The traditionally low-cost pasture-based dairying regions, such as Australia, have lost their cost advantage as input prices have risen, and now compete on the global market with a similar cost of production to producers with more intensive farming systems, according to a recent report from agricultural finance organisation Rabobank.

In the report, No longer low-cost milk down under’, Rabobank said global milk production costs have converged between dairy-exporting countries, as the traditionally low-cost milk producers have seen their production costs rise because of volatile global feed prices and the increasing use of feed in pasture-based regions.

Rabobank said lower-cost regions had already largely capitalised their efficiency gains in a high milk-price environment into the price of land and other assets. Therefore, there is a need to adapt to this loss of absolute competitive advantage in milk production.

“It is likely that optimal supply chain efficiency could at least partially mitigate this loss,” said Michael Harvey, Rabobank Senior Analyst and co-author of the report. “Efficiencies achieved downstream in milk processing and marketing via a strong route to market and established supply chain relationships will likely play a greater role in differentiating competitive export companies and industries into the future,” he said.

Mr Harvey said to ensure that competitiveness is based on more than just the cost of producing milk, the Australian dairy sector would need to work hard to ensure it stayed “ahead of the pack” in supply chain efficiency, market access, marketing and sensible regulation.

Global milk production costs converge

Historically, countries in the Southern Hemisphere, such as Australia and New Zealand, have been well known for their low-cost dairy exports.

Mr Harvey said that extensive pasture-based production systems, plentiful natural resources and low opportunity costs in alternative land uses gave this region a competitive advantage.

“Countries such as Australia and New Zealand had surplus milk production, relative to the demands of their small population base,” Mr Harvey said. “Recognising that exporting was not discretionary activity for them, they developed focused export strategies,” he said.

“By contrast, dairy sectors in the EU and the US were highly regulated, resulting in production costs at least 50 per cent higher than the Southern Hemisphere as recently as ten years ago,” Mr Harvey said.

However, according to Mr Harvey, between 2002 and 2012, the local currencies of Australia and New Zealand dairy exports strengthened 90 per cent and 75 per cent respectively, against the US dollar, accelerating the convergence of production costs and making US exporters relatively more competitive.

Traditional low-cost producers lose their edge

The cost of producing milk in typically low-cost extensive pastoral production systems, such as those found in countries in the Southern Hemisphere, has increased since 2002.

Mr Harvey said producers in these lower-cost export countries had enjoyed “buoyant returns” and capitalised them into high valued assets, primarily land, bringing on-farm production costs to levels similar to those in intensive feed-based dairy systems.

“Productivity, in terms of feed produced per hectare, has increased, but this has been well outpaced by land prices,” Mr Harvey said. “Pasture or dairy land prices in Ireland have doubled since 2002, peaking in 2007 at more than four times the 2002 price. In Victoria and New Zealand, land prices have more than trebled since 2002, and in Sao Paulo, Brazil, they have increased six-fold,” he said.

Furthermore, the Rabobank report found that farming systems in historically low-cost production regions had intensified by lifting inputs, thereby increasing production, but at an additional cost.

“Higher milk prices and land prices have encouraged milk producers to maximise their existing assets — such as cows and milking infrastructure — resulting in greater use of purchased brought-in feed, higher on-farm stocking rates and increased production per cow,” Mr Harvey said.

Low-cost Australian milk producers impacted by issues outside farm-gate

A hybrid production system of a pasture base supplemented with grain is core of the Australian dairy industry and is supportive of the industry still being one of the world’s low-cost milk producers, according to Rabobank.

However, Mr Harvey said there are some unique cost pressures facing Australia’s dairy value chain.  These include a shortage of dairy labour and rising energy costs.

“While efforts are being made to combat these issues, they continue to damage Australia’s competitive edge,” Mr Harvey said.

The Rabobank report highlights that farm labour is scarce and expensive, adding to the difficulties the Australian dairy sector is facing compared to other, lower-cost nations.

Energy costs are another issue, even with the potential removal of the carbon tax, the Rabobank report found.

“While the carbon tax only applied directly to large emitters, the cost burden is being passed through to end-users,” Mr Harvey said. “To combat high energy costs, investment is being made in low-carbon, more energy-efficient technologies, often with assistance from government grants — but this is only going to become more important as energy costs continue to rise in the future,” he said.

Australia’s competitive advantages

The relative lack of market regulation and the strong market share of farmer-owned co-operative milk processors in Australia has resulted in a swift transmission of market pricing back to the farm gate, according to Rabobank. This has seen higher farm-gate milk prices delivered to farmers quickly when global market prices increase.

Mr Harvey said the top-performing milk producers are likely to become enthusiastic about expanding milk production at milk prices lower than the wider industry considers profitable – with typically lower production costs and better productivity, those in the top quartile of their peer group will have incentive to continue to invest in milk production but may lack the capacity.

“Milk producers in Australia should consider where the competitive advantage lies for their own operations,” Mr Harvey said. “Increased exposure to the global dairy market for some milk producers and great intensification on-farm for other has added complexity to many dairy farm businesses. A flexible production system at a higher average cost may still be competitive if it provides resilience during a downturn,” he said.

With high volatility expected to continue for both milk prices and production costs, the ability to lower inputs and/or costs during periods of abundant global supply would be a distinct advantage, Mr Harvey said.

“Southern Hemisphere producers previously survived global market downturns for prolonged periods due to the size of their absolute comparative cost advantage,” Mr Harvey said.

“With this cost advantage now minimal to non-existent, other strategies to survive the inevitable downturns – albeit likely short-term – will be required,” Mr Harvey said.