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2008 - 2013
March 2008

Neil Blackburn and Edward Lott Kite Consulting

professional about your business

This report updates the ‘Kite Milk Projections’ report, prepared in November 2006. The past 18 months have seen some of the most volatile times ever for dairy products. World stocks effectively ran out last summer and this led to commodity prices doubling over a nine month period. Although world prices eased over the winter, they are still running at significantly higher than last year. The impact on the UK milk price has been unprecedented with a 40 to 50 per cent increase seen by most farmers, equating to between seven and nine pence per litre. Although world commodity prices have fallen since the autumn, this has not translated into falling milk prices in the UK, for reasons explained later in the report. Milk production, however, is still falling, with the UK predicted to produce 13.19 billion litres in the 2007-08 quota year, some 300 million litres less than 2006-07. Although adverse weather has played a part in this fall, other factors are still contributing to dairy farmers’ decision to quit the industry, even though milk prices have increased significantly over the past 12 months. These ‘other factors’ are explored further in this report, as they are important to understand when looking at future production trends. The aim of this report is therefore to project forward milk production over the next five years, and to assess the effect of seasonal milk production on processor requirements on an annual basis.

“Even though milk prices have risen by between seven and nine pence per litre, milk output has still fallen some 300 million litres in the last 12 months”

Kite Consulting is a modern consultancy company focused on delivering excellence to its customers in the farming and allied industries. Recognised as specialists in the dairy sector, we operate a team approach based on proven experience with some of the industry’s leading consultants. If you have any queries about the content of this document then please contact: Neil Blackburn Tel/ Fax Mobile E-Mail Edward Lott Tel/ Fax Mobile E-Mail 01793 875058 07815 284850 01824 780464 07980 917555

In our 2006 report we accurately predicted many of the supply and demand issues that arose in 2007, although the speed of the rising world commodity prices brought forward the time when the issues started to occur. To summarise that report we: • Compared UK milk production to a supertanker, as it would be difficult to turn around quickly; Even though milk prices have risen by between seven and nine pence per litre, milk output has still fallen by around 300 million litres in the last 12 months, something that can only partially be blamed on the weather. Farmer scepticism; a lack of heifers; profitable arable alternatives and higher costs have all played a part in holding down milk output - proving that it is going to take a lot more time for farmers to have the confidence to invest in new facilities to increase output. • Forecast continued rising world demand for dairy produce would strengthen commodity prices and in turn lead to an improvement in the milk price; • Put forward the hypothesis that the UK would have an increasing shortage of milk in the autumn trough months; • • Predicted that falling milk output would lead to increased price volatility; Believed that the major retailers would want to form closer working relationships with their suppliers; Tesco, for example, subsequently ring fenced Wiseman and Arla suppliers, and in addition formed a new link with DFB for localchoice milk. Sainsbury’s now has a dedicated supply of milk from Arla and Wiseman. • Felt that the main dairies would want to reduce their reliance on the Co-ops and brokers for milk and would take on more direct suppliers; Since then Wiseman, Dairy Crest and Arla have been on major recruitment campaigns. • Believed that there was increasing demand for UK and regional dairy products, which was an opportunity for the whole chain. Apart from the growth in demand for regional UK cheeses, there are now regional and local liquid milk options being developed.

The sharp rise in world commodity prices in 2007 was essentially a reaction to world stocks of dairy produce running out. Over the previous four years stocks had been eroded by demand outstripping supply but previously this had had little effect on prices as there was still an effective surplus in store. The balance of world supply and demand over the past seven years is summarised in the table below: Change in world dairy stocks Billion Litres 2001/02 2003 2004/05/06 NET CHANGE 2007 +4.1 0 -6.4 -2.3 0

Source: Torsten Hemme, International Farm Comparison Network What is clear is that changes in world stock levels are a key factor in the prediction of milk price and that this needs to be more closely monitored going forward. To ensure that we can keep our clients better informed of the dynamics of the world market, Kite has now formed a link with Torsten Hemme and his economists at the International Farm Comparison Network (IFCN). There are many factors affecting the balance of trade and the key ones are listed below: • • • • • World demand trends – in particular in the emerging eastern markets World supply trends – in particular from China; India; Oceania; US; South America and EU (if quota continues to be increased) Political factors – e.g. recently in India, Argentina, US, China and Russia Weather factors – e.g. recently in Australia, New Zealand, US, Europe Land alternatives – e.g. arable cropping & biofuels

All of these will ultimately impact on world commodity prices, which in turn impacts on the UK. However, as UK output is falling, the proportion of milk that is made into commodities in the UK falls and hence the impact is lessened. In addition to all these factors, currency exchange rate fluctuations impact upon UK prices. The recent strengthening of the Euro is making imports more expensive (e.g. cheese from Ireland) but is partially balanced by the weakness of the Dollar, which makes the US more competitive (e.g. SMP prices).

UK DAIRYING TRENDS: 2005 - 2007
UK milk industry figures and production statistics for the years 2005 – 2007 are provided in Appendix One. In summary, the key findings are: • The UK is predicted to produce 13.19 billion litres in 2007-08 – a record 821 million litres under quota; • • Production will have fallen by 300 million litres in 12 months; UK producer numbers stood at 17,846 in June 2007 – a fall of 6.13 per cent compared to the previous year; • • Cow numbers fell by 1.3 per cent in 2006-07; Milk yield per cow has remained relatively static over the past two years and is predicted to have fallen by 0.25 per cent over the past 12 months

In our 2006 report we arrived at various assumptions for the structural change to the UK dairy industry over the period 2007 - 2012. Due to the changing economic environment, we have updated our key predictions to the following, assuming the current market conditions prevail: 2006 assumptions Change/yr. Reduction in herd numbers Reduction in cow numbers Increase in milk yield per cow The reasons for these changes are as follows: • The recent increases in milk price will slow down the number of dairy farmers getting out of milk and reduce the fall in cow numbers; • This will be partially balanced by higher stock prices encouraging an increasing number to cash in ‘on a high’. Furthermore, the increasing profitability of arable farming is encouraging more dairy farmers to sell their cows and plough up grassland; • The annual increase in milk yield per cow is forecast to slow down due to (a) a lower milk to feed price ratio. This leads to (b) an increased switch to spring production, which is generally operated at a lower yield level. - 7.0% - 2.7% + 1.5% 2008 assumptions Change/yr. - 5.0% - 1.5% + 1.0%

“World stock levels are a key factor in the prediction of milk price and this needs to be more closely monitored going forward”

Based on the above assumptions, the following projections can be made: 2008-09 Herd numbers Cow numbers Herd size Production (Billion Litres) Production per farm (Litres) Yield (Litres/cow) Key points: • • • 19% drop in herd numbers to just under 13,000 dairy units by 2012-13; Milk production per holding increasing to just under one million litres; Total UK milk production falling below 13 billion litres by 2010-11. 6,957 7,026 7,096 7,167 7,239 823,367 862,239 902,945 945,574 990,215 15,936 2009-10 15,140 2010-11 14,383 2011-12 13,664 1,802,584 132 12.92 2012-13 12,980 1,775,545 137 12.85

1,886,196 1,857,903 1,830,035 118 13.12 123 13.05 127 12.99

“Critically, as arable cropping is now more profitable, there is a viable alternative for many that did not exist before.”

The level of milk production in the UK is affected by many factors and the industry needs to be aware of how finely balanced it is at farm level. The key factors that drive whether a farmer stays in milk or not, or, if they do stay in milk, whether they expand or not, are: • • • • • • • Milk price; Cost of production;


i.e. separate elements of profitability

Confidence in future milk prices; Milk price : feed price ratio – which affects sentiment; Non-dairying alternatives – e.g. arable cropping; Higher stock prices creating an opportunity to cash in ‘on a high’; Catalysts for change – e.g. a falling milk price, new NVZ rule changes, bluetongue outbreaks, sons/daughters not wanting to return home to farm.

Indeed, although we are now predicting a slowing down in the reduction of milk output in the UK due to more favourable economic climate, a change to one or more of the above factors could easily change this position. Just one example of this is a recent NFU survey in the North West. This showed that between 55 and 70 per cent of farmers did not have the infrastructure to cope with the proposed new NVZ rules. The NFU estimate that the average spend on new facilities to meet the new standards would be £50,000 and their view was that ‘many farmers won’t spend the money’ leading to an exodus from the industry. It is also clear that a fall in milk price would cause a new wave of farmers to lose confidence in the industry and give up milking. Critically, as arable cropping is now more profitable, there is a viable alternative for many that did not exist before.

Core milk requirement
One of the key messages from our 2006 report was that the UK has a core requirement for domestically produced milk to fulfil demand for fresh liquid milk, territorial cheeses and branded products. Furthermore, additional milk is required for balancing on a daily, weekly and seasonal basis. At the time, we estimated that the UK had a core milk requirement of 12.6 billion litres and, due to the seasonal milk production effect, we predicted that we would be short of milk by 2012. Our revised core milk requirement for the UK has now been increased to 12.95 billion litres, due to the following factors: • World dairy commodity prices are now forecast to be firm for the next 3 – 5 years; • The world shortage of dairy products in 2007 has caused a greater interest across the chain in maintaining a secure UK supply of milk; • There is greater consumer demand for regional and UK food, supported by the multiples; • There is greater demand for value added dairy products from the UK – for example, mature cheddar now accounts for 70% of household cheddar market; • There is more interest in food miles and the opportunities to reduce dairy’s carbon footprint by sourcing from the UK; • Exchange rate change effect - both positive on UK via Euro and, to a lesser extent, negative via Dollar. Not only will the above factors result in a greater core requirement for UK milk, but will help underpin the retail liquid milk price and value-added milk price for the foreseeable future. Milk prices for true commodities could be more volatile. Taking into account the seasonal supply of milk in the UK, there is predicted to be a shortage of milk each autumn period, as highlighted by the graph: The potential autumn shortage of milk will be partially balanced by dairies making additional mature cheddar, SMP and butter in the spring and selling surplus milk in the autumn. Although this helps to balance the milk in the short term, it creates inefficient dairies and inefficient transport systems. Furthermore, it creates even more price volatility and leaves the UK seasonally exposed to the vagaries of world markets.

UK Milk Production vs Demand - 2008/09


Millions of litres / day




Supply Demand
















Over the last 10 years there has been a greater awareness of meeting the demands of the UK dairy market. As the demand is primarily for fresh product there needs to be a year round supply. This has seen a large proportion of the industry actively try to meet this demand and level out their production of milk. This system of production requires constant attention to even out the effects of the seasons rather than manage with them.

“The difference in farm costs between spring calving and level production is more than four pence per litre”

At Kite we have many customers who have embraced the level supply system which has suited the premium liquid milk contracts. However, we are increasingly aware that the cost changes seen in the industry over the last 18 months could have the effect of changing farmers sentiments on the system. We decided to set up a farm model to look at different dairy systems and examine the cost differences and decide whether this could effect farmers decisions.

The farm models
• • 2 farm systems – level production and spring calving (NZ style) Fixed output of 2 million litres for both systems Spring calving 400 cows 625 acres (435ac rented @ £100/ac) 5,000 litres per cow 0.15kg/l @ £200/t + youngstock 200ac grass silage £110,000 of labour/family 7% on £515,000 capital (cows etc) Level production 240 cows 380 acres (190ac rented @ £100/ac) 8,300 litres per cow 0.36kg/l @ £200/t + youngstock 150ac grass silage – 142ac maize £110,000 of labour/family 7% on £350,000 capital (less cows etc) Level supply £/farm 157,000 30,000 281,168 Level Supply £/farm 66,000 45,000 24,500 135,500 ppl 3.30 2.25 1.22 6.77 ppl 7.85 1.5 9.35


Milk Profiles

Spring calving £/farm Feed
Flat Spring


ppl 3.85 1.4 5.25

Litres / month


77,000 Similar 28,000 Similar 105,000


Vet and AI Dairy sundries/ straw Forage costs Differential

















Spring Calving £/farm Labour Power & Mach. Property Costs Sundries Interest Differential Similar 37,500 62,000 Similar 36,000 135,500 1.80 6.77 1.80 3.10 ppl

The overall differences in farm costs are at the variable cost stage and the difference in cost between the two systems is + 4 ppl.

The ‘drift’ effect
The difference in costs of 4ppl is mostly due to feed costs and the level producer is acutely exposed to the sensitivity of feed prices – in our model the level producer needs 720 tonnes of feed and the spring calver needs 300t of feed. But farmer sentiment will drive production as much as the facts and figures. If farmers feel that maintaining production in the summer-autumn is not rewarded well enough, then they may make (irrational?) decisions to cut back this production by reducing summer feed or stop calving in the summer. Any measures to ‘drift’ away from summer calving will all tend to increase the autumn trough in production.

Milk price : feed price ratio
This is a measure used extensively in the US to predict farmer sentiment, not profitability. Put simply, it indicates how much feed (in kg. of concentrates) a farmer can buy by selling one kg of milk. The higher the ratio, the more economical it is to use concentrates. (Source: IFCN) The US often sees ratios of 2.5+. In Europe, the ratio has typically been between 1.5 - 2.0. The milk price : feed price ratio’s in the UK look like this: • The ratio reached a peak in the autumn of 2007 at 1.5 but is likely to fall to 1.1 (>25% reduction) by April 2008 unless milk prices increase further. Many feed costs are already more than £200 per tonne. The underlying aspect to this is that margin per litre over feed cost has still improved but the margin for error or waste has been drastically reduced. The effect of this is that for many farmers the sentiment will be to cut concentrate feeding from this spring.

Most milk processors have a seasonality regime within their milk contract to either promote level supply or to avoid a massive peak in production in the spring. However, since the increase in milk prices from approx 18ppl to 25ppl+, the effective importance of those schemes has deteriorated. The table below shows five of the largest milk buyers in the UK and the bonus and deductions for being a level or spring supplier. Level (ppl) A B C D E 0.80 0.27 0.33 0.00 0.00 Spring (ppl) -0.94 -1.51 -1.27 -1.14 -0.35 Level / Spring differential 1.74 ppl 1.78 ppl 1.60 ppl 1.14 ppl 0.35 ppl

The biggest differential available is 1.78ppl against the difference in costs of 4ppl. Increasing the + or – in the spring and autumn does not have the dramatic affect on the differential paid that might be thought. For example, processor A currently has a -2.5ppl in the spring and +2ppl in the autumn. If these extremes were doubled the differential only rises to 2.2ppl.

Our farm systems budgets show that the difference between the cost of spring and level production is +4ppl. While we do not think this will lead to a wholesale shift in production systems it could lead to a drift away from summer calving or the maintenance of summer production through feeding. Rising feed costs and the lack of incentives for level production from milk buyers could worsen this drift, in turn increasing the autumn production trough. Discussion points: • What effect will farmer sentiment over feed prices vs milk prices have on production cycles? • • What happens to UK output if milk price : feed price ratios continue to fall? The incentives for level production have fallen in significance over the last 12 months how will they be re-introduced?

UK milk prices for retail liquid milk and value added products are set to remain firm for the foreseeable future and this will slow down the fall in milk output. However, this is balanced by a greater core demand for UK milk leading to a continuation of seasonal shortages of milk and longer term imbalances. The position is finely balanced, as confidence on farms is fragile and we only need to see one or more negative factors occurring for the previous exodus trends to be continued. This will lead to a greater shortage of milk – something that will now be exacerbated by the greater core demand for UK milk. Discussion points: • A better understanding of the world supply and demand balances is required to better predict commodity prices; • For some producers, high stock prices and viable arable and biofuel alternatives should be seen as an opportunity to get out of milk ‘on a high’; • For dairy farmers on contracts that are linked to the cost of production there is the opportunity to expand with a greater degree of confidence; • • Potential for futures markets to be developed to smooth out prices; Seasonality payments that more accurately reflect the cost of producing a level supply of milk need to be developed further; • There is an opportunity to add value to more dairy products – e.g. more branded and health food products; • Increasing interest in reducing food miles and in the carbon footprint of food provides a major opportunity to promote British dairy products and reduce imports.

Milk Production (All figures in million litres) Note: Actual figures for 2005-07 are used and Kite estimated figures for 2008. Year 2004-05 2005-06 2006-07 2007-08 Source - RPA Producer Numbers Year 2005 2006 2007 England & Wales 14,732 13,778 12,798 1,523 1,472 1,429 Scotland Northern Ireland 4,058 3,761 3,619 20,313 19,011 17,846 Total UK quota 14,002.5 14,001.5 14,070.5 14,201.0 Annual deliveries 13,765.7 13,604.0 13,492.4 13,189.5 Annual Bf adj. deliveries 13,853.3 13,735.4 13,661.0 13,379.4 Under/Over quota -149.0 -266.0 -409.5 -821.6

Sources – June census figures from DHI, SEERAD, DARD Cow Numbers Year 2005 2006 2007 Cow numbers 1,998,000 1,979,000 1,954,000 Herd size Year 2005 2006 2007 Cow numbers 98 104 109

Source – Cattle Tracing System Milk Yield Year 2005 2006 2007 Litres/ cow 6,890 6,874 6,905

Source - DHI, SEERAD, DARD Output per Holding Year 2005 2006 2007 DARD Litres/ year 682,002 723,444 765,494

“...confidence on farms is fragile and we only need to see one or more negative factors occurring for the previous exodus trends to be continued.”

Source – DEFRA


Kite Consulting Rodbaston College, Penkridge, Stafford, ST19 5PH Tel: 01785 713166 Fax: 01785 713266