Power Cuts Ripple Through China's Dairy Market

Views on the Ground

Feedback from a range of dairy industry participants suggests that the impact of power cuts on the dairy processing sector appears to be limited for now. However, the seriousness of the power situation varies from region to region. For example, the capacity utilization of processing companies in southern areas like Guangdong has been more impacted than other regions, and northeastern provinces have experienced severe power shortages.

Some Contingency Planning Works for Now, but the Persistence of the Situation Could Hurt

Some well-established dairy processing companies are equipped with in-house backup generators to ensure business continuity. Still, they face the same problem as the power companies: very high thermal coal prices. For the time being, companies that can manage the government relationship well can plan for power cuts or minimize the number of cuts to ensure food production. However, the consensus from our contacts is that, should the situation persist, the potential negative impact on manufacturers would eventually become a reality, especially if power cuts are implemented indiscriminately.

Looming Uncertainties Across the Supply Chain

Whichever way one looks at it, this places further uncertainties on the dairy processing sector regarding processing capacity, packaging availability, storage (chilled products), and possibly distribution channels, putting more pressure on the cost side. We have, however, yet to clarify the impact on upstream dairy farming, where the operation of milking machines, milk storage facilities, water pumps, and manure pumps could be interrupted, causing a lot of disruptions and potentially holding back supply.

Rabobank estimates China's processing demand strength based on dairy product manufacturing data, released by the National Bureau of Statistics. Recent data shows year-on-year growth of 0.3% and 1.9% in July and August, respectively, a sharp slowdown from the 16.8% YOY growth experienced during 1H 2021 (vs. a very weak 1H 2020). The data implies that the peak recovery period has passed (Q1 2021), and the current normalized demand growth is anything but robust.

A Turn in the Milk Price Emerging

Farm-level milk prices have risen significantly during the past 12 months and are currently off the historical peak but still up 12% YOY as of late September 2021. On the other hand, the government's dairy consumer price index averaged below 2% YOY for the same period. This suggests that midstream dairy processing companies have been bearing the brunt of the cost pressure from rising raw milk prices (and costs of ingredients and other inputs) all along, with minimal power to pass this onto consumers. If higher costs were passed significantly onto consumers, demand destruction would be likely if the situation in 2013/2014 is any indication.

Power Cuts Aside, Rabobank’s Fundamental Market Outlook Remains Unchanged

The power situation is a new development, but it does not fundamentally shift our view of the market over the next 12 months. We expect China to work through some of the inventory built up since last year, on the back of much stronger supply than demand growth, in the form of declining import demand starting in the latter half of 2H 2021 and into 2022. We also anticipate the likelihood of a meaningful reversal in the Chinese milk price to rise in 1H 2022. Investments made in 2020 continue to contribute to production growth, which could drive milk prices into a cyclical downturn starting in 1H 2022. It may take some time for milk production to respond and for the Chinese market to reach a better supply and demand balance.