Annex Two: Prospects Sector-by-Sector

Red Meat and Wool

The future for red meat appears positive, though there are several risks that will need to be taken account of going forward.

In terms of international market conditions, the first thing to note is the growing world demand for meat products as developing countries’ incomes rise and tastes change. This trend is expected to continue into the foreseeable future. Strong lamb prices are expected to continue as world demand for lamb increases and production (including in New Zealand) is expected to decrease. Generally weaker beef prices are expected as production increases to match demand, but the enduring effects of recent outbreaks of BSE in the United States and Canada are difficult to assess.

In 2001, the world average agricultural tariff was 62%, and the average tariff for meat products ranged from 75% to 91% across different meat products (World Bank, 2004). Significant opportunities to reduce these trade barriers are offered by both the Doha round of trade liberalisation talks, and the bilateral free trade agreements that New Zealand is discussing with several countries at present. While progress in achieving reductions in trade barriers has generally been slow, the current Doha round remains the country’s top trade policy focus.

Turning to the productivity of New Zealand beef and sheepmeat production, the consistent improvements in both on-farm and processing efficiency experienced over recent decades are expected to continue as new technological advances are applied. For instance, the significant increases in lambing rates and lamb weights as a result of selective breeding and feed improvements should continue as the benefits from recent genetic enhancement techniques become more widely applicable. Economies of scale in farm units and processing facilities will continue to be explored, as will mechanisation opportunities in processing.

The shifts towards exporting higher-grade cuts of meat and chilled rather than frozen meat to meet changing international market tastes have both improved returns. As world incomes continue to rise, opportunities to continue these developments will exist.

Despite these positive trends going forward, a number of threats to the continued prosperity of beef and sheepmeat will need to be managed. Clearly, the sector will continue to be vulnerable to biosecurity risks such as foot and mouth disease. Significant government investment in biosecurity generally, and in addressing specific threats including foot and mouth disease, will allay but not dispose of these concerns.

Beef and sheepmeat will also continue to be vulnerable to short-term commodity price and exchange rate fluctuations, and the interrelationship between overseas beef and dairy market conditions. Most world consumption of beef and sheepmeat is met from a domestic source, so the export market can act as a release valve with considerable variation in prices.

Having grass-fed stock, while providing a comparative cost advantage over many of New Zealand’s overseas competitors, leads to seasonal fluctuations in production. Accordingly, meat processors need to have capacity to meet the peak production requirements, and therefore they carry excess capacity for the rest of the year. This can lead to considerable competition in the quieter periods. Competition policy considerations limit options for addressing overcapitalisation.

There are some barriers to exit from meat processing – for instance the redundancy costs of closure. Because of this, there can be incentives for firms that are not profitable to wait for other competitors to exit in order to enjoy the benefit of the dispersal of the stock that firm processes. Hence, processing may not adjust to changes in market conditions as rapidly as might be desirable from an efficiency perspective.

As is discussed above, agriculture plays an important role in New Zealand’s climate change position, but the costs of agricultural greenhouse gas emissions are largely not being passed on to the sector. How agriculture is factored into New Zealand’s response to climate change issues in future years is unclear, but if production and investment decisions are to take the international price of greenhouse gas emissions into account, agriculture will need to receive appropriate signals and incentives.

Environmental concerns are likely to play a greater role in the future, particularly relating to access to water for irrigation and effluent/chemical run-off concerns. While significant increases in fertiliser application have increased production over the last fifteen years, water quality issues may well speed the shift to more sustainable fertiliser use.

Turning to wool, New Zealand is a significant player in the international wool market, particularly in the coarse wool segment of the market. There has been a long-term decline in wool volumes and inflation-adjusted prices, due largely to the impact of synthetic fibres from the middle of the twentieth century onwards. These trends are expected to continue.

If prices are to remain static or declining, the profitability of the wool industry will lie in reducing costs and producing and processing wool more efficiently. Potential improvements in labour productivity may come through the use of more capital or through innovations in processing.

Another option for New Zealand wool producers that has proven successful for some companies already is a shift to higher-end products, either away from producing coarser wool used in carpets towards finer wool used in designer clothing, or towards alternative end-uses for strong wool, such as in healthcare products. Such moves may provide opportunities for improved margins.

As wool is a by-product of sheepmeat production (except in the case of fine wool), similar land and water use issues as outlined above apply to wool production.

Dairy Farming

Generally, the prospects for dairying look positive although this is not to say that the outlook is without risks.

World demand for dairy products is expected to steadily increase, partially in a response to the westernisation of tastes, although international supply is expected to increase also. For example, there is a concerted effort to increase Chinese production to meet domestic demand – growth in output of 6% per annum is expected as barriers affecting genetics, feeding management and processing are addressed (OECD, 2004).

It is expected that New Zealand’s dairy productivity and efficiency will continue to increase, both in terms of on-farm activities and in processing systems. This is likely to result from a variety of sources such as the research and development effort currently being expended in dairy and dairy-related activities, ongoing genetic improvements and continuing increases in herd and farm size.

There are, however, a series of risks that the dairy industry faces, and these risks will require ongoing careful management for the dairy industry to continue to contribute fully to New Zealand’s ongoing economic performance.

In particular, the dairy industry is vulnerable to biosecurity risks, and to breakdowns in world trade negotiations. There is a gradual liberalisation of barriers to trade in dairy products,[26] and the Doha round suggests this will continue, but a reversal of this trend would have significant consequences. New Zealand exports the vast majority of the milk products it produces so our reliance on ongoing access to export markets is critical.

Fonterra is the world’s largest dairy exporter. Fonterra is the dominant player in the New Zealand dairy industry, and there is a heavy reliance on Fonterra's ongoing performance.[27] This applies at all levels of its processing and marketing functions, as well as Fonterra's ongoing relationship with its shareholders.

Although large in terms of export volumes, Fonterra is by no means the world’s largest dairy company. Often, domestic producers meet much of the consumption need in foreign countries so New Zealand becomes a price-taker. This is particularly the case for commodity products, but less so when Fonterra is able to differentiate its products on a quality basis.

Issues for Fonterra exist domestically as well as internationally. An example of an issue that Fonterra faces relates to the way in which price signals to shareholders are structured. Currently, shareholders’ returns from Fonterra take the form of a payout based on production levels. This price signal provides shareholders with incentives to increase the volume of milk and milk solids supplied. Depending, however, on the relative value of commodity milk versus various value-added activities in the future, the 'bundling' implicit in the price signal has the potential to distort signals as to the relative value of various investments through the sector.

Though increasing the size of dairy farms and herds has been a very effective way of increasing efficiency, this is leading to concerns about the barrier faced by new entrants to the industry. It is becoming increasingly expensive to purchase an economic dairying unit, or for people entering the industry as sharemilkers to purchase requisite stock. The average age of dairy farmers is around 55 and has been increasing, which may lead to succession problems when an increasingly large cohort of farmers looks to retire. Thought is being given within the industry to ways of addressing barriers to entry, such as by altering the traditional 50:50 sharemilking arrangement to make it less expensive to enter, or by focusing on other factors that can make a difference to successful entry into the industry – for instance training systems and HR support. In the last few years there have been some shifts away from the family farm regime towards a more corporate form of ownership, including equity partnerships.

In addition to the climate change issues for agriculture outlined above, environmental concerns are likely to become more prominent in the future. The most obvious of these are water-related, both in terms of access to water to support farm production systems, and issues related to run-off of effluent or chemicals.[28] These concerns are often specific to particular regions, and an ongoing challenge will be to ensure the efficient allocation and use of available water, and to ensure that the effects of run-off are mitigated as effectively as possible. On the latter, efforts are already underway to develop technologies to address these issues, for instance through the development of nitrate inhibitors.