Supply, demand and the dairy industry

Supply and demand are key forces in economics and the dairy industry is beset by excessive supply and flagging demand, leading to a situation in which prices for many farmers have fallen below the cost of production, although there are signs of a revival in prices.

The supply crisis was started by the end of milk quotas in 2015 and the Russian embargo on European dairy products. However, there has been a seven per cent fall in UK milk production and both global prices and those paid by milk processors are edging upwards.

On the demand side, the EU has brought in a milk reduction scheme which pays 12p for every litre not produced compared with output in the same period the year before, up to a maximum of 50 per cent.

The problem with schemes of this sort is 'additionality': do they change behaviour, or are they simply taken up by farmers who intended to reduce output anyaway? For example, it may be attractive if bTB has taken cows or calving has slipped. In any event, the effect on the total volume of production will be marginal and short-term.

On the demand side, younger people are drinking less milk. Celebrities advocating a vegan diet and concerns about the contribution of cattle to climate change are helping to persuade teenagers to switch to soya milk and other plant-based alternatives, according to Dairy UK. There is also concern about the fat content of milk, although it has other nutritional benefits.

According to research by Kantar Worldpanel, those over 65 consume milk 875 times a year compared with only 275 times for 5 to 24 year olds. Other research shows that 19 per cent of 16 to 34 year olds do not consume milk at all.

Dairy farmers under pressure

The recent cuts in farm gate prices for milk have placed dairy farmers under real pressure and there is no doubt that many of them are not covering the cost of production. Blockades and evident consumer sympathy have stirred many supermarkets to increase the price they pay for liquid milk.

However, that is only part of the story. Half of all milk produced goes for manufacturing and that has always attracted a lower price (although the old Milk Marketing Board had a complicated system that varied the price according to the end use of the milk so more was paid if it was used for chocolate crumb than cheddar cheese).

Manufacturing prices are driven by global markets which are in turn affected by low cost mega dairies in California and elsewhere. There is hope that prices may firm up after the seasonal production peak in Europe. Prices in June were firmer for some products, particularly butter and cream, but average dairy commodity prices fell back by 5.9 per cent at Fonterra's latest Global Dairy Trade auction earlier this month, largely as a resut of increased supply. Prices may well remain stagnant until September.

Factors to take into account include whether product stocks will be sold before the next flush of milk begins in the southern hemisphere where countries including New Zealand, Argentina and Uruguay are efficient producers. The emerging economy growth rate is also an important consideration as it drives greater consumption of dairy products. The recession in Europe also has an impact and British deliveries in the two weeks to the end of June were down 2.1 per cent on the same period last year.

It is also worth bearing in mind that farmers are encountering these financial difficulties despite substantial EU subsidies.