As the milk price falls, Fonterra needs to react by rethinking its strategy

Agribusiness is different. Long investment cycles, equally long production cycles and environmental perturbations combine to erode resilience. The current milk price debacle is a clear case in point.

Farmers have responded to the signals they have been sent by their processor and marketing arm (Fonterra) and society (environmental compliance) and achieved productivity gains. The downside of everything they have achieved has been an increase in debt, but the upside has been a booming economy.

The good times are crashing.
The slump that is being experienced in dairy prices is part of a global problem. At the beginning of August the FAO announced that dairy and vegetable oil price drops had led the FAO Food Price Index to its lowest level in six years. ‘Lower demand from China, the Middle East and North Africa, and above average European Union milk output’ were cited. The role of Russian sanctions was not mentioned, leaving questions in New Zealand on where Russia is sourcing milk and how full the warehouses in China really are.

And why Fonterra has persisted (until Black Friday 7th) with its Strategy Refresh Volume, Value and Velocity (V3) model.

On the 29th March 2012, ‘Fonterra outlines plan to extend leadership in dairy nutrition’ was a featured headline. The article is still on the Fonterra website with Fonterra Chief Executive Theo Spierings explaining that ‘Strategy Refresh was built on an in-depth look at the Co-op's strengths, social and economic trends as well as underlying projections for a marked increase in global demand for milk’.

"Strong economic and population growth in emerging markets is driving a situation where global demand for milk is forecast to grow by more than 100 billion litres by 2020, with New Zealand expected to contribute only 5 billion litres of additional supply by that date," Spierings said.

That year the Milk Solid payout was $6.08 with a 32c dividend.

In the 2012/13 year the payout dropped to $5.84 (again with a 32c dividend), and on 25th September 2013, it stated that ‘the Co-operative has continuing confidence in its Volume and Value strategy in our key markets. Looking ahead, prospects for the dairy industry and for Fonterra look positive and its growth ambitions remain unchanged.’

Five months later (27th February 2014) the payout was lifted to $8.65. Chairman John Wilson said the higher forecast was good news for farmers, and for New Zealand, and that the increase reflects continuing strong demand for milk powders globally.

Six months further on again (27th August 2014) Fonterra maintained the forecast for the 2014/15 season at $6.00. Chairman John Wilson said the decision to maintain the forecast Farmgate Milk Price reflected the longer term outlook for international prices for dairy.

The slide started shortly afterwards.

Friday’s forecast of $3.85/kg milk solids is the lowest since 2006, and costs of production (which include rates, power, fuel, grazing costs and wages) have increased significantly since then.

Long investment and production cycles mean that decisions made in 2012 in response to Fonterra’s ‘in-depth look at the Co-op's strengths, social and economic trends as well as underlying projections for a marked increase in global demand for milk’ are coming in to play. Expenditure on semen from high breeding worth bulls used in cows in October 2012 resulted in high breeding worth calves in August 2013. The heifers were reared and then put to the bull in October 2014. They are calving and coming into the herd this season. These are heifers that require more than grass to fulfill their genetic potential in milk production, and are part of the efficiencies of New Zealand dairy production.

Research by the International Food Comparison Network released last year categorised New Zealand’s costs of milk production in the US$30-40 per kg ECM (energy corrected milk), whereas the EU, Middle East and China were US$40-50 per kg ECM and the US, Canada, Austria, Norway and Switzerland were greater than US$60 per kg ECM.

Research by the same group released in 2011 put New Zealand in the ‘best management practice’ group for greenhouse gasses per kg of milk (large cow housed herds in the US were more efficient in GHG).

Farmers at the leading edge of efficiencies are likely to be those carrying the debt as the technologies implemented (effluent disposal, animal shelters and milking sheds that reduce labour costs) are expensive. And budgets done on a long term $6.00 payout are not coping this year.

That is why there have been questions, including from dairy companies other than Fonterra, on why Fonterra is continuing to auction milk.

Auctions work well when demand is greater than supply. When the reverse is true, a reserve price is usually set to ensure that the seller is protected. In Auckland a decade ago, as the move from fixed price was occurring, most house sales at auctions were passed in – and agreement reached between the vendor and purchaser afterwards. Negotiation was the key in achieving a contract between the parties with terms that both could accept.

The basic requirements are a reserve price that indicates the lowest price acceptable without negotiation and the expertise of the negotiators if the reserve price is not achieved.

The current auction system is eroding the potential to achieve increased prices in the next few months. The starting price each fortnight is 15% below the last ‘winning’ price, there is no reserve price, and volumes have increased as the season progresses. It isn’t a winning formula. Worse, it locks forward contracts in a dismal slide.

It is this forward contracting that might be why Fonterra hasn’t responded to criticisms of the auctions with anything but a ‘willing buyer’ comment.

After the latest Global Dairy Trade (GDT) auction, Fonterra Managing Director Global Ingredients Kelvin Wickham tweeted that “No one likes low prices but important to remember GDT has not caused low prices – they’re a reflection of what’s happening in the market.”

He went on to say that “Nearly all of the product offered on GDT this week sold to willing buyers.”

Of course buyers are willing at low prices.

But as media reports have made clear – the milk producers are not. They have been voting with their feet and joining other companies over the last few years. This year there could well be uproar at the AGM and elections.

Creating a successful future from the current state will take a rethink of the strategy; it requires a fresh approach. Shareholders have been promised this in the past by people campaigning to represent their interests on the board, but well-intentioned new directors find themselves constrained once they are part of the official Fonterra employment.

Fresh thinking requires a fresh start. If all directors stood for re-election this year, not just the three on rotation, it could give them a chance to let shareholders know what they really think should be done. It doesn’t mean that they wouldn’t get re-elected – it is important to maintain some corporate memory – but it would allow freedom of speech.

They might also explain how they will add value in creating that future - their vision, track record and skills and abilities to assist in creating a credible new strategy.

The latest pay-out forecast at $3.85, plus a dividend of 40-50c, in combination with the falling proportion of the world market indicates that the V3 strategy hasn’t worked.
Strategy refresh is not enough; Strategy clean start is required

Comments (11)

by Tim Watkin on August 11, 2015
Tim Watkin

Sorry about the earlier version. We had formatting issues, but have cleared out the bugs now.

by Murray Grimwood on August 12, 2015
Murray Grimwood

Dairying is a process which turns fossil fuels into food. Meat - and we can assume dairy to be similar - takes somewhere between 10 and 27 calories of oil, to one of produced food.We're essentially eating oil, while drawing down resources like phosphate and aquifers and pollution-absorption capability.

That is obviously unsustainable, always was going to run into its own Limits to Growth..

The problem is that payment (for everything) relies on fossil fuels too - or it will show up as unredeemable debt. This is because real wealth required goods/services to have been produced for trade, that takes work, work takes energy. There is no order-of-magnitude replacement for Fossil Fuels.

Rowarth points to "9 billion by 2050, all needing fed'.

Two problems with that statement; Firstly, anyone under 35 in 2050 has yet to be born; condoms might be better than vested justification.

there is not enough FF reserve to do the 2050 feeding - not in meat/milk at any rate - and that begs the question; What then? And what then? And.......... This is a 'growth can't go on forever' problem, begging the real question: When is it better to cease the growing - now or later?

The bottom 2 billion (and we need to remember that that was the total population around 1930) would probably take all the milk the planet can suppy - but due to their inability to access energy, they'll never be able to pay the kind of resource-purchasing-proxy (money) that First World farmers demand.

http://www.resilience.org/stories/2015-08-11/how-economic-growth-fails

by Wayne Mapp on August 12, 2015
Wayne Mapp

Murray,

You could not be more wrong. And you seemingly show a woeful ignorance of the New Zealand farming system, which probably uses less fossil fuel than any other large scale farming system on the planet.

Dairying in New Zealand is in fact is a process which turns rain and soil nutrients into milk which is then further processed. Yes, the processing requires some fossil fuel, and electricity, most of which comes from natural (hydro, geothermal, and wind) sources.

Sure the products have to be exported, but the fuel to do so is tiny when considered on a tonne of exported product basis. Probably more fuel is used in the country of import, with their distribution systems, supermarkets etc.

Your post seems to counsel global society where there is no trade, and a total population of a few hundred million people. But that is not going to happen. There will be 8 to 9 billion people in 2050. And provided they can all reach a European style of living (as opposed to US style), that will be infinitely sustainable. After all in Europe nearly 600 million people live in quite a small area, with a progressively improving environment.

In most advanced European nations, they have been able to improve the quality of their ecosystems, with improved water quality, improved air quality and a greater portion of land being reverted to a natural sate, with the evident return of wildlife and fish in streams. Actually this is also happening in the North East United States as well.

So New Zealand's ability to feed nearly 100 hundred million people, essentially on a natural pastoral cycle (I do appreciate that a lot of native forest was destroyed to achieve the pastures) through our agricultural exports, is extremely valuable to the world as a whole. 

 

by Katharine Moody on August 12, 2015
Katharine Moody

but it would allow freedom of speech.

A very sad indictment of where the "cooperative" has gone.

by Katharine Moody on August 12, 2015
Katharine Moody

Also of note, this bit of news got no profile and no explanation as to why/what happened;

http://www.stuff.co.nz/business/68901957/aquaduct-nz-pipe-supplier-to-hu...

Is the whole scheme going belly up?

by Murray Grimwood on August 12, 2015
Murray Grimwood

Reasonable reply, thanks for that. Many tend to shoot the messenger by way of avoiding the unpleasant.

We have to be careful when comparing things. The ultimate depletion of a linchpin resource - Fossil Fuels the case in point - can be slowed by efficiencies, but not halted. The Jevons paradox:  https://en.wikipedia.org/wiki/Jevons_paradox   tends to take up the slack, as does outright growth. We have never stopped using Fossil Fuels more efficiently, but we have never stopped using more of them per year, either.So even if the NZ system is 'more efficient', that doesn't mean it's sustainable, nor does it mean the global fiscal system is either (it being wholly based on energy too).

A compounding problem is the cherry-picking one; we use the best stuff first; the best coal is gone, the best oil likewise; we're down to fracturing rock, deep-sea, even contemplating lignite. (That goes for the coal that Fonterra use - 30% I seem to recall - but I'm not as concerned about Climate Change as others, it's not likely to be first cab off the rank).

You state "And provided they can all reach a European style of living (as opposed to US style), that will be infinitely sustainable".

Actually, no. You are mixing up rates and volumes; both impact the total. There is not the FF resource left on the planet (of useful EROEI) to lift the current global population to current European standards, even if the US reduced to same. Europe - like all the First World, is not self-sufficient. What do you thin the Ukraine scrap is about, a bogey-man's ego? Europe - like us - has merely offshored its pollution, sucks in its energy.

Is it a 'natural pastoral cycle'? Can they really do it without phosphate and palm-kernel?

Regardless, if your aim is really to feed people (and not to disguise maximising profit as feeding people) then original growth is better fed directly. It's just physics; a cow is an energy equation, as are we all. We lose energy we've gained from food as low-grade entropic heat - the same way most energy is lost. This is us sheding clothing when we work hard, this is why tractors - while ever-more technically advanced - still need radiators.

So the grain fed straight to the eater, is the less-loss way to go. I'm no raving vegie (like my meat n' cheese - just sayin) but thats the simple fact.

I agree about shipping - one of the most efficient fuel-to-result ways we use FF. But it still uses them, and they still deplete. On a sustainability basis, it still isn't.

Global carrying capacity - paddock-stocking of humans in the long term - depends on consumption per head (of everything). Somewhere between 1 and 2 billion, probably, depending on whether it's peasant-level or our level. I suspect the latter is unobtainable; the economies of specialisation at 1 billion probably preclude maintaining our present level.

 

by Wayne Mapp on August 12, 2015
Wayne Mapp

Apologies to Jacqueline that I have got diverted from her rather pressing Fonterra article, but just one question for Murray.

To what extent is Europe not self sufficient? Certainly it imports from the globe, either to get more diverse products or cheaper products. But for instance in WW2 France was probably doing OK (at least in an economic sense). Germany was not, but that was because it was trying to run a global war.

As I understand it, the European CAP is primarily about agricultural self sufficiency (partly as a result of the war experience). This has been largely achieved. New Zealand's argument is that it would make more sense for Europe to import from a low cost producer, rather than subsidize inefficient European (and especially French and German farmers).

As for fossil fuels, well in Europe their use is going down, and is likely to go down quite a bit more in coming decades. Photovoltaics looks like it is starting to make a real breakthrough in the amount of energy produced.

Looking forward to seeing Fonterra do a restart rather than a refresh.

 

by Murray Grimwood on August 12, 2015
Murray Grimwood

http://www.foeeurope.org/sites/default/files/publications/foee_report_-_...

There's probably better around, but that'll do.

:)

by Murray Grimwood on August 12, 2015
Murray Grimwood

Wayne - I went to a lecture from a fellow from one of the Helmholtz think-tanks, he was charged with staging the alteration in the German grid from coal/nuclear/gas, to solar (South) and wind (North). 4 trans companies and a 20-year programme. At the end, will be 35% renewable, and that's only the grid, not FF replacement.

Somebody has known this for some time:

http://www.paep.ca/en/CIYL/2007/doc/The%20Role%20of%20Science%20and%20Su...

She's one smart cookie............

Fonterra? Cooperatives are good, greed is bad, unresearched assumptions can be fatal. Who would borrow on this graph?For how long?

http://www.drydipstick.com/2004Scenario.jpg

 

by Charlie on August 15, 2015
Charlie

Murray, you Club of Rome world view is well out of date. We can grow massive amounts of food without fossil fuels. 

Read these two examples:

http://www.theguardian.com/environment/2012/nov/24/growing-food-in-the-d...

http://www.dailymail.co.uk/sciencetech/article-2687674/Now-THATS-power-p...

Never in the history of mankind have we produced so much food per capita and with new technology, including genetic modification, the future is bright.

 

 

 

by Murray Grimwood on August 16, 2015
Murray Grimwood

Laughed till I wept. Thanks for that.

You need to get a little perspective, and to study energy some. Embedded energy and EROEI (Energy Return on Energy Invested). Then have a wee think about scale. You gonna feed 7 - or is it 9 - billion hydroponically using solar boilers and LEDs close to the sea? Built from? By? In the remaining timeframe? Infrastructure, feedstock (yes, you don't get something for nothing, 3D printers need feedstock processed and available too)

We have only produced this much - never more - food by using the one-off hit of fossil fuels, and by concurrently drawing down on 'Natural Capital.

Technology doesn't create energy, merely facilitates our access to and use of what is available. That includes GE.

The limits to growth can be no more out of date than the fact that you will die. You can argue that because you han't died yet, you won't. I call that delusional. The stats are that on any particular day your chances of dying are very small, but they increase with every day, and inevitably arrive at 100%.

Who are you spinning on behalf of, some vested interest or personal fear?

 

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