A big international banker claims growing world consumption of dairy products at the same time as growth in supply slows is expected to underpin sustained higher, though volatile, prices.

Agribusiness lender Rabobank said that despite short-term challenges facing the sector -- including slumping prices for dairy commodities -- the medium to longterm outlook is robust.

"In this new era, global demand for milk at any price point has shifted upwards," the bank said in its report, Global Dairy Industry -- Reshaping in a New Market Era.

World demand for dairy is expected to start recovering in late 2009 and New Zealand will be in a good position to provide additional world supply.

"New Zealand is expected to generate a substantial increase in supply as its 2008-2009 season builds," said report co-author, Rabobank senior analyst Hayley Moynihan,

"After a slow start, supply is expected to bounce back from the recent drought as farmers respond to higher milk prices and with approximately 300 new dairy farms commencing operation after widespread conversion of sheep farming land."

Further strong growth is expected for 2009/2010 as additional conversions come on line and conversions from recent years build to average productivity levels.

But beyond this growth spurt, NZ supply growth is expected to again be constrained by land availability, Ms Moynihan said.

Income growth in many parts of the world, and favourable demographic and cultural trends had boosted the number of people who are aware of dairy, have access to dairy, want to consume it and can afford to do so.

Rabobank said the medium-term "equilibrium price" has made a step-change upwards from its longterm average.

"Economic growth and cultural changes have substantially increased the price the market will pay for milk," it said.

Increased world demand and constraints on longterm global supply growth will help prices recover and keep future trading in a higher price band -- a prediction Ms Moynihan said was good news for New Zealand exporters.

"For additional export supply, the market will eventually need to turn to regions with higher costs of primary production, less efficient supply chains or greater structural impediments -- such as Latin America and the US," she said. "Extreme volatility in the dairy market is likely to remain."

Global dairy stock levels are low and, in the medium-term, there are likely to be more frequent shocks in the demand and supply aspects of the markets. "Players all along the supply chain will need to re-evaluate their strategies," the report said.

Even with higher dairy commodity prices, farmers in most regions will not necessarily see margin improvements due to the increased cost of production, while those in export regions must be prepared to manage volatility on all sides of their business.

Export dairy processors will need to develop competencies to suit changed conditions, such as huge increases in export volumes.

And traders face the prospect of limited volume growth from the EU, and need to be ready as other regions develop milk surpluses.

Dairy ingredient users need to reconsider how they secure supplies and manage price volatility, balancing the costs of reformulation and recipe flexibility with savings from substitution.

And all players will need to consider the implication of increased credit risk and capital shortages.