Tag Archives: Primary Sector

New Zealand benefiting from high commodity prices.

New Zealand’s commodity prices have increased by 17% this year and is expected to increase by 22% by December 2021. What has caused this increase in prices? With Covid restrictions lifted in many countries this has seen an increase in demand especially from China and South East Asian countries. Dairy, horticulture and forestry commodity prices have been the big winners. Kiwi fruit returns are expected to be the highest on record and log prices have increase over 20% in the last 6 months. Furthermore with the opening up of restaurants in the northern hemisphere the demand for meat will undoubtedly increase which is a good omen for sheep and beef farmers. At this time of year lamb prices normally fall but prices have actually increased over April and May.

Shipping costs have been very high of late but as they start to come down with more supply this will be a further boost to exporters especially bulky exports like forestry. It is expected that wood export volumes will be approaching record high levels over 2021 and 2022. The strong return from commodity prices will mean higher national incomes and will support the strength of the NZ$ and interest rates.

This could be a honeymoon period for New Zealand exporters as supply will eventually catch-up with demand and bring down prices. From a longer-term perspective, environmental constraints are biting on global food production. New Zealand’s dairy sector is at the coal face and the demands by government for fencing and other environmental restrictions means that there is less land being used and lower stock numbers. Other dairy exporters in Europe are also experiencing the same restrictions and it is the consumer who is likely to bear the increase in costs with higher retail prices.

Source: Economic Overview. Reshaping the world. May 2021

Milk prices on the up – supply and demand

Demand – this has been healthy especially from China as higher domestic milk prices there has likely led to greater milk imports from New Zealand. The number of unsatisfied buyers at recent auctions has been elevated and forward price curves for major products are relatively flat suggesting fundamental strength rather than a near term short squeeze.

Supply – NZ supply as milk production dipped below usual levels in November and with drier weather in North Island extra supply for this time of year will be unlikely.

Fonterra lifted its 2020/21 milk price forecast to a range of $6.90 to $7.50 (up from $6.70 to $7.30 previously) – see graph below.

BNZ Bank – Economy Watch

This being said Fonterra has to be cautious with:

  • NZ weather conditions – drought can increase the price of feed and deplete water stores for cows and can reduce the ability of dairy farmers to grow feed and ultimately reduce their herd.
  • challenges from further escalation of COVID – global demand could soften as a result of extended shutdowns, or large falls in discretionary spending.
  • increasing milk production in the Northern Hemisphere – In Europe and the US, previous dairy stockpiles are now reaching commercial markets which will depress prices.
  • Strong NZ$ – milk is sold on the GlobalDairyTrade (see below) in US$. If the NZ$ gets stronger it will take more US$ to convert into NZ$ so higher domestic milk prices.

How does the GDT work?

GlobalDairyTrade trading events are conducted as ascending-price clock auctions run over several bidding rounds.  In each auction a specified maximum quantity of each product is offered for sale at a pre-announced starting price. Bidders bid the quantity of each product that they wish to purchase at the announced price. If the price of a product increases between rounds, to ensure their desired quantity a bidder must bid their desired quantity at the new, higher price. Generally, as the price of a product increases, the quantity of bids received for that product decreases. The trading event runs over several rounds with the prices increasing round to round until the quantity of bids received for each product on offer matches the quantity on offer for the product (as shown in the diagram below). Each trading event typically lasts approximately 2 hours.

Brexit – no longer ‘Mind the CAP’

After 47 years the UK has now left the EU and with it the Common Agricultural Policy (CAP). At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector.

The economics behind CAP intervention price
An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

  • It encourages an increase in European production. Consequently, output is raised to 0Qs1.
  • At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
  • In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
  • There is a contraction in domestic consumption to 0Qd1Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.

Figure 1: The effect of an intervention price on the income of EU farmers.

The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.

CAP and the UK

At considerable cost to the taxpayer the CAP has subsidised intensive farming methods that have impacted the British countryside and also increased the price of land making it harder to get into farming – since 2003 the price of land has risen from £4,500per hectare to £16,500 today. Subsidies also encourage farmers to develop land which is not suitable for farming and thus supports unproductive farms. The average English farm made a profit of just £6,200 in the tax year 2018-19 and being propped up by the subsidies has led to inertia and little or no innovation. Sheep farmers have especially struggled, in particular the 30% that are located in areas that are not conducive to farming – the Lake District, the Peak District, Exmoor and Dartmoor – but are seen by the public as picturesque walking areas. The issue being that farm income for grazing livestock in 2018-19 was approximately -£5,000 (lowland) and -£19,000 (upland) – see graph below.

Source: FT

New Zealand experience

New Zealand went through the process of removing the subsidies for farmers and in 1984 the Labour government ended all farm subsidies under the Lange Government and by 1990 the agricultural industry became the most deregulated sector in New Zealand. In the short-term there was considerable pain amongst the farming community and land values collapsed, inefficient farms went bust and the service sector that supports the industry. However to stay competitive in the heavily subsidised European and US markets New Zealand farmers had to increase efficiency, became more innovative and export-orientated – 95% of Fonterra’s produce (dairy) is exported. Compared to the UK, New Zealand does have a lower population density, weaker environmental standards and a different climate.

Post-CAP and the UK

In the Post-Brexit environment the UK government have pledged to keep overall subsidy levels although they will be replaced by the Environmentally Land Management Scheme (Elms) which is expected to be rolled out nationally by 2024 – the old subsidies will end in 2027. The Elms focuses on environmental benefits, such as flood mitigation and fostering wildflowers. Payments under Elms will initially be calculated on the basis of so-called “income foregone”, or what farmers could have otherwise made from farming on the same land, plus the estimated costs of the environmental work. The issue here is that a lot of this subsidy with go to the farmers who are already well off.

Agricultural support from the UK government is now focused on ‘public goods’ such as better air and water quality, thriving wildlife, soil health, or measures to reduce flooding and tackle climate change.

US Farm subsidies and EU dump cost New Zealand farmers

Donald Trump’s subsidies to US farmers (see below) could be above what is allowed under international trade rules and it has been suggested that subsidies in 2020 will make up 36% of farm incomes.

US farm subsidies

  • 2018 – US$12bn
  • 2019 – US$16bn

This year US farm incomes are set to drop 15% even after the payment of subsidies and billions of dollars have been set aside to assist the farming sector. New Zealand officials are concerned that the subsidies given to US farmers will exceed the US$19billion which is the WTO’s limit. They want formal notification of payments in 2020 and how the US plans to reduce this assistance to farmers. The EU, China, India and China are asking similar questions of the US.

Source: Tutor2u

Subsidies distort trade and entice farmers to keep producing even though prices are falling – see graph . This output tends to be inefficiently produced and would not be competitive in a normal market free of subsidies.What the subsidies did in New Zealand was to encourage people to develop land that was not really suitable for any agricultural use. However as they got a subsidy from the government efficiency or quality didn’t feature as a major factor in maintaining competitiveness. With subsidies prices take longer to recover their former levels while excess supply is worked through as was the case in 2018 and 2019 when the EU dumped subsidised skim milk powder on the global market. But the support package to the US farmers is very significant and has the potential to negatively impact those countries that have unsubsidised farmers.

The Dairy Companies Association of NZ’s (DCANZ) executive director Kimberly Crewther says while other countries had propped up their farmers since the start of the pandemic the US was “way out in front” with the size of its support programmes. 
That was concerning given the growth trajectory the US dairy industry was currently on.
“They have the potential to become the world’s largest dairy exporter, but that is going to come at a high cost to unsubsidised producers and not just exporters like NZ if that growth is coming from subsidies,” she said.

EU dumping has NZ Farmers lose $500m
The dumping of subsidised skim milk powder (SMP) by the EU in 2018 is estimated to have cost New Zealand farmers $500m. In 2016 the EU moved nearly 25% of its production into storage before dumping it on the market in 2018 and 2019 at discounted prices. The purchasing of SMP by the EU was done with the intention of putting a floor price under the low EU farm gate milk prices.
EU stocks – 378,000 tonnes in 2017 – 16% of global supply. Release of stocks onto the market had the estimated impact on prices:

World Price

Source: Tutor2u
  • 2018 – SMP prices down by 3.6%
  • 2019 – SMP prices down by 8.7%

US farm gate prices

  • 2018 – SMP prices down by 1.7%
  • 2019 – SMP prices down by 3.9%

The cost to NZ farmers is estimated at 30c per kg of milk solids in 2018 or 4.7% of the payout. The Eu was able to undercut competitors and increase its share of of the global SMP market from 30.6% in 2016 to 42.3% in 2019. New Zealand’s share fell from 23.5% to 16.3% over the same period.

Source: Farmers Weekly – November 9, 2020

Carbon Footprint – NZ v UK primary industry

Useful video on Food’s true carbon cost from the FT – mentions New Zealand apples being sold in the UK not necessarily having a greater global footprint. Apples kept in cold storage would cause a greater carbon footprint than apples being shipped from New Zealand.

Previously food miles (the total distance traveled as food is transported from its place of origin to the consumer’s plate) was one measure of the global footprint and New Zealand is particularly vulnerable due its large quantities of agricultural exports and its geographical isolation. However, transport had been taken out as it was difficult to single out one part of the food system and conclude that because it has come from thousands of miles away it is automatically less sustainable. Therefore, the food miles argument for favouring domestic produce was only valid if food is produced using identical processes around the globe.

In order to reduce CO2 emissions, merely taxing imported food can’t be seen as the answer. As CO2 is emitted at roughly all stages of the process of transporting food to the dining room table, an appraisal of the environmental cost of devouring food from different countries should assess CO2 emissions throughout the product’s complete lifecycle. Stages in a food’s lifecycle include sowing, growing, harvesting, packaging, storage, transportation and consumption. Every phase uses energy and consequently create CO2. These include; Direct Inputs, Indirect Inputs, and Capital Inputs. A simplified flow chart representation of these inputs and the farm outputs, including environmental impacts, but excluding the transport occurring outside the farm gate is shown in Figure 1. Although it was done in 2006 a study by Saunders et al assessed the total CO2 emissions released in the supply of four New Zealand and UK food products to British markets. The report showed (see Table 1 for report data) that in the case of dairy and sheepmeat production NZ is by far more energy efficient even including the transport cost than the UK, twice as efficient in the case of dairy, and four times as efficient in case of sheepmeat.

In the case of apples NZ is more energy efficient even though the energy embodied in capital items and other inputs data was not available for the UK. Onions – where transport emissions account for around two-thirds of all CO2 resulting form the supply of New Zealand crops – are the only product for which UK consumers can reduce CO2 emissions by favouring domestic produce.

A major contributor to New Zealand’s relative CO2 efficiency in dairy production is that New Zealand agriculture tends to apply less fertilisers (which require large amounts of energy to produce and cause significant CO2 emissions) and animals are able to graze year round outside eating grass instead large quantities of brought-in feed such as concentrates. European dairy farms involve housing animals for extended periods of time. The fact that New Zealand farmers do not require subsidies to be internationally competitive, unlike their British counterparts, indicates these efficiencies of production.

UK farmers get a double hit: COVID-19 and Brexit

As COVID-19 absorbs most of the headlines worldwide there are other concerns in the UK like Brexit. The farming industry has been impacted by both:

  • COVID-19 – shutdown of the service that serves the farming industry – 1/3 of the lamb market has gone.
  • Brexit – a deal needs to be negotiated with the EU.

Brexit and lamb exports to the EU – when the UK was part of the EU it was part of a custom union where there was no tariff between member states but there was a Common External Tariff (CET) which meant that countries outside the EU have to pay the same tariff when they export into any EU member state. For Britain leaving the EU without a deal has serious consequences for the farming sector. Over 90% of lamb exports in the UK have gone to the EU but with no longer being a member state the industry will no have to pay a CET which will undoubtedly make UK exports more expensive in the EU market. The FT visit a farm in Wales to look at the importance of the Brexit negotiations – a lamb is valued around £80 but if the EU charges the going rate of tariff between 40-80% that would bring up the price of lamb to between £112 – £144 in EU countries. This would make it very hard for farmers to remain financially viable. Furthermore it is not just the farming sector as the UK’s overall trade with the the EU is significant:

2018 – 45% of all UK exports go to the EU – $291bn
2018 – 53% of all UK imports from the EU – $357bn

The UK produces approximately 60% of what is required to feed its population with the remainder being imported. The UK’s £110bn-a-year agriculture and food sector is deeply integrated with Europe relying on the bloc for agricultural subsidies of £3.1bn ($4bn) under the CAP – Common Agricultural Policy (explained later in the post). The government has promised to pay the equivalent of the CAP subsidies up to 2022, no one is certain what will happen after that. There lies ahead some major challenges in the UK and not just for the farming sector. The video from the FT below is very useful for explaining the impact of trade barriers and CET.

What is CAP?

At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector has been known as the common agricultural policy – CAP. The CAP was established under Article Thirty Nine of the Treaty of Rome, and its objectives – the justification for the CAP – are as follows:

1. Raise and maintain farm incomes, through the establishment of high prices for food. Such prices are often in excess of the free market equilibrium. This necessarily means support buying of surpluses and raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide flutuations that often occur in the price of agriculutural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the efficiency of all units. To reduce the number of farms and farmers especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.

CAP Intervention Price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.


Figure 1: The effect of an intervention price on the income of EU farmers.

The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.

Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU.

New Zealand primary sector holding up but challenges remain

With countries around the world imposing a lock down for its population the global economy is entering a recessionary phase. Levels of unemployment not seen since the Great Depression of the 1930’s are anticipated – in the US 10 million people now looking for unemployment benefit. With this level of unemployment the demand side of the economy takes a hit and consumers who are worried about job security ‘batten down the hatches’ and start to be a lot more conservative with their spending – only essential items. One significant advantage for New Zealand is the fact that we have large primary sector which allows us not only to feed the population but also export – Fonterra exports 95% of local production to 140 countries. The panic buying that was seen in supermarkets around the country led to a government advertising campaign saying that we have plenty of food (and toilet roll) so no need to stockpile necessities. However this panic buying seems to have eased off and although doing the shop at the supermarket maybe slower than normal, people are getting their food okay – Good Friday tomorrow sees the supermarkets shut so they can restock.

On world markets New Zealand’s major primary export product prices have been declining as a percentage (see graph above) but what is encouraging is that this decline has been from a strong position which is unlike those in other sectors of the global economy. Meat and dairy sales surged prior to coronavirus with sales values rose 7.4% ($649 million), to $9.5 billion in the 2019 December quarter. On the contrary stock markets around the world have taken a significant hit with some declining over 20% but also coming from much weaker positions.

Other factors that help the primary sector

NZ dollar
The 11% decline in the NZD/USD exchange rate gives the primary industry some protection against the fall in global food prices. Remember a decline in the value of the NZD makes our exports cheaper.

Oil prices
The cheaper oil prices have been passed on at the pump and this has reduced costs for the primary sector.

Inelastic good
Food is a necessity good as people need to eat – i.e. very inelastic. Therefore food related products are expected to holdup better than most. Even in the worst of downturns there will still be demand for food.

Restaurants, bars and cafes

With the closure of eating establishments during the lock down the profile of global food demand has changed as people buy more provisions from the supermarket. This has meant that supply chains have had to adjust and reallocate resources to online etc. When the country comes out of the lock down there is a supply issue for firms to get up and running again but let’s not forget the demand side. Will consumer behaviour have changed? Will people still want to go to restaurants and bars as before? One interesting statistic to lookout for will be the activity in these areas.

Not all rosey
Even though the points above suggest that things might not be too bad for the primary sector, one has to be aware of the recent drought conditions in the North Island and parts of the South Island which were classified as a large-scale adverse event by Agriculture Minister Damien O’Connor. Also with Covid-19 and border restrictions there are labour shortages in some industries with up to two-thirds of the workforce coming from overseas, half on Recognised Seasonal Employer (RSE) visas and half backpackers. Further concerns are the transport links into Asia for exports as the airline industry cuts back on international schedules. Important to remember that the vast majority of commercial flights carry cargo.

All that being said I think we are quite lucky to be in New Zealand.

Source: BNZ Rural Wrap – 9th April 2020

EU’s uncommon Common Agricultural Policy

At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector known as the common agricultural policy – CAP. Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU. The EU’s seven year budget (2021-2027), also known as the ‘multi-annual financial framework (MFF) is currently being discussed and agricultural subsidies are once again a controversial issue although have been reduced from previous years – 70% of the EU budget in 1980 to 37% in 2018 – see graph right from The Economist.

The aim of discussions is to reduce the amount to between 28% and 31% of the MFF. EU support levels are very high when compared to other countries. The graph below shows the support that other countries receive – producer support estimate (PSE), as a share of total farm income. EU is 20.% (2018) above the OECD average and well ahead of China, USA, Russia, Canada, Brazil, and Australia. Norway is at 62.36% whilst New Zealand is 0.48%.

Source: https://www.cgdev.org/publication/new-estimates-eu-agricultural-support-un-common-agricultural-policy

Who gets what from EU farm subsidies?

Source: https://www.cgdev.org/publication/new-estimates-eu-agricultural-support-un-common-agricultural-policy

There is wide variation in the support provided to agriculture within the “Common” agriculture policy. Latvia does the best of any country in the EU with a lot of other more recent eastern European entrants into the EU – of the top 10 Greece and Finland are the only non East European countries. The Netherlands gets a mere 7% of their income from EU support and traditional supporters of agriculture spend like Ireland, Luxembourg, Italy, and Poland are all below the EU average

  • Despite being a vocal critic of the CAP (and receiving a separate rebate) UK support is broadly the same as the EU average
  • France’s support is only just above average, while Germany’s is in the bottom quarter
  • In terms of the “market price support” element—which inflates EU food prices—Belgium, Hungary, Malta, Poland, and UK producers benefit most

The variation seen here reflects a combination of factors, few of which relate to a policy objective. Most payments are distributed on the basis of a farm’s size in hectares—though per hectare rates vary and were often based on the historical value of production. Other payments relate to sustainability of farming methods, numbers of young farmers, or how much farms produce. With agriculture seen as a significant contributor to global emissions should subsidies be tied to those farmers reducing their impact on climate change?

The economics behind CAP intervention price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

  1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
  2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
  3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
  4. There is a contraction in domestic consumption to 0Qd1
    Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.

Figure 1: The effect of an intervention price on the income of EU farmers.

The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.

Sources:

  • https://www.cgdev.org/publication/new-estimates-eu-agricultural-support-un-common-agricultural-policy
  • The Economist: 23-11-19 – Milking taxpayers

Brexit and the Common Agricultural Policy (CAP)

With the 29th March deadline approaching UK farmers are particularly opposed to a no-deal Brexit; customs hold-ups at the borders could ruin fresh produce. And there is concern that new trade deals with countries like New Zealand could lead to a flood of cheap imports and therefore making it harder for British farmers.

The EU bloc receives receives about 60% of UK food exports with 70% of the UK food imports come from the EU bloc. Lamb and beef exports could face export tariffs of at least 40% if the UK reverted to World Trade Organization rules under a no-deal exit. The UK produces approximately 60% of what is required to feed its population with the remainder being imported. The UK’s £110bn-a-year agriculture and food sector is deeply integrated with Europe relying on the bloc for agricultural subsidies of £3.1bn ($4bn) under the CAP – Common Agricultural Policy. The government has promised to pay the equivalent of the CAP subsidies up to 2022, no one is certain what will happen after that.

What is CAP?

At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector has been known as the common agricultural policy – CAP. The CAP was established under Article Thirty Nine of the Treaty of Rome, and its objectives – the justification for the CAP – are as follows:

1. Raise and maintain farm incomes, through the establishment of high prices for food. Such prices are often in excess of the free market equilibrium. This necessarily means support buying of surpluses and raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide flutuations that often occur in the price of agriculutural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the efficiency of all units. To reduce the number of farms and farmers especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.

CAP Intervention Price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.

CAP Int Price
Figure 1: The effect of an intervention price on the income of EU farmers.

The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.

Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU.

Global Dairy Prices down but why does NZ have such high milk prices?

On the 21st August the GDT Price Index continued its decline and dipped 3.6pc, with an average selling price of $3,044 per tonne. Whole milk powder was down 2.1% at $2,883 – see graph below:

How does the GDT work?

GlobalDairyTrade trading events are conducted as ascending-price clock auctions run over several bidding rounds.  In each auction a specified maximum quantity of each product is offered for sale at a pre-announced starting price. Bidders bid the quantity of each product that they wish to purchase at the announced price. If the price of a product increases between rounds, to ensure their desired quantity a bidder must bid their desired quantity at the new, higher price. Generally, as the price of a product increases, the quantity of bids received for that product decreases. The trading event runs over several rounds with the prices increasing round to round until the quantity of bids received for each product on offer matches the quantity on offer for the product (as shown in the diagram below). Each trading event typically lasts approximately 2 hours.

Why are prices so high in NZ?

Fonterra is responsible for 30% of the world’s dairy exports with revenue exceeding NZ$20 billion and is New Zealand’s largest company. With New Zealand being one of the biggest producers you would expect prices for New Zealand consumers to be lower than what they are – a litre of fresh milk in Germany was selling for the equivalent of $1.51, compared to $2.37 in New Zealand.

Milk being inelastic in demand and is an essential part of the typical family shopping basket. Up until 1976 the price of milk was set by the government and producers were subsidised the loss that they incurred by a set price. The subsidy was completely removed in 1985 and by 1993, milk could be sold at any price. In January 1994, two litres was selling for the modern equivalent of $3.95. Consumer NZ estimates that for every $3.56 bottle of milk (an average retail price at present), about $1.19 would go to the farmer, $1.91 to the processor and retailer and 46c to GST.

Who gets what?

Because Fonterra take over 80% of what farmers produce it is difficult for the market to decide what an appropriate price to pay farmers. Therefore they work out what they believe is the highest sustainable price it can pay its farmers. It looks at the global dairy trade auction price and operating costs and capital costs to determine the farm gate price.

GDT price – Operating Costs – Capital Costs = Farm Gate Price

So farmers in New Zealand are at the mercy of the global market not how much is demanded in NZ supermarkets.

NZ Supermarket Prices

Supermarkets buy their milk from local distributors, either direct from Fonterra or other processors such as Synlait, or from suppliers who had value along the way. They then add their own costs to give a final price to the consumer but New Zealand food retailing effectively is a duopoly. Milk in Germany is much lower in price because of the high levels of competition with multiple chains operating there. In New Zealand however the price consumers pay reflects the concentrated nature of the market. Domestic milk market is dominated by one big supplier, Fonterra (see graph below), and two big supermarket chains – Foodstuffs and Progressive Enterprises – which means there’s little competition for your dairy dollar.