FEU Special Topic: The outlook for dairy exports

Special Topic: The outlook for dairy exports

New Zealand’s future dairy export volume and price growth will likely be slower than previously experienced and a change in the product mix is unlikely. Growth in global dairy demand will largely be met by growing supply, and existing trade barriers will limit access to some export markets.

The dairy industry is a significant contributor to the New Zealand economy…

The dairy industry has been a consistent pillar of the NZ economy over many decades, even as the economy has been transitioning towards the service sector. The success of the New Zealand dairy industry to date reflects New Zealand’s natural comparative advantage in the sector and strong export revenue growth. Dairy exports were valued at $23.7 billion in the year to March 2024, representing 24% of total export values.

Figure 1: New Zealand dairy exports (quarterly)

Source: Stats NZ, Treasury

…but dairy production is slowing…

The expansion of the New Zealand dairy herd and land conversions to dairy had previously been the driver of increasing dairy export revenue. However, production growth has slowed considerably over the last 10 years as cattle numbers have plateaued and environmental regulations have been introduced (figure 2). The size of the national dairy herd peaked in 2015 at just over 5 million cows and has been slowly declining since (figure 3). Likewise, total effective hectares peaked in 2017 and has since gradually declined. Over the same period, dairy export values have increased markedly, driven by price increases and the ability of New Zealand exporters to add value (figure 1).

Figure 2: Annual dairy production

Source: Dairy NZ, LIC

Figure 3: Dairy production constraints

Source: Dairy NZ, LIC

…and emissions-reduction measures will further constrain production growth

New Zealand’s agricultural industries make up roughly half of New Zealand’s gross greenhouse gas emissions and approximately 90% of our short-lived gas emissions, with dairy contributing to just under half of New Zealand’s agricultural emissions.

The government has confirmed it will keep agriculture out of the Emissions Trading Scheme (ETS) for now, instead focusing on technological improvements to reduce agricultural emissions. However, ongoing environmental constraints such as freshwater quality regulations and future emissions policies are likely to limit dairy production expansion in the future.

Productivity gains will provide an offset

Productivity growth in agriculture, including dairy, outperforms other parts of the New Zealand economy and will likely continue to do so in the medium term. Since 2000, milksolids per cow have increased ~1.3% per year, while milksolids per effective hectare have increased ~1.6% per year (figure 4). These productivity gains have been derived from improvements in dairy genetics, advances in farm-management practices and new technology and are all expected to drive further yield growth and support dairy production volumes as cow numbers drop.

Figure 4: Dairy productivity

Source: Dairy NZ, LIC

A change in product mix is unlikely but value can still be added

Whole milk powder is New Zealand’s leading dairy export product (figure 5). This suits the seasonality of New Zealand’s pasture-based production and our distance from export markets. New Zealand has developed a very competitive position in the global dairy market and a continued focus on adding value into powders makes strategic sense for most New Zealand dairy exporters. The co-op structure of New Zealand’s dairy industry focuses on maximising value returned to farm-gate, and the value mix at the sales end is set up to minimise risk to farmgate milk price. Furthermore, New Zealand’s dairy exports are operating in an extremely tight market where only around 7% of production is traded. Milk powders and butter tend to be the most traded dairy product classes, hence a continued focus on these products makes sense for most exporters. Fonterra’s (New Zealand’s largest dairy company) recent proposal to divest itself of all production and marketing of consumer goods, with a renewed focus on producing ingredients, is a sign that the industry is seeing long term value in milk powders and specialised ingredient powders.

Improving processing efficiency offers opportunities for increasing value-add in NZ’s existing dairy-export products. Additionally, continued investment in sustainable practices and emissions reduction may bring with it a price premium as consumers shift their preferences towards sustainable products. However, this is less likely to be the case in developing countries, where New Zealand’s exports are concentrated, as consumers are more price sensitive and the evidence base for enduring price premiums is nascent. Nonetheless, increasing sustainability is crucial for maintaining access to markets and customers, and will support the industry’s long-term prospects once agriculture is brought into the ETS.

Figure 5: New Zealand dairy export values by component (quarterly, seasonally adjusted)

Source: Stats NZ, Treasury

Global dairy demand is increasing…

Barring catastrophic climate disasters or disease outbreaks, global supply will likely keep pace with global demand growth in the coming years, limiting upward pressure on global dairy prices.

The Organisation for Economic Co-operation and Development (OECD) and the Food and Agriculture Organization of the United Nations (FAO) forecast global dairy demand to increase over the next 10 years as incomes and population rise. Dairy is a key source of protein for many diets across the world and global dairy consumption trends indicate continued growth. Growth in global dairy consumption is expected to largely be driven out of India and Pakistan, two of the largest consumers of dairy products. Both countries, however, are largely self-sufficient, reflecting consumer preferences towards fresh dairy products and large domestic dairy sectors protected by trade barriers.

…but yield growth will allow supply to keep pace

The OECD-FAO expect that improvements to dairy cow yields will sustain dairy production in many developing countries, enabling the likes of India and Pakistan to meet growing consumer demand with local production as cow numbers grow and supply chains improve, alongside improving yields.

The outlook for New Zealand’s key export competitors is steady. In the European Union (EU), cow numbers are expected to decline, with further yield growth coming from productivity gains. The EU uses a mix of grass and feed-based production which is expected to allow yields to improve faster than New Zealand’s grass-based production. In the United States (US), cow numbers are expected to be largely unchanged in coming years, but higher yield growth compared to New Zealand is expected due to the dominance of feed-based farming.

Chinese import growth is expected to weaken…

China will continue to be an important market for New Zealand’s dairy sector, but long-term growth opportunities may be limited. A declining population and improving dairy self-sufficiency are expected to reduce China’s demand for imported dairy products over the medium term, although rising incomes will provide an offset (figure 6). As a consequence, New Zealand will have to look to other export markets to maintain historic levels of dairy export volumes.

Figure 6: OECD-FAO China dairy import volume forecasts

Source: OECD-FAO

…while markets outside of China are highly protected

The global dairy trade is highly protected by tariffs and subsidies, and remains a constraint to diversifying export markets. Additionally, non-tariff measures such as regulatory requirements impose costs on New Zealand dairy exporters. New Zealand’s free trade agreement (FTA) with China opened a significant market for dairy products, paving the way for strong export growth into China. Dairy exports to most other countries are subject to tariffs of varying sizes and forms. Reducing trade barriers would allow continued growth of NZ dairy export revenue but achieving significant trade barrier reductions will be a challenging task.

The Indian market remains highly restricted…

New Zealand has maintained a long-standing ambition to improve access to the Indian export market. However, apart from a few instances where India had short-term supply shortages, New Zealand has not been able to break into the Indian dairy market. The OECD-FAO expect India, the world’s largest consumer of dairy, to remain largely absent from global dairy markets over the medium term. Domestic production will likely keep up with considerable demand growth in the next 10 years, leaving little room for imports.

New Zealand’s access into the Indian dairy market is also limited by high tariffs across all dairy product categories ranging from 30-60%, as well as complex non-tariff barriers. The Indian market would offer a lot of value to New Zealand dairy exporters if these trade barriers were to come down.

Growth opportunities in Southeast Asia

Other fast-growing economies offer greater prospects to grow and diversify New Zealand’s dairy export markets. A leading candidate is Southeast Asia, as a growing population and increasing incomes are expected to increase demand for dairy products. Unlike India, demand in Southeast Asia is expected grow faster than production, leading to increased import demand. 

Southeast Asia currently represents approximately 16% of New Zealand’s dairy exports. Over the past 10 years, dairy exports to Southeast Asia have been growing at almost twice the rate of dairy exports to the rest of the world excluding China (figure 7). New Zealand also has reasonable existing FTA coverage with Southeast Asia. Over the medium term, Southeast Asia will likely become increasingly important for the New Zealand dairy industry as an export destination.

Figure 7: Dairy export values to Southeast Asia[1] (quarterly, seasonally adjusted)

Source: Stats NZ, Treasury

Global prices are forecast to slowly increase

Given China’s position as a leading dairy product importer, weakening Chinese import demand will weigh on global dairy prices in the coming years. The extent to which prices are affected will depend on demand growth from other regions, particularly from Southeast Asia, the Middle East and North Africa, which are likely to offset slowing import demand in China.

The OECD-FAO forecast annual global dairy price growth of ~1% over the next 10 years for key dairy export commodities, compared to annual growth of ~2% between 2010 and 2023 (figure 8). Modest global dairy price growth coupled with plateauing production indicates modest dairy export revenue growth for New Zealand. Maintaining the wedge between New Zealand dairy export prices and global dairy prices, representing the “New Zealand premium”, will be important to maintaining dairy export revenue.

Figure 8: OECD-FAO global dairy price forecasts

Source: OECD-FAO

Global uncertainties present opportunities and risks for the New Zealand dairy industry

A number of risks to the global dairy market could prove beneficial or detrimental to New Zealand’s dairy export performance in coming years. These risks include shifting consumer preferences, changing trade dynamics, biosecurity threats and environmental risks.

Shifting consumer preferences towards locally produced fresh dairy produce over reconstituted dairy products could prove detrimental to New Zealand’s dairy exports. Likewise, plant-based replacements eating into the share of dairy consumption in key export markets presents downside risk. This trend is most prevalent in developed countries, to which New Zealand exports relatively less. However, plant-based replacements reducing global demand for dairy would put downward pressure on global prices.

Shifting trade dynamics present both upside and downside risk. New trade agreements and ongoing efforts to reduce trade barriers could unlock new markets for New Zealand exporters, but recent heightened trade tensions point to downside risks for global growth. New opportunities may emerge as countries look to shore up food security and broader supply chain resilience in response to heightened uncertainty and volatility.

Environmental legislation is likely to have a considerable impact on the future dairy production worldwide. Importantly, New Zealand’s dairy emissions are well below competitor countries such as the EU and US, which could give New Zealand an advantage as consumers become more sensitive to climate change or as overseas producers are increasingly exposed to a price on their carbon emissions.

Slower dairy export growth over the medium term will have implications for national income

While dairy will continue to remain a significant contributor to the New Zealand economy into the future, slowing dairy export growth over the medium term has implications for national income. Weaker dairy export growth will weigh on the trade balance and the current account if it is not offset by gains from other exports or a fall in imports. Weaker dairy export growth could also see the exchange rate depreciate, which would support other exporters and import-competing industries, but would reduce New Zealanders’ overseas purchasing power.

In the context of a more uncertain outlook, the dairy sector’s ability to weather storms will be essential for protecting growth prospects. Resilience could be built across trade exposures and relationships, supply chains, climate adaptation and biosecurity. Continued innovation in the industry, maintaining strong trading relationships with key export partners, and seeking new export destinations are all important to maintaining New Zealand’s dairy export performance.