Weak dairy prices prompt analysts to pull back Fonterra forecast payout for next season

Weak global dairy prices have prompted analysts to pull back their expectations for Fonterra Cooperative Group's payout to farmers for next season.

Average prices dropped 3.5 percent in the GlobalDairyTrade auction overnight. New Zealand's key product, whole milk powder, slipped an average 1.8 percent, extending its cumulative decline over the past five auctions to 27 percent.

Auckland-based Fonterra, the world's largest dairy exporter, last week cut its forecast payout for the current 2014/15 season to $4.50 per kilogram of milk solids, from a previous forecast of $4.70/kgMS and last year's record $8.40/kgMS, citing an oversupply in international markets and volatile commodity prices.

Fonterra is expected to pay farmers between $5.50/kgMS and $5.75/kgMS for the upcoming 2015/16 season, according to a BusinessDesk survey of five analysts, two of whom reduced their forecasts following last night's GDT auction. The forecasts have come back from a month ago when Fonterra was expected to pay between $5.75/kgMS and $6.20/kgMS for the upcoming season. The cooperative is expected to publish its forecast for next season following its May 27 board meeting.

Global dairy prices have slumped amid higher production and weaker demand. Fears that drought conditions in New Zealand could crimp milk supply proved unfounded, with Fonterra now expecting production this season to lift 1.5 percent from last season, from a previous forecast that it could fall 3.3 percent. Meanwhile, demand is weak, particularly in China, the world's biggest importer of dairy products, with New Zealand whole milk powder exports to China in March less than half what they were a year ago.

The challenge for dairy prices at present is supply has proved to be relatively strong while demand has proved slow to recover," ASB Bank rural economist Nathan Penny said in a note. "Dairy prices are low and staying there a while longer. We expect prices to remain low over the next two to three months, before finally beginning their lift."

ASB's Penny cut his forecast for next season to $5.70/kgMS from a previous expectation of $6.20/kgMS.

In the latest GDT auction, longer-dated milk powder contracts flattened relative to shorter-dated deliveries, suggesting the dairy price recovery will remain gradual, he said.

Attempts to stimulate the Chinese economy will bear fruit, but it will take time, Penny said.

Meanwhile, lower prices should discourage farmers from increasing production, particularly for those who won't break even at the current $4.50/kgMS price, he said.

"We continue to expect dairy prices to recover from the current low levels," Penny said. "But increasingly, we expect that recovery to come later, with prices remaining muted over the next couple of months. With recovery expected to now be that much later in 2015/16, the season's overall outlook is now lower."

Dairy products are New Zealand's largest commodity export group and the dairy sector generates more than 7 percent of the country's gross domestic product.