1. MACQUARIE
AGRICULTURAL FUNDS MANAGEMENT
The case
for investing
in dairy

2. Contents
Executive summary 03
Demand side 05
Supply 12
Where can the world expand dairy supply? 16
Conclusion 26
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3. Executive summary
During the past three years, the grain, oilseed and outgrew demand and prices hit the floor. Where
meat markets have received a significant amount prices came to rest on this floor in 2009 is an
of attention. This can be attributed to accelerating important point to highlight in itself.
demand from the biofuel sector and a surge in
The new price ‘floor’ revealed in the aftermath
global food and feed demand from emerging
of the global financial crisis indicated that a
economies which led to an unprecedented
significant structural shift had taken place. No
increase in most agricultural prices. Similar
longer was the international dairy product price
structural changes can also be seen in the global
upside capped at just over $2,000/t, but this price
dairy markets. In rapidly developing countries,
level effectively became the new floor post-2007.
dairy products are facing unprecedented demand
pressures from the emerging middle classes. The structural changes within the global dairy
Throughout the developing world the emerging markets can be attributed to several important
middle class, higher incomes, urbanisation and factors, one of these being dairy demand in
access to dairy retail facilities have all had a emerging economies. Growing levels of disposable
profound impact on the world dairy markets and is incomes across emerging economies has led
likely to continue to do so for many years to come. to increased demand pressures on the available
global dairy supply. If more people are demanding
Oceania dairy product export prices dairy products, and are willing to pay for them,
higher prices are likely to follow. Additionally, rising
input costs across all major dairy production
regions have also contributed to a structural shift
in the global dairy markets. A combination of
higher feed grain, fuel, and land prices has led
to a constrained incremental demand growth
across the sector. It is also important to consider
that the recovery of global dairy prices by early
2010 indicated that the market had moved from
oversupply to balance.4
Throughout the global economic downturn poor
returns in many dairy regions contributed to a
significant decline in the global dairy herd. It
Source: United States Department of Agriculture (USDA), will take time and higher milk prices to recover
Macquarie production capacity lost over the duration of the
financial crisis and to re-build the global dairy
Global dairy markets have experienced many herd. It is anticipated that the return of dairy
extremes in recent years.1 In 2007/08 dairy demand growth in 2010 will continue, and in
prices rose to record highs, along with the fact there are already signs emerging of supply
majority of agricultural commodities. This rise constraints developing in the market.
in dairy product prices was a direct result of
Markets such as China and South East Asia are
growing global economic prosperity.2 Like in most
expected to provide significant opportunities
commodity cycles, while the price boom did lead
for dairy producers over the coming decades
to a surge in supplies it also acted as a natural
as per capita consumption of dairy products
brake on demand growth.3 Thus, when the
expands throughout the region. Additionally, the
global financial crisis hit at the end of 2008 the
vast majority of countries in the world have dairy
global dairy market, like many other commodity
supply deficits which bode well for increasing
markets, came under significant strain as supply
consumption growth and dairy trade in future.
1. Dairy Australia
2. International Dairy Federation
3. International Dairy Federation 4. Australian Bureau of Agricultural and Resource Economics (ABARE) 3

4. Executive summary
Most of the world faces a dairy supply deficit
Source: Food and Agriculture Organisation (FAO), Macquarie
4

5. Demand side
The global dairy markets cover an array of Demand in
products including cheese, dry powdered milk,
fluid milk, whey and yoghurts. This provides developed economies
diversification for the market as different countries During the last decade dairy demand has
and different economic situations provide multiple remained relatively stable in the major developed
layers of demand for dairy products. Our analysis economies. Dairy consumption trends have
of FAO data, which looked at which countries become entrenched with per capita usage which
consume what dairy products, revealed that the are already at very high levels. During the global
higher a country ranks on scales of economic financial crisis incremental fluid and dry milk
development, the higher both the volume and demand growth remained on trend. However,
the diversification of dairy consumption. Thus, it demand for butter and cheese products fell
can be inferred that with economic development slightly, as high unemployment rates, higher
comes not only more dairy consumption on a savings rates, and low consumer confidence led
volume basis but also more consumption of to a decline in higher-end food product demand.5
higher cost, higher value-add products such as
Total milk product demand is yet to fully recover
cheeses and yoghurts.
back to the growth trend seen pre-recession.6
Global milk product consumption – Once the Organisation for Economic
excluding fluid milk (tonnes) Cooperation and Development (OECD)
countries’ demand improves, a higher milk
price will receive further support. Currently high
demand from emerging economies, combined
with OECD demand recovery will put pressure
on recovering global dairy stocks.
Total EU/US/Oceania milk product demand
Source: USDA (2009)
Source: USDA, Macquarie Research (2010)
5. Dairy Australia
6. USDA 5

6. Demand side
The emerging economies are the key driver
In emerging markets dairy demand has grown significantly while continued high unemployment and an
unsteady economic recovery in the developed world has led to flat consumption growth in traditionally
strong dairy consuming regions.
Milk product consumption moves higher with GDP growth
Source: FAO, Macquarie (2007)
The strong economic performance of rapidly China's urban/rural dairy divide in 2008
developing economies, such as those in
South America and Asia, have provided
a solid underpinning to the global dairy
markets in 2010, a trend which appears to be
accelerating. The key areas of dairy demand
growth are centred in East Asia, South East
Asia, South America and the former Soviet
Union. The emerging middle classes in these
countries are becoming more health conscious
and with increased spending power are willing
to pay more for higher-end dairy products.
Source: USDA Attache, Macquarie Research, (January 2011)
6

7. It is anticipated that demand for milk will continue have higher bone density levels thus lowering
to rise in line with the growing global population risk of osteoporosis later in life
and the industrialisation and urbanisation process „ Immune protection – studies suggest milk’s
unfolding across the developing world. Across whey component provides glutamine and
emerging markets it is evident that a young, lactoferring, which studies show may offer
urbanised population is altering their dietary immune protection
patterns, demanding more higher-value food
„ Digestion – milk’s whey protein can help
products and moving from lower to higher-value
provide amino acid glutamine which, when
foods including dairy and meat products.7 In fact,
lacking, has been shown to cause upset
data available on the divide between urban and
rural per capita milk consumption in developing stomachs
economies clearly illustrates that rural populations „ Exercise recovery programs – scientists
lag far behind their urban counterparts.8 have demonstrated that dairy products such
as chocolate milk are an effective exercise
Per capita milk product consumption, 2010 recovery aid due to their combination of
carbohydrates and protein.
Dairy products are the richest and most effective
source of calcium in the diet and cannot easily be
substituted by other sources.10 According to the
United Nations (UN) World Health Organisation
(WHO), diets that are low in dairy products will
generally not provide sufficient calcium, which is
particularly vital for the proper development of young
children.11 The UN considers that milk consumption
is a key variable to combat malnutrition and has
committed significant resources to establishing
Source: Food and Agricultural Policy Research Institute school milk programs in developing countries.12
(FAPRI), USDA, Macquarie (2010) For adults milk consumption is routinely cited as a
key factor for the prevention of osteoporosis.
Health benefits of dairy
An increasingly urban world population boosts
Dairy products are an important source of several demand for milk products
key nutrients. Outlined below are several proven
health benefits of milk consumption9:
„ Essential nutrients – protein, carbohydrates,
fats, vitamins (A, B12, and riboflavins), and
minerals (calcium, phosophorus, magnesium,
potassium and zinc)
„ Blood pressure – milk products are high in
potassium, magnesium and calcium; minerals
which may help lower blood pressure
„ Healthy bones – dairy foods are the main
providers of calcium. Consumption of milk
products has been shown to improve bone
density and prevent osteoporosis. Studies
of children have shown that those who have Source: FAO Secretariat, Macquarie
consumed adequate amounts of milk products
7. UN Secretariat, Macquarie Research Economics 10. USDA, Dairy Australia, UK Food Standards Agency, National Dairy Council,
8. USDA FAS Attaché UN WHO, International Dairy Federation
9. USDA, Dairy Australia, UK Food Standards Agency, National Dairy Council, 11. UN WHO 7
UN WHO, International Dairy Federation 12. UN WHO

8. Demand side
The UN forecasts that the global population will reach Currently, China’s per capita dairy consumption
9.1 billion by 2050; a growth of 33 per cent from is 12.3kg/capita, 86 per cent below current
today’s population of 6.9 billion. The UN also predicts United States (US) per capita consumption.15
that an increasing proportion of the population will Over the next decade China’s per capita dairy
be situated in urban centres. Today the world’s consumption is expected to rise by 160 per
population is split roughly 50/50 between urban and cent.16 South East Asian countries such as
rural dwellers. However by 2050, the UN forecasts Indonesia and Vietnam have also been identified
this split will widen to 70 per cent urban 30 per cent as key consumption growth regions. Currently,
rural.13 As increased urbanisation and growing per capita consumption stands at 1.4kg/capita in
prosperity generates higher disposable incomes, Indonesia and 2 kg/capita in Vietnam. By 2019,
more protein and processed foods are anticipated to per capita consumption is expected to grow
be consumed. In fact, in many regions consumption by 76 per cent and 34 per cent respectively.17
of dairy products is still considered a luxury, however According to these figures, per capita
this is rapidly changing as milk products are consumption across the world, and particularly
becoming a dietary staple.14 Urbanisation allows for in South East Asia, still has tremendous upside
easier marketing and distribution of dairy products potential for the future.
to consumers as people have greater access to
distribution and cold storage, along with greater Three stages of accelerating milk
choice through large retailers and restaurant chains. consumption growth in emerging markets
Comparative consumption trends
In many developing countries per capita milk
consumption remains far below North America
and Europe. The graph, Comparison of per capita
milk consumption across the world, highlights
the growth potential inherent in the world’s dairy
markets. Countries such as Brazil, India and
Mexico are approximately mid-way up the demand
curve but have further upside growth potential over
the next decade. On the lower end of the scale
countries such as China, Venezuela and South
East Asia have only begun to consume increased
quantities of milk which could potentially lead to
large upside growth over the coming decades. Source: USDA, Macquarie
Comparison of per capita milk Total milk consumption (including all products) in
consumption across the world the three major dairy growth markets of South
America, South East Asia and East Asia has
been accelerating. The chart, Three stages of
accelerating milk consumption growth in emerging
markets, depicts three distinct growth phases.
First, from 1964 to 1981, milk consumption
growth was constrained by underdevelopment
in these economies. Consumption growth still
managed to surge 62 per cent but came from
an extremely low baseline. Second, from 1982
to 1993 many of these countries saw increased
rates of development with milk consumption
growth at 49 per cent over the period. The third
Source: FAPRI, USDA, FAO, Macquarie
and current stage running from 1994 to present
15. FAPRI
8 13. UN Secretariat 16. FAPRI
14. KPMG 17. FAPRI

9. has seen a 128 per cent surge in consumption as Indonesia is not the only country facing growing
the industrialisation process is undertaken.18 It is import requirements. In 2010 Russia’s drought
difficult to gauge how long this process of strong disaster diminished total grain production by over
linear year-on-year growth in demand will continue, 35 per cent from 2009.22 This led to soaring
however, judging from the comparative per capita domestic feed prices which in turn caused
consumption data across different countries, increasing livestock herd liquidations.23 Although
increasing prosperity will likely continue to act as a China will be the largest importer of fluid and
stimulant for increasing dairy consumption growth. dry milk, Russia will remain the world’s largest
importer of all milk products in 2010. Total
Indonesia’s dairy market is an example of the demand is expected to grow by 10 per cent
potential for dairy market growth in South in 2010 from 2009. This large dependency on
East Asia. Between 2000 and 2010, Indonesia imported milk products will take time to reduce
expanded milk production by 35 per cent, despite the Russian government’s current five-
producing 1.06mt by 2010.19 However, demand year plan to promote the development of the
growth also doubled over this period. In order domestic livestock and poultry industries.24
to meet this demand, major dairy exporters
Total dairy product importers
New Zealand and Australia have had to supply
(includes fluid/dry milk, cheese and butter)
much of the additional demand needs in the
form of dry milk powder.20 Indonesia’s whole
milk powder imports have surged 187 per
cent between 2000 and 2010, while non-fat
dry milk imports are up 170 per cent.21 Given
this, the outlook for Gross Domestic Product
(GDP) growth over the next decade coupled
with constraints on expanding domestic dairy
production – in line with demand growth –
means Indonesia will continue to be a significant
and growing net importer of milk products.
Indonesian milk consumption vs GDP growth
Source: USDA, Macquarie
China has become the world’s largest importer
of fluid and dry milk products and will continue to
be the dominant force in the global dairy markets.
Growth in China’s milk product demand presents
a significant opportunity for dairy producers. As
outlined in the subsection regarding China’s dairy
industry, strong import demand growth has been
fuelled by consumer mistrust of domestically
produced milk following the 2008 melamine-tainted
milk crisis. Imports reached 335mt in 2010, tripling
import levels in 2008.25 China simply cannot supply
Source: USDA, Macquarie
all of its milk product demand needs.
18. USDA 22. USDA
19. USDA 23. USDA FAS Attaché
20. USDA 24. USDA FAS Attaché 9
21. USDA 25. USDA, Macquarie

10. Demand side
Despite attempts by the Chinese Government
to encourage domestic dairy production, the
general view is more supportive for an increasing
China milk import demand program. Cash corn
prices in China are now at record highs having
increased 35 per cent between early 2009 and
late 2010.26 A surge of feed and industrial corn
demand in the absence of significant supply
growth has led to internal shortages and imports
of US corn for the first time in more than a
decade. With flat corn yield growth and limitations
on arable land expansions, it appears China will
continue to struggle to produce enough feed
grains domestically to support a growing dairy
herd, along with other livestock and poultry
supply growth. Soy meal prices have also
increased nearly 10 per cent between 2009 and
2010 as feed demand requirements continue to
significantly expand soybean imports.27 These
feed cost pressures, along with limitations on dairy
production expansion – due to disease and a lack
of water resources – should prove conducive to
continued milk import demand growth28.
Major dry/fluid milk importers
Source: USDA, Macquarie
26. Thompson Reuters
27. Thompson Reuters
10 28. USDA

11. China’s melamine crisis offers opportunities
to milk producers in exporting countries
It has been a slow road to recovery for China’s domestic dairy production industry following the 2008
melamine-tainted milk scandal. Immediately following the crisis, demand for domestically produced
milk products plummeted causing a 17 per cent reduction in the size of China’s dairy herd between
2008 and 2009. Total demand recovered quickly, however, consumption was then fuelled by dairy
imports, not local production. This caused total milk product imports to surge 210 per cent between
2008 and 2010. This import surge was led by dry milk powder products due to very strong demand
for infant formulas and it appears this trend will continue at least until the Chinese dairy herd size
makes a full recovery.
According to the USDA, China’s dairy herd size is increasing once again as demand for domestically
produced milk begins a slow turn-around. The government has adopted stringent melamine
contamination prevention measures while continuing to subsidise dairy production at the farm level.
The Government’s dairy plan sets a target for 48mt of milk production by 2013; nearly double current
production levels. However, this target may turn out to be optimistic due to continued consumer safety
concerns, extremely high feed costs, and a growing incidence of disease outbreaks such as Foot and
Mouth Disease (FMD). Therefore, although China’s dairy herd is projected to have grown seven per cent
between 2009 and 2010, dairy product import demand has grown at a much faster pace of 38 per cent
over the same period. It may take many more years for the domestic dairy sector to make a full recovery.
In the meantime it is highly likely China will remain the world’s largest market for dry milk powder exports.
Total dairy product importers Total dairy product importers
(includes fluid/dry milk, cheese and butter) (includes fluid/dry milk, cheese and butter)
Source: China Statistics Bureau Source: USDA
According to the China Statistics Bureau, monthly dairy product output (a good proxy for demand)
recovered back to pre-crisis levels by late 2010. Total output has already reached 15.6mt from January
through September 2010, up nine per cent from 2009. China’s dairy consumption growth is being
fuelled by higher disposable incomes, increasing health consciousness, and greater access to dairy
products at the retail level. Over the past decade China’s total milk product demand has increased
over 340 per cent29. However, on a per-capita basis, China’s total consumption still lags far behind
that of developed economies. Even more striking is the disparity in milk consumption between China’s
urban and rural populations. The graph, China’s urban / rural dairy divide in 2008 on page four, clearly
shows that per capita consumption of milk in rural areas is still only a fraction of what is currently
being consumed in urban areas. With China’s trend toward rapid urbanisation and an expanding
middle class, the scale of milk consumption growth potential is indeed significant. This means China’s
dairy market will continue to provide ample room for a solid growth in imports over the next several
decades. This highlights the great opportunity which exists for the world’s major dairy exporters to
continue gaining market share in China.
29. FAO, National Bureau of Statistics China 11

12. Supply
Global dairy production has remained on an Global dairy herd vs productivity
upward trend over recent decades and more
specifically over the last ten years to 2008;
global milk production has increased on average
by two per cent per annum.30 In contrast, for
decades dairy herds globally have been in
structural decline shrinking 28 per cent between
1984 and 2009. In fact, the global dairy herd
declined to 124.7m head by 2009 after a short-
term peak in cattle numbers in 2008 at 126.5m
head. In 2010 the dairy cattle supply stabilised
at 125.5m head, up 0.63 per cent from 2009
following a recovery in international dairy prices
and improving import demand.
Global milk production Source: USDA
It is also important to look at the dispersion of
dairy cattle herds globally. From the late 1990s
to 2010, the world’s major traditional dairy
exporters saw a 10 per cent decline in overall
herd numbers. Between 2009 and 2010, the
economic slowdown accelerated this trend
with dairy cattle numbers falling 1.6 per cent.
In 2009 and early 2010 slow demand growth in
developed countries, combined with weak export
markets, contributed to weak dairy producer
margins in Europe and the US, which in turn
led to herd reductions. Of this group, only New
Zealand realised herd growth over the 2008 to
2010 period with four per cent growth registered
Source: Macquarie Research (November 2010) between 2008 and 2009 and another 2.4 per
cent growth between 2009 and 2010.32
Productivity per animal has improved markedly
over the past few decades due to improvements
in dairy farming practices including more scientific
feed rations, industry consolidation (economies of
scale) and improvements in dairy health. In 1965
the world average milk produced per cow in one
year stood at 2.1 tonnes per year improving 13.4
per cent to 2.48 tonnes by 1985. By 2010 the
average was 3.5 tonnes, a total increase of 60 per
cent from the 1965 level.31 The boost in efficiency
and productivity has contributed, in part, to the
decline in the total world herd size while keeping
total milk production on a steady uptrend.
30. USDA, FAO
12 31. USDA 32. USDA

13. Major milk exporters’ dairy herds shrinking In terms of overall dairy production, Europe and
North America are the largest dairy producing
regions, making up over 50 per cent of the total
world production.34 Due to the high population
base in the US and European Union (EU), these
dairy markets are focused mainly on internal
market dynamics. Dairy is a thinly traded
agricultural commodity as many countries are
focused on maintaining internal balance with only
a few major players involved in export markets.
Only between seven and eight per cent of total
global milk production is traded internationally.35
World milk production by region in 2010
Source: USDA
Beyond the traditional dairy exporters, dairy herds
have also been increasing in South America, and
more specifically Brazil. Although dairy exports
have been increasing from South America,
strong rates on internal milk consumption have
prevented South America from becoming a major
player in the world milk trade.33 Although there
will be many constraints on dairy herd expansion
moving forward, global dairy herd numbers are
predicted to begin stabilising into 2011 and may
even gradually increase. Source: USDA (2010)
Global dairy herd Fresh milk is a highly perishable good which
means most countries with high levels of dairy
Million head 2005 2006 2007 2008 2009 2010
consumption also have high levels of dairy
India 38.00 38.00 38.00 38.50 38.00 38.50
production. Thus, international dairy trade is
EU 25.36 24.94 24.18 24.18 24.19 23.66
dominated by products with a longer shelf-life
Brazil 15.10 15.29 15.93 16.70 17.20 17.60
such as powdered milk products, primarily skim-
FSU12 14.53 13.74 13.13 12.90 12.39 12.17
milk powder (SMP) or whole milk powder (WMP).
United
Combined, these products make up the bulk of
States 9.05 9.14 9.19 9.32 9.20 9.12
international dairy trade at 21 per cent and 26 per
China 6.80 7.90 8.76 8.58 7.12 7.63
cent respectively. Cheese and butter products
New
comprise the balance at 25 per cent and 21 per
Zealand 3.97 4.10 4.16 4.20 4.37 4.47
cent respectively. Fluid milk exports, however,
Argentina 2.10 2.15 2.15 2.15 2.10 2.10
only account for seven per cent of global dairy
Australia 2.04 1.87 1.80 1.64 1.68 1.60
product trade.
Canada 1.07 1.02 1.00 0.99 0.98 0.98
Source: USDA
34. USDA
33. Dairy Australia 35. Fonterra 13

14. Supply
World dairy product exports by type in 2010 Total dairy exports and production have been
steadily increasing as regions which lack dairy
production capacity have seen the strongest
demand growth. Long-term trends in dairy
exports from the three major exporting regions
of the US, EU, and Oceania suggest that a solid
upward trend remains intact. Total net exports
from these three major exporting regions have
increased on an average of one per cent per
year over the past decade leading into 2010.
Looking ahead, FAPRI estimates that net-export
growth from the top three exporting regions will
accelerate with average yearly increases of two
per cent per annum over the next decade.37
Source: USDA (2010)
Total net milk product exports
Australia and New Zealand (Oceania) only account
for six per cent of total world milk production
however, these two countries provide over half
of global dairy trade.36 Efficient, export-oriented
production models, coupled with low domestic
populations and proximity to key markets in Asia
means this region has become the pivotal dairy
supplier to world markets. The EU is the second
largest dairy exporting region, accounting for
31 per cent of global dairy trade in 2010.
World dairy exports by region as proportion of
total world dairy trade
Source: FAPRI, USDA (201)
FAPRI’s data highlights another important trend
in regards to export market share. Due to the
competitive dairy production models in Australia
and New Zealand, and proximity to key import
markets in Asia, the share of Oceania milk
product exports as a proportion of total net trade
among the major exporting regions is expected to
increase over the next ten years.
Source: USDA
14 36. USDA 37. FAPRI

15. Per cent share of export market
Source: Macquarie Research, January 2011
This will likely come at the expense of the higher-
cost producers in Europe and the US. Australia is
expected to experience the greatest increase in
the share of total net trade, climbing 15 per cent
by 2019 compared to an 11 per cent share in
2010. New Zealand’s share of dairy export trade
is also expected to increase to 48 per cent from
a current 46 per cent. In contrast, it is anticipated
that EU market share will decrease to 21 per cent
by 2019 compared to nearly 30 per cent in 2010.
US market share is expected to remain relatively
steady near eight per cent, increasing only slightly
from a current share of approximately 7.5 per cent.
These projections suggest that the countries
which already have established export-oriented,
deregulated dairy industries will be able to benefit
most from emerging market demand. Australia,
with a recently deregulated market, is expected to
receive a much greater share of the new import
demand emerging from Asia.
15

16. Where can the
world expand dairy supply?
Regional supply focus Average producer milk prices 2009 ($US/cwt)
Growth in global milk supply can come about
in two ways – either by increasing the global
dairy herd and/or increasing productivity per
cow. Increasing herd sizes requires significant
investments at the farm level while increasing
productivity per cow generally involves higher
feed and management costs. Thus, there is
usually a time lag between when additional supply
is needed by the market and when producers will
be able to increase production.
Europe
The European dairy production model can be Source: International Dairy Federation (2009)
described as highly policy-oriented. Since World
War II most major dairy producing countries in The EU also makes use of intervention purchasing
Europe and now the EU forged a dairy industry programs to ease market surpluses. The common
reliant on a complex government support reference to “lakes of milk” and “mountains of butter”
program utilising subsidies, quotas, intervention in discussions over the EU’s Common Agricultural
purchasing, and high tariffs.38 This has meant Policy (CAP) describes the EU historical policy of
that internal EU milk prices have generally trended storing large amounts of these products as a price
higher than international equivalent prices over support mechanism. This policy still exists but has
much of this post-war period.39 evolved into more of a safety-net than a price support
program with predetermined limits set on prices and
These measures were implemented at various quantities offered into the intervention program.42
times in order to preserve internal market balance.
The EU’s milk quota system was introduced In recent times the EU has again used the
in 1984 to restrict milk production and control intervention program to ease excess milk supplies
surpluses.40 However, the policy is expected which temporarily developed during the global
to expire in 2015 which means the EU dairy financial crisis. Although EU intervention dairy
industry faces considerable liberalisation over the stocks reached the highest level since 2003 by
next decade. The likely restructuring of the EU the early months of 2010, stocks have decreased
dairy sector is anticipated to align EU milk prices significantly as supplies are absorbed by the export
closer to international prices over time (which and domestic markets. The EU Government’s dairy
could translate to lower prices in the EU). While stocks continue to have an impact on wholesale
the number of dairy farms will likely decrease, milk prices in the EU. With low butter stocks,
farm sizes will increase to take advantage of wholesale butter prices have rebounded much
economies of scale.41 However, because of the stronger than SMP prices. The gap between
high-cost model of dairy production in the EU, it these two prices has in fact widened showing that
is far from certain whether this liberalisation will the EU’s support programs continue to have a
provide a situation which will lead to a significant direct impact on prices. Dutch butter prices have
increase in total EU milk production. rebounded 83 per cent from the lows seen in 2009
to the highs in 2010 while SMP prices have only
increased 40 per cent over the same period.43
38. Dairy Australia
39. DIN Consultancy
40. EAAE Seminar paper: Agri-Food and Biosciences Institute Northern Ireland,
FAPRI, Queen’s University Belfast 42. Joint AES and SFER Conference ‘The Common Agricultural Policy Post 2013’
41. EAAE Seminar paper: Agricultural Economics and Rural Policy Group, Paper presented by Alan Matthews, Trinity College Dublin
16 Wageningen University 43. DIN Consultancy

17. EU dairy wholesale prices Thus, even though the EU’s dairy herd is
expected to continue declining over the next
decade, increasing productivity will support slow
incremental supply growth. FAPRI data suggests
EU milk production should continue its slow
incremental growth of 0.30 percent over the next
decade, roughly in line with incremental demand
growth.45
EU dairy balance
Source: DIN Consultancy
As highlighted in the table, Global dairy herd, the EU’s
dairy herd has shrunk significantly over the past five
years; declining 6.7 per cent or 1.7m head between
2005 and 2010. Poor returns due to weak demand
growth domestically and high feed prices has
contributed to the decline over the past five years.
However, like most other major dairy producing Source: USDA, FAPRI
regions, the EU is experiencing consolidation in the
industry as the number of farms shrinks while at the The EU dairy market could remain relatively
same time the sector is experiencing an expansion static, as a result of incremental supply growth,
in farm sizes. Efficiency gains are driving this process over the medium term due to existing entry
of consolidation. In the EU 4,723kg of milk were barriers (quotas), the distortionary impact of
produced per cow in 1999 but this has increased various price intervention measures, and the
1,000kg/cow or nearly 20 per cent by 2010.44 high costs associated with production. In the
medium-term, increasing market liberalisation
EU herd decreasing along with in the EU will provide efficient producers with
productivity gains an opportunity to expand production. However,
there could be an extended period of adjustment
to this liberalisation and to the higher feed grain
price plateau which could result in temporary
contraction and consolidation before the industry
would be in a position to expand once again.
However, at this point, the length and severity of
the adjustment process is highly uncertain.
Source: FAPRI
44. FAPRI 45. FAPRI 17

18. Where can the
world expand dairy supply?
The United States
The US dairy production system is highly intensive and heavily exposed to increasing feed costs.
Milk is predominantly produced in consolidated feedlot operations which utilise large amounts of feed
grains and protein meals. This milk production system can take advantage of economies of scale while
the high-intensity feeding rations mean productivity per cow is much higher than the world average. In
2010 the average milk produced per cow in the US stood at 9.5t/year, this compares to 5.75t/year in
Australia; 5.6t/year in the EU; and only 3.7t/year in New Zealand.46
US dairy farm concentration
Source: USDA
However, the major inhibitor to US dairy production growth going forward is cost. Whereas Australia
and New Zealand can take advantage of a relatively warm climate and pasture-feeding year-round,
much of US dairy production occurs in states such as Wisconsin which experience cold winters. Thus,
the average US dairy operation is much more input-intensive, requiring more buildings, equipment, and
feed as well as labour.47
46. USDA
18 47. University of Wisconsin-Madison

19. Productivity per cow US dairy production margins
Source: USDA
Source: USDA
Feed costs alone account for approximately 70 per
cent of total dairy operating costs in Wisconsin.48 A key determinant of dairy producer profitability
According to USDA data dairy feed prices have in the US is the milk to feed price ratio. The milk
increased 69 per cent between 2003 and 2010. to feed price ratio trend has grown increasingly
The drought in Russia during the summer of 2010 negative for US dairy farmers over the past decade.
combined with disappointing US corn yields are a The following graph depicts the milk to feed price
reminder that significant grain price volatility may ratio since 1985 as well as an indicative range
persist in the future. Accelerating feed grain and between which US dairy farmers typically begin to
protein demand from Asia and biofuel use worldwide, expand production. It suggests that since late 2007
has proved difficult for livestock producers in the US there has been little incentive to expand dairy herds
to keep up with, due to heightened competition for significantly. It also illustrates that the current recovery
available supplies. This has pushed grain prices well in milk prices relative to feed prices still does not
above historical averages. indicate a solid milk supply expansion is imminent.49
The unfavourable milk to feed ratio will likely mean
Feed prices increasing in the US that the US dairy herd will struggle to grow over the
medium-term. To turn this situation around the US
dairy market would need to see either a structural
shift higher in milk prices internationally or a structural
shift lower in feed prices.
Source: Thompson Reuters
48. USDA 49. USDA 19

20. Where can the
world expand dairy supply?
US milk:feed price ratio US monthly dairy cow slaughter rates
Source: USDA
Source: USDA
Similar to the trend in all major dairy producing
US dairy herd size falling; productivity growing regions, the US dairy herd has decreased
over the past few years while productivity has
increased. US dairy cow productivity is highly
seasonal with peaks in the spring and troughs
into the autumn. Average production per cow
per month in the US has increased eight per
cent between 2005 and 2010. Thus, despite the
record monthly dairy cow slaughter rates brought
about by the herd liquidations in 2009 and the
early months of 2010 (shown above), total milk
production did not fall significantly owing to these
productivity gains.50
It is also important to remember that the US dairy
industry operates alongside various government
intervention programs including direct subsidies and
Source: USDA
intervention stock purchasing programs. The 2008
Farm Bill included even greater potential support
These economic dynamics have had clear
than previously existed for dairy farmers by providing
implications for the size of the US dairy herd. US
greater protection against decreases in milk prices
dairy herd had previously posted consistent growth
or feed cost increases.51 The dairy intervention stock
rates, increasing by four per cent or 351,000 head
program has receded somewhat in importance if
between January 2004 and December 2008. By
looked at from the basis of stocks (government and
December 2009 the US dairy herd had peaked
private combined) as a proportion of total domestic
at 9.33m head. The herd decline has bottomed
consumption. Compared to the heavy stock-build
out near 9.1m head by late 2009 due to the poor
seen in the early 2000s, the increase in dairy product
margins outlined above. High dairy slaughter
stocks through 2008 and 2009 never surpassed
rates through 2009 and 2010 have reduced the
15 per cent proportion per total domestic demand,
dairy herd by 2.3 per cent between 2008 and the
compared to 20-25 per cent in the early 2000s.
end of 2010. Improving margins into 2010 has
led to a stabilisation of the dairy herd at 9.18m
head. However, with the unfavourable milk to feed
ratios it is unlikely that the herd size will increase
50. USDA
20 significantly over the medium or even longer term. 51. ABARE

21. US dairy product stocks This matching of production growth (roughly four
per cent over the past five years) and consumption
growth (also at four per cent) will very likely limit
South American milk product export growth until
the region’s per capita consumption rates begin to
level off.55 This may take many years due to the
high population in Brazil and other South American
countries coupled with per capita consumption
rates only half that of countries such as Australia
and Canada.
Balanced dairy market in South America
provides little room for exports
Source: USDA
Although the US dairy industry retains expansion
capacity through herd or productivity growth,
higher costs of production and relatively high
internal dairy stocks will continue to constrain
expansion over the medium term. This will be
an important factor that may provide other dairy
producing regions, which are not as heavily
exposed to grain prices, a key advantage to
attain a greater share of demand growth in
emerging markets.
Source: USDA
South America
One possible region which can sustain long-term New Zealand
dairy production growth is South America. South Along with Australia, New Zealand dairy
America is endowed with generally ample feed production can be characterised as a
grain and oilseed supplies, low labour costs, deregulated, export-oriented, grass-fed
and vast grasslands which can support larger production system. In fact, New Zealand is the
and more productive dairy herds. In fact South dominant milk exporter in the world market
American countries, like Brazil, are increasing per accounting for 34 per cent of world dairy trade in
capita dairy consumption at a rapid pace. 2010.56 New Zealand has been one of the only
The South American dairy markets are largely countries in the world to expand milk production
balanced with production increasing to supply throughout the global financial crisis of 2008-
the fast growth pace of domestic milk demand.52 2009 thereby continuing to entrench its dominant
This leaves little room for exports.53 Total dairy position in global dairy trade.
product exports from South America reached
296,000 tonnes in 2009; only a fraction of the
2.6mt of combined New Zealand and Australia
dairy exports54.
52. Dairy Australia
53. Dairy Australia 55. USDA
54. USDA 56. USDA 21

22. Where can the
world expand dairy supply?
Concentration of New Zealand Herd size and overall production moving higher
dairy production
Source: Dairy New Zealand, USDA
The structure of the New Zealand dairy industry
has evolved quickly into a highly consolidated
system. Average herd size per farm has increased
from only 154 head in 1988 to 366 head by
2008, an increase of 137 per cent. The number
of herds in production in New Zealand has
Source: Dairy New Zealand (2009)
meanwhile remained on a steady downtrend,
declining 21 per cent between 1988 and 2008.58
New Zealand dairy herd growth has remained
on a steady uptrend for many years. Between Increasing consolidation and
2000 and 2010 New Zealand expanded its dairy efficiency gains in New Zealand
cattle herd by 28 per cent to a record high 4.5m
head.57 Milk production has also remained on a
steady uptrend increasing 36 per cent over the
same period. Although New Zealand’s annual
milk production per cow remains low compared
to other major dairy production regions at only
3.7t/head compared to the world average at 3.5t/
head and the US at 9.5t/head, New Zealand’s
dairy sector is still highly competitive. Its low-cost
grass feeding production system has effectively
insulated the industry to a large degree from
swings in global grain prices over history.
Source: Dairy New Zealand
These industry dynamics, within the context
of a deregulated, export-led dairy market have
produced efficient economies of scale and
allowed New Zealand dairy farmers to secure a
place among the world’s largest milk exporters.
22 57. USDA 58. Dairy New Zealand

23. New Zealand’s total dairy product exports In Australia the dairy industry comprises a large
slumped in 2008 and 2009 from the all-time proportion of the rural economy. Measured in
record highs established in 2007. Export volumes value of production, dairy comprises roughly 10
declined 11 per cent between 2007 and 2008 per cent of the agricultural sector in Australia,
but quickly stabilised into 2009 with a growth or $A3.8 billion in 2009.59 Dairy production is
rate of eight per cent year-on-year. For the 2010 centred in the southeast corner of Australia, in the
season, New Zealand dairy exports rose to states of Victoria, Tasmania, and South Australia.
2.1mt, up 21 per cent over 2009. The trajectory These areas combined comprise 80 per cent
of consolidation and improving productivity per of national dairy output.60 Dairy production is
cow will mean New Zealand will likely maintain concentrated in these coastal regions as these
solid production and export growth over the areas generally received higher amounts of
foreseeable future. natural rainfall.
New Zealand dairy product exports Dairy producing regions of Australia
Source: USDA
Australia
Despite producing a small proportion of the world’s
total milk supply, Australia is among the world’s
major players in global dairy trade. This role as Source: ABARE (2010)
major dairy supplier to the world is expected
to increase over the coming decades. Dairy Due to the warm climate and abundance of pasture
farmers in export-oriented regions have generally lands, Australia is well suited for dairy farming. This
fared better during world economic slowdown favourable combination of natural resources means
compared to regions focused on maintaining an that the Australian dairy industry is predominantly
internal dairy supply and demand balance. The pasture-based which results in an efficient, low-
deregulated dairy industry in Australia has enabled cost milk production model when compared to
greater flexibility to adapt to changing global many other major dairy producing countries (EU
market dynamics and capitalise on growing import and US).61 Only two per cent of the Australian dairy
demand from Asia. Certainly the geographical sector operates as complete feedlots while over
proximity to these major import markets is a key 75 per cent utilise some proportion of both pasture
reason for this competitiveness. Australia is also and supplementary feeding.62
less exposed to high international grain prices due
to a low-cost production model based on a high
proportion of grass-feeding operations.
59. ABARE
60. Dairy Australia
61. Diary Australia
62. Dairy Australia 23

24. Where can the
world expand dairy supply?
The dairy industry is a significant contributor Total Australia milk production
to overall Australian agricultural earnings
Source: ABARE
Source: Australian Bureau of Statistics
Australian milk production peaked in 2001 at 11.3
The Australian dairy market has been gradually billion litres shortly after the market deregulation
deregulated since July 2000 leading to a program was initiated. Drought and market
rationalisation and consolidation of the sector over consolidation since then have led to a decline in
the past decade.63 This has aligned international milk production into 2009. Australia’s dairy herd
dairy prices with those received by the Australian fell by 26 per cent between 2001 and 2009 with
farmers and has resulted in a highly cost-efficient total milk production declining 20.5 per cent over
production system geared toward the export this period. Poor pasture conditions and high
markets. This has decreased the number of farms feed costs contributed to this herd liquidation
but increased farm size and efficiency.64 Indeed, however, improving productivity also played a
the structure of the Australian dairy industry is role. Through consolidation and efficiency gains,
changing rapidly. The number of dairy farms Australian producers have been able to steadily
operated by a single person only or with a partner push up milk yields per cow. In 2000, the average
(typical family farm) has fallen rapidly from 43 per milk yield per cow stood at only 4,800 litres/
cent in 2007 to 28 per cent by 2009.65 Between cow, but has since increased 15 per cent to just
1991 and 2007 the number of dairy farms in under 5,700 litres/cow by 2010.67 This means
Australia declined by approximately one third.66 that through flexibility in supplementary feeding
Over the same period, the number of cows per rations producers have been able to increase milk
farm also increased significantly. production in 2010 despite no significant increase
in dairy herd numbers.
Providing there is a return of ample rainfall across
eastern Australia in the 2010 season the dairy herd
size should begin to stabilise and slowly increase in
2011. Additionally, ample feed supplies should also
allow milk output to make steady gains. Over the
longer term, Australian dairy producers still have
room to increase productivity per cow. Average
annual milk produced per cow in Australia by 2009
had reached 5.8t/head compared to 3.8t/head in
1990.68 This suggests that Australian producers
have managed to increase productivity rates at one
63. Dairy Australia
64. ABARE
24 65. Dairy Australia 67. ABARE. USDA
66. ABARE 68. USDA

25. of the fastest rates of any major dairy producing are expected to increase another 3.6 per cent
region. Thus, even though Australia maintains a in 2011, and thereafter maintain a solid uptrend
grass-based production system, productivity is into the end of the decade.71 Indeed, Australia is
increasing very quickly through improvements expected to be one of the principal beneficiaries of
in herd management and strategic use of feed growing milk product demand throughout Asia.
supplements. Clearly, if the economics work for
feeding more high protein feeds as supplement to Total value of Australian milk exports
pastures, the Australian dairy sector can continue
to boost productivity levels going forward.
Australia dairy herd declining into 2009, but
productivity continues higher
Source: ABARE
Judging from the demand analysis provided in this
report incremental supply growth from Australia
will be required longer term. With the slowdown in
milk production throughout most major producing
countries into 2010, higher feed prices and
potential for market liberalisation, it is important
Source: ABARE for Australia to provide efficient supply growth. As
milk demand continues to recover in the developed
Australia also has the advantage of well economies and accelerates in developing countries,
developed export markets throughout Asia. Japan Australian dairy producers are well placed to seize
remains the largest buyer of Australian dairy the opportunities that will arise.
products accounting for 51 per cent of Australia’s
cheese exports and four per cent of SMP exports Australia dairy product net trade
in the 2008/09 season.69 Other major buyers of
Australian dairy products (SMP, WMP, cheese
and butter) include China, Malaysia, Philippines,
Singapore, Thailand and Saudi Arabia.
Australia’s milk product exports have declined
over the last decade along with the drought-
induced dairy herd reduction. Total net-trade of
dairy products in Australia declined 40 per cent
between 1999 and 2008.70 However, there are
signs that this trend is beginning to turn around.
According to FAPRI’s latest figures net dairy trade
increased 5.8 per cent into 2009 and another
seven per cent in 2010. Projected net exports
Source: USDA, FAPRI forecasts
69. ABARE 25
70. FAPRI 71. FAPRI

26. Conclusion
Demand for dairy is expected to grow due to increasing population, rising gross domestic product
(GDP), income growth and increased urbanisation. These factors are leading to changes in diets and
increased consumption of dairy products. In addition, the nutritional benefits of dairy are also driving
demand as consumers and governments in developing countries are becoming increasingly aware
of these benefits and are starting to promote the consumption of these products. Export focussed
countries, such as Australia, are well placed to benefit from this increased demand, in particular the
growing demand from South East Asia.
While there are a range of factors driving demand for dairy products, supply must increase to meet this
demand. Supply challenges include the increased cost of production, quality of products, few surplus
producing countries surplus producers and reduction of herd sizes.
The majority of countries have dairy supply deficits with only a handful of countries being surplus
producers including Australia and New Zealand. Australia has the benefit of a mature, well established
dairy industry, trade relationships with key growing markets and is also recognised as a reliable source
of quality products.
The structural changes occurring in global dairy markets have seen international dairy product prices
break through $2,000/t, with this price level effectively becoming the new floor post-2007. It is
anticipated that the return of dairy demand growth will continue, in turn leading to growth in supply
constraints to the global market and enabling surplus producers to take advantage of these conditions.
Global dairy production cost comparison
26

27. Contents about Macquarie Agricultural Funds
For more information
Management, please contact:
Tim Hornibrook,
Co-Head, Macquarie Agricultural Funds Management
P: +61 2 82320579
F: +61 2 82329999
E: tim.hornibrook@macquarie.com
Macquarie Agricultural Funds Management
Macquarie Group Limited
1 Shelley Street, Sydney NSW 2000
Australia
27

28. Contents
28