Australian Milk Pricing: A Journey of Discovery

Bound by Global Forces

Fundamentally, global dairy commodity prices are the primary driver of Australian farmgate milk prices because the sector is trade-dependent and operates as a liberalized market subjected to international market forces.

In recent years, adverse climate and disruptive marketing conditions have challenged Australian milk production growth. As a result, between 2017/18 and 2019/20, Australian milk production shed 550m litres (or 6%) and reduced the volume of milksolids exports. Nonetheless, Australia remains a net exporter when assessing total milk solids.

The Departure of Cooperative Principles

The Australian dairy industry has experienced constant change since the onset of deregulation nearly two decades ago. Furthermore, a major shift occurred in 2018 with Murray Goulburn Co-operative’s acquisition by publicly traded Saputo Inc. For an extended period, Murray Goulburn was the lead mechanism for milk price discovery. As the nation's largest milk buyer and a farmer-owned cooperative, it had an overarching principle to milk price to shareholders. Competitors specifically benchmarked their milk pricing structures to the Murray Goulburn reference price. The sale of the cooperative triggered a search for a new milk price leader.

Some dairy companies have adjusted accordingly and now benchmark their milk price against a bundle of leading companies operating within a geographic region.

Others have chosen a different path forward. In response to risks associated with benchmarking competitors, some Australian dairy companies have introduced market-based pricing structures.

Soft Hand of Regulation

More recently, regulation has played an important role. The Dairy Code of Conduct became effective January 1, 2020. The Dairy Code has a broad remit but ultimately provides a framework for how farmers and milk processors conduct “their dealings with one another.”

A key feature of the Code addresses price transparency. Dairy companies must publish standard milk supply agreements (MSAs), including minimum pricing, by June 1 each year for the upcoming season beginning July 1. There are around 20 mid- to large-sized dairy companies procuring milk in Australia, all needing to publish one or more MSAs. This has shifted some market pricing risk from dairy farmers back to the companies from a commercial perspective.

The Code also places significant restrictions on step-downs in milk supply agreements. In addition, an industry initiative developed the Milk Value Portal as a tool for farmers to better understand pricing in their region.

Local Dynamics at Play

Market forces still play an essential role in determining milk prices. Dairy farmers capture additional value beyond the commodity basket for milk because the domestic consumer market is the largest consumption pool for milk supply. This provides some brand value through to farmers and allows for multi-year price security tied back to retail contracts.

The current competition among dairy companies for milk supplies has resulted in a value shift to the farmgate. Ultimately, dairy companies need to ‘meet the market’ in order to retain and grow their milk supply. The strength of competition varies by region, depending on available milk supply versus production capacity, and leads to regional pricing becoming more prominent.

The current Australian dairy supply chain is short on milksolids due to the lingering impact of drought and low profitability from previous seasons. This coincides with the already planned processing capacity expansions and new market entrants looking for a milk supply.

Summary

Australian dairy farmers see benefits in improved transparency, greater price security, and earlier price signals. This will help with budgeting and planning and potentially support investor confidence.

For dairy companies, competition is intense, and the goal post has moved. There is also a need to manage commodity price risk in advance of the seasonal production curve. The compromise is that the benefits suppliers receive translate into stabilization and subsequent recovery in the milk pool, thereby improving utilization of assets and providing scope to explore growth prospects.