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Drought-induced shortage of pasture leading farmers to use palm kernel as feed -Photo by Andrew Smith

Dire Dairy Desperados

Drought-induced shortage of pasture leading farmers to use palm kernel as feed -Photo by Andrew Smith

Drought-induced shortage of pasture leading farmers to use palm kernel as feed – Photo by Andrew Smith

Resorting to stuffing their cows with palm kernel in response to the drought-induced shortage of pasture, is just the latest instance of a New Zealand dairy industry that continues to take more and more risk in order to keep the meagre money train rolling.

When cows eat palm kernel, and other grain foods for that matter, it changes the fat content of the milk. The Omega 3 you find in milk from grass fed cows disappears, and in its place appears the less healthy palmitic fatty acid and even trans fats. We know artificial trans fats are bad – real bad – the stuff that boosts our risk of heart attacks. This is why cheap margarine is such a curse and more a less the choice nowadays only of the budgetary challenged – few in their right mind with free choice would feed that crap to their families. We don’t yet know if the trans fats from cows are as bad as the margarine version, but in many European countries all trans fats are banned.

I’ve written a bit on this lately – our dairy industry, which is really important, has become so unhinged from sustainable economic reality that its decisions are increasingly being driven by short term opportunism that is putting the future of the industry, and the country for that matter at risk. The pressure that has driven us to such extremes is best summarised as the price of land, which has become totally unrelated to the financial earnings of farmers. With a pitiful rate of income return on such an expensive asset being the norm, there has never much of a cash cushion for farmers to weather stormy economic climes. As we all know the raison d’être for dairy farming certainly isn’t income, for decades now it’s been the appreciation in land values. Can this just continue forever?

The answer to that is no, it can only continue so long as expectations of greater income some time down the track are fulfilled. Otherwise, as we’ve seen in plenty of other instances the speculative fervour, once shown to be unjustified, leads to a crashing of the asset prices. Housing markets around the world are a great recent example.

Back to dairying. With growth in the world’s appetite for protein we know demand conditions for the product are favourable. But so are they for meat and from that example we know how it doesn’t necessarily follow that the value of meat-producing assets are guaranteed to appreciate. But of course so far for dairying they have, and understandably the longer that has gone on the more the conventional view is that it will continue. Farmers gear up and buy more land, invest more in intensifying their farming, including feeding not just pasture, but grain to livestock.

The New Zealand dairy industry remains a volume game, kgs of milksolids are the holy grail of dairying success. Anything the farmer can do with his payout cheque or Fonterra dividend to raise production he will – some beyond the point of rationality – pursuing the nirvana of greatest kgs of milksolids per cow and per hectare. The rationale is simple – other farmers price the value of the asset on the basis of kgs of production, virtually irrespective of the costs of production. So long as that is the buyers’ rationale the industry will continue to grossly over-invest on-farm. And it will until farm prices reflect profitability not revenue.

But the risks are rising – the 2008 episode with melamine and the 2013 DCD scare are examples of the types of risk that food safety concerns can deliver, trans fats are another. For New Zealand, the more dependent we are on milk volumes the more vulnerable we become to risks around the quality (eg: from contaminants) and the quantity (eg: from drought or an outbreak of cow disease similar to what PSA has done to kiwifruit) of that volume. It’s a simple problem of having too many eggs in one basket. If you combine this with the wafer thin buffer of income farmers get from investing in such an expensive asset (land) then it doesn’t take much of a stress test on the industry to catapult it into a major shock.

Now any business has risk, it’s part of the game. But what we’re discussing here is the extent of the risk and whether in the case of New Zealand dairying the risks are steady to declining or growing. As a firm matures the norm is that risk declines – mainly achieved from diversification of income streams. Therein is the test our dairy industry is failing. There is little diversification of income sources, it remains predominantly from the volume of milksolids. And we know the rate of return on asset values is woefully inadequate already, meaning the cushion for shocks is getting less not greater.

What to do? The industry faces a challenge – it’s faced it for over 30 years and has only played around the periphery in trying to address it. Instead of all the dividends being re-invested pretty much on-farm in pursuit of volume, it needs more to be coming from those areas of the supply chain that provide markedly higher margins. They include delivery of consumer products in international markets, transfers of on-farm technology and IP to other countries. Now there is a little of this occurring but it is pitiful in relation to the industry’s main act – it simply is not effective diversification.

Until that does occur we continue to raise our bets on the one nag – kgs of milksolids coming off NZ farms. And we know that is way past the profit-maximising point, and without relying on further appreciation of land prices dairying is high risk, low return. The relevant question is not how long this can continue – because that is unknown. It is how many of the investors in the sector accept the argument and are moving to protect their personal investment stake? And on that front you’d have to say, bugger all.

  • http://www.facebook.com/trinnynz Trinny Tokerau

    can you please provide link to your PK references and Trans fats in milk.

    • http://garethsworld.com/ Gareth Morgan
      • Roy

        As an economist Gareth and your skill in communicating bad business activities you might be more influential if you analysed and reported what if any marginal benefit arises from the importation of 1.4m tonnes of PKE. Does imported PKE produce any additional export $ income for the NZ economy?

      • http://twitter.com/YMBFA jb

        “Here IS a couple of links”?! Bloody hell…..

  • http://www.facebook.com/people/John-Jackson/100001376701586 John Jackson

    Absolutely right but the other problem with this is that the current governenment sees the dairy industry as growth Nirvana hence the sale of assets to invest in a direct subsidy to farmers in the form of irrigation schemes. That the government takes an industry with a 2% return as the debt salvation of NZ is naive and that it allows the industry to debase it’s product with the likes of palm kernal and grain is gross stupidity. Reliance on commodities has been shown time and time again to lead to disaster Solid Energy being but one example.

    • John Morrison

      I do not see “rain harvesting” as a subsidy to farming! But rather an investment in NZs future. A no brainer; people will whinge whine, run back and forth wringing their hands about NZ running out of water. I say bollocks, the water is running out of NZ, and we should’ve been rain harvesting 70 years ago.

  • Julian Fitter

    The other basic problem with the industry is that much of NZ is not natural dairy farming country. This is not Western Europe and while we have high rainfall the pattern is very different. We are more South of France or North Africa, not areas you would normally reckon as ideal spots to start a dairly farm. We need to be smart in our land use and use it appropriately, and sustainably.

    The drought is surely a timely reminder of the limitations of dairy farming in much of NZ, but will we learn the lesson? I certainly would not put any money on it.

    The crying shame is that while we focus on old unsustainable agribusiness, we are not encouraging new industries and employment with the result that many of our brightest and best, who unsurprisngly do not want to be dairy farmers, take their skills elsewhere.

  • Bruce

    “Short term opportunism…” it’s the Kiwi way. Small country equals small mind. We seem hardly anything for the long term. It has long been my observation that Kiwis think the best dollar earned is the one they earn now. They seem always prepared to alienate the future possibilities in a market to make that dollar. I’ve noticed that at small town business level even. It’s just our way or haven’t you noticed?

  • Bruce Cunningham

    Well bugger me Gareth, where have you been since the GFC. Could you show me a dairy farm that has sold above the pre GFC price, granted they were to high then. All I can say, I’m pleased ours didn’t sell pre GFC our return has been equally as good as our investment in GMI.

  • disqus_DpWQnAraqo

    Gareth why don’t you go out and talk to some farmers, they will tell you the biggest stumbling block would actually be compliance and red tape. Its literally strangling all manner of industries in NZ. Thats the biggest problem. The other big one is the high dollar.

  • Countryhicks

    So as a nation we just stop dairying do we? Talk about throw the baby out with the bathwater. How many NZers buy woollen carpets, woollen clothes? Buy NZ Lamb, Beef or Venison? Support tourism activities on high country farms? Its not as easy as just changing land use as there has to be a market for the product. For over 10 years my husband and I have slogged our guts out sheep and beef farming in NZ. Quite honestly if it weren’t for the family assistance we receive for 3 children we would be further up shit creek without a paddle. And yes I don’t agree with family assistance and believe that taxing people correctly the first time is the way to go but the tax system is what it is. We are both University Educated and both remained in NZ working paying off our respective student loans. We employ two full time workers through our farm and contracting business. We haven’t had a holiday in over 6 years and for all the work we do we would be well under the minimum wage. Yes we would have been better off to jump the ditch to Aussie and earn the $$$$ but we are kiwis and we have stayed. So while you townies sip on your lattes and work your 40 hour weeks spare a thought for all the hardworking farmers yes dairy farmers as well that work for bugger all and have stopped this country going futher down the gurgler than what it has. How about supporting NZ farmers i.e. replace your synthetic shit in your lounges with sustainable NZ wool carpet. Buy some proper clothes that aren’t made from synthetics, buy some NZ meat not imported Aussie meat. Then we might see a land change use in NZ. And for goodness sake NZ lets support one another in what has been a very trying year for all farmers. And last but least instead of flying off to the islands for a holiday why not check out some of the wonderful tourist activities thats exist on many of the hig country farms such as http://www.organicexplorer.co.nz/shop/New+Directory/Browse+By+Region/Canterbury/Hurunui+High+Country+Track.html

    http://www.tuataratours.co.nz/
    it will keep you fit in the process!

    • http://www.facebook.com/rcarterbrown Ross Carter-Brown

      I agree with most of what you said. However farming is a lifestyle choice (not just a job) that you made, no one forced you to go farming… I suspect you prefer it to doing 40 hours a week in an office, if you didn’t you would probably be working in that office right now.

    • Paul

      the family assistance you speak of has resulted in a sizable proportion of middle class Kiwis paying no tax at all. …the tax take burden is now taken up mainly by the wealthy and the poor in NZ. No wonder the Govt has to borrow 100mill plus a week. You guys are the back-bone of the country for many reasons and long may it continue…and thank you for that….but don’t think you work harder than anyone else. I work a 65 hour week…holiday what’s that?…..and get no assistance of any kind, no flexibility from the IRD ,no ministers advocating on my behalf…so hearing someone say “townies sip on your lattes and work your 40 hour weeks”…kind of rattles the cage a bit.
      …..some dairy practices are shonky to say the least and if you want to keep your industry going in the future take note…it’s the ‘townies’ that buy your product and the townies who are aware of what they’re eating..

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  • http://twitter.com/farbro farbro

    As a Dairy Farmer (owner operator) with 31 years experience. I’m totally disillusioned with my fellow farmers behaviour and attitude to a) the concept of profitable business b) their treatment of “our” environment. The amazing coup in 21st century dairy farming is the shift of agricultural profits from farmers to agribusiness. They seem so proud of how much urea, PKE, maize silage etc they can get though regardless if they make a profit from it from or not!. And please don’t get me started on the industries attitude (non attitude) to climate change!

  • http://www.facebook.com/maryjane.j.walker Maryjane Jennie Walker

    Wait when they Irish relaunch their dairy products as organic, small farms of 250 cows., whereas we have a railtrail, cannot drink the water out of the streams thanks to dairying, and personally I will not do it. Southland dairy farms of 2000 cows, its all wrong oh dear..

  • Guest

    It’d be a much better article with the anti-farmer hyperbole was left out.

    • John Morrison

      I do not see it as anti- farming. One problem in farming is that farmers see themselves as special. We are not special, we are just ordinary NZ business men and women and I wish the damned Gov. would treat us as such!

  • Ross

    It’d be a much better article without the anti-farmer hyperbole. Certainly there are issues around farming, but that is true of virtually every industry.