north island and then in the south, where more irrigation and corn silage are used, but that expansion has limits. “We think that in 10 to 15 years, New Zealand production will be capped in its overall production,” Anderson says.

Europe is eliminating a production quota system by 2015, which will lead to a 5 percent increase “hiccup” with gains shifting into a small handful of countries. Netherlands, Austria, Ireland, Belgium, Spain and Germany will increase production, with reductions in other countries.

Australia is a large but “flat” global player, but experienced three, 100-year droughts in the past decade, meaning growth there will largely only be able to meet internal supply. Ukraine had been poised to grow, but capital flow “evaporated” there in the economic downturn.

Brazil went from being a small net exporter to a small net importer in the past two years. “We still have to keep an eye on them as someone who could chase us to fill that demand gap,” Anderson says. Argentine policies use export tariffs that keep domestic prices low and limit foreign market growth potential. Belarus has growth potential, but mostly into Russia.

U.S. price position

The U.S. could grow, but is limited by the upward trend and volatility in commodity markets. “We can flex production, we’re nonseasonal, we have the capital to support it,” and the study shows the industry will be competitive elsewhere in the world. Analysts project the U.S. dollar will continue to weaken, strengthening exports.

The total cost of U.S. production is higher than Poland, Brazil and Ukraine but remains in the middle of the pack and compares favorably with other significant players with growth potential.

The U.S. cost of milk production is $450 per metric ton (even including likely volatility in input costs), compared with more than $600 in the Netherlands, a “decent proxy” for much of the European Union but higher than Ireland and Poland.

Meanwhile, China’s dairy production is costing about $550 per metric ton. New Zealand production is at about $300 per metric ton today, but will rise to the $600 range when the industry exhausts its potential under the pasture-based model.

With global supplies running short, some major customers are starting to invest in their own captive supplies in places such as Latin America.

In the “mid-term” time frame, growth markets will continue to import and New Zealand will reach peak production, and low-cost suppliers such as Ukraine, Poland and Argentina will emerge. “That’s finite, and at some point that window will close,” he says.

Anderson says the study suggests that the federal milk order system won’t work long term, and that support prices are so low now that they are meaningless much of the time, and induce companies to produce products that global markets don’t want.

“Nonfat dry milk is not the product that global buyers buy,” he says. “And yet that’s what co-op executives feel they have to build their capacity around and create inventories of,” he says. “Anytime your marketing strategy is, ‘My customer of last resort is the government,’ that can’t be good, commercially.”

He says federal policy should create ways for dairies to manage the volatility of markets with futures contracts, just as other industries have. One of the problems is that dairy farmers have to take one-fifty-second of their production to the market every week, compared to grain farmers who can store their production for longer periods.

Production and processing standards should be more in line with international demand, Anderson says. To stay competitive, farmers need to improve efficiencies and processors need to produce products new customers need, Anderson says. Costs have to be low enough to be below the average in Europe to be attractive to producers and processors, for the U.S. to succeed.

For details about the study: www.usdairy.com/Globalization/GlobalImpactStudy/Pages/BusinessCase.aspx.

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