The Marginal Cow III - Dairy production intensification and risk

This article is intended to promote political and economic debate as well as provide information. It was originally inteded to be a technical paper explaining aspects of production intensification in pastoral agriculture. It now provides a less detached but more pointed analysis of the changing nature and risks of high intensity dairy production under conditions of uncertain payout.

Changes to industry cost structures mean practices that two years ago could be described as ill advised should be now more accurately described as financially disasterous. The NZ dairy industry simply won't survive into next eason in reasonable health unless serious questions are answered quickly, and production levels decrease in response to declining payouts. Both industry and political leaders need to become engaged.

The only economics required by this paper is to understand that when the next unit increase in production for a farm (the marginal revenue, MR) returns less than than the cost of its production (its marginal cost, MC) then making that last unit increase loses money. Sometimes a lot of money.

The farm referenced throughout this article is MAF’s average Waikato dairy farm for either 2007 or 2009. The farm is 107 ha, milks a herd of greater than 300 cows and produces between 95,000 and 100,000 Kg of milk solids at a production intensity of between 900 and 950 Kg MS per ha.

Below is the marginal cost curve facing that farm for the current (2009) season:

Figure 1

What does Figure 1 show? It shows conclusively that:

1. Any increase in the level of production on this average Waikato dairy farm will cost more per additional unit than the existing production. Intensifying production comes with increasing, and sometimes steeply increasing, marginal costs.
2. The level of production where marginal costs start to exceed marginal revenue is highly variable depending on revenue - effectively the payout for milk solids (MS)
3. At current costs and conceivable prices, much of the existing high marginal cost dairy production is losing significant money and reducing farm profitability.

What has changed? Excessive production has been common for some time and reasonably accepted by industry and government leaders, but costs have increased dramatically as shown in Figure 2:

Figure 2

The increased costs appear to be worse at higher production intensity. A comparison of marginal costs shows:

Figure 3

The margianl cost curves have changed radically between 2007 and 2009. This has major implications for production levels and associated risk.

The bulk of the operating surplus of a dairy farm comes from the less intensive part of its production. Given that this farm typically has a herd size of 300-320 cows, the following information is of concern:

Table 1

These results are represented in more detail:
Figure 4

Figure 5

Figure 6

The changed nature of dairy farm costs mean there are now steep penalties for excessive production. There is little upside to increasing production, and significant risk if payout may fall. When there is uncertainty around the level of payout, it would appear safer to err on the side of producing at a lower intensity.

MAF forecasts of kilograms of milk solids productiuon per ha for the 2008/09 season are: Northland – 669; Waikato – 906; Taranaki – 938; Lower North Island – 892; Canterbury – 1424 and; Southland – 1152.

If we return to Figure 3, what do the different zones represent? Figure 7 identifies different zones:

Figure 7

1. Pasture is available to meet animal requirements at all times of the year. At some times of the year pasture is surplus and wasted (returned as soil organic matter) or disposed of. This zone represents the clean green image of agriculture we would have the world believe. NZ dairying up till the 1980s.

4. All pasture produced is always consumed in situ. Pasture production is never sufficient to meet animal needs and supplements are used at all times of the year. This is near feedlot production supported by grazing pasture.

2. To increase production additional dry matter is needed at some times of the year. This comes from a range of sources used in decreasing order of cost effectiveness. Competing sources in this zone are moving the availability of dry matter through making silage or the use of nitrogen fertiliser, and purchasing additional grazing off farm. NZ dairying through the 1990s.

3. Any increase in production requires all additional dry matter to be purchased as supplements. Concomittant with that is a decrease in silage made as that pasture is increasingly fed in situ. This represents a cost saving over zone 4.

5. This step represents a change where increasing production requires moving dry matter availability over time through making silage when pasture is surplus.

6. This step is a switch to a quite different system where additional dry matter is purchased as supplements. It is a major transition with matching investment required. It has impacts on management. Required cow genetics change and cow health becomes a bigger issue. Once purchased supplements are available, management of pasture production tends to suffer.

7. This step is the transition away from where farm silage is made to all pasture produced being fed in situ.

It is important to understand that the NZ dairy industry produces 95% commodity products and only 5% fresh. That is unusual as most of the world's dairy production is centred on producing fresh products.

Does it matter? It is critical - generally fresh products are profitable while commodities are produced from surpluses to fresh requirements. Even Australia, another major dairy commodity exporter, has 50% of milk production going into fresh products.

The difference between fresh and commodity milk products is best illustrated by what is seen in the supermarket. The last time I did this exercise fresh milk products were retailing for around $25.00 per Kg MS, and commodities for $15.00. Some examples are simple to calulate: 1 Kg of milk solids requires 12 litres of whole milk; 1 Kg milk solids produces about 1.5 Kg of whole milk powder. Other milk products are more complicated to determine, but the prices for milk solids remain broadly consistent.

There is also a third category of product I will call consumer brands. Anything branded with Nestle will be in the category. These pay approximately $80.00 per Kg MS. Even something like a tube of Nestle’s condensed milk.

The production of dairy commodities requires low production costs – something from the past. The response of the NZ dairy industry to this increasing reality is another subject in its own right.

More detailed analysis of marginal costs and production efficiencies are presented in The Marginal Cow I - Allocative Efficiencies and The Marginal Cow II - Productive Efficiencies

Acknowledgements:
Barrie Ridler of GSL for producing the raw data from which the marginal costs and other curves are constructed.
The Ministry of Agriculture and Fisheries for use of the Waikato Regional Dairy Model.

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