Why Do World Markets Matter?
While Australia has seen a reduction in the portion of output that is exported over the last 10 years, we still remain a very ‘trade exposed’ industry. Around 75% of all raw milk produced is ‘trade exposed’, meaning it is converted to products that compete with imports in Australia or exports from other countries in the world market. Apart from fresh milk, products like cheese, butter and milk powders are either exported from Australia or compete directly with imported products in the domestic market.
Australia is a trading nation. It is estimated 45% of the nation’s GDP and one in five jobs is directly related to trade. Successive Australian governments have pursued active and ambitious open-trade agendas designed to strengthen the local economy and maintain living standards.
Australia has signed 13 regional and bilateral trade agreements and is negotiating others – including with the EU. As well as offering access to markets, these agreement necessarily open Australia to inward trade and investment.
The Australia-New Zealand Closer Economic Relations agreement has been in place for over three decades and offers one of the largest global dairy exporters unfettered access to the Australian market. The US also has access, and tariffs applied to imported products from other countries are relatively low.
In the Southern Region, as the amount of milk that is destined for the local fresh milk products is proportionately smaller as some 85% of raw milk produced is ‘trade exposed’. Hence, international commodity prices and exchange rate movements continue to influence returns to processors and the value of raw milk – regardless of whether product is sold at home or in overseas markets.
This results in Southern Region farmgate milk prices being more closely correlated with the bundled returns from key commodities, cheese, SMP, WMP and butter as indicated in this chart.
Due to their small domestic market and reliance on commodities, the New Zealand farmgate milk price is more closely correlated to the dairy commodity basket. However, Australian processors have been increasingly strategic in light of a dwindling national milk pool, pursuing higher value ingredient and finished product opportunities in domestic and export markets to generate higher more stable returns. This offers a premium above commodity returns that can be paid in farm gate milk price, increasingly important in a highly competitive milk supply market.
Based on average industry product mix and conversion costs the value of commodities can be converted into a milk price equivalent. This is termed the commodity value of milk (CMV). Based on the past five years, the CMV typically accounts for around 85-90% of the Southern Region farmgate milk price.
In the Northern/WA Region FMP is less volatile due to a market that is opposed to Southern Region – high reliance on domestic demand for fresh milk products and reduced direct exposure to dairy commodities. Hence Northern/WA Region FMP has a low correlation to the volatility of dairy commodities.