Milk is the new oil thanks to climate change, "free" trade, and biofuels

In a growing world, milk is the new oil
By Wayne Arnold
International Herald Tribune, France
Published: August 31, 2007

HAMILTON, New Zealand: After years of saving, Geoff Irwin finally scraped up enough money to buy his parents' dairy farm near here in 2003. Now his parents have retired to a house nearby and Irwin, 45, runs the farm with its 300 cows.

It is hard work, 12 hours a day, but already it looks as though it has paid off: Just four years later, the farm is worth more than twice what he paid for it. Prices for dairy farms in New Zealand are soaring along with dairy incomes, thanks to a global milk boom.

"It feels really good," Irwin said. "It feels like we're going to be earning and be rewarded the way we should."

Driven by a combination of climate change, trade policies and competition for cattle feed from biofuel producers, global milk prices have doubled over the past two years. In parts of the United States, milk is more expensive than gasoline. There are reports of cows being stolen on Wisconsin dairy farms.

"There's a world shortage of milk," said Philip Goode, manager of international policy at Dairy Australia in Canberra.

But the biggest force driving up milk prices is the same one that has driven up prices for conventional commodities like iron ore and copper: a roaring global economy. Rising incomes, from China and India to Latin America and the Middle East, are lifting millions of people out of poverty and into the middle class.

It turns out that, along with zippy cars and flat-panel TVs, milk is the mark of new money, a significant source of protein that factors into much of any affluent person's diet. Milk goes into infant formulas, chocolates, ice cream and cheese. Most baked goods contain butter, and coffee chains like Starbucks sell more milk than coffee.

Just meeting that demand, according to Alex Duncan, an economist at Fonterra, the dominant dairy cooperative in New Zealand and the world's largest dairy-exporting company, will require the addition each year of the equivalent of New Zealand's entire annual milk output.

That is a lot of milk. New Zealand is one of the world's largest milk producers, according to IFCN Dairy Research Center in Germany, but the largest exporter of dairy products. Some dairy economists doubt the world's heifers are up to the task, and say there is a possibility that the shortage of milk now being seen in parts of the world will spread.

Others say there are plenty of places where more milk can be produced if the price is right. One thing they agree on is that milk prices are likely to stay high and rise even higher.

"No one forecast this rapid shortage of milk," said Torsten Hemme, head of the IFCN center.

This is not good if you are in the market for milk. Pizza parlors and ice cream vendors are raising their prices. Starbucks has raised the price of its drinks. Raising the price of its candy bars didn't stop milk prices from pushing Hershey's profit down 96 percent in its latest financial year. Milk is also weighing on profits at Cadbury Schweppes and at Kraft Foods' cheese unit.

What is unusual, and somewhat confusing, about the milk boom compared with other booming commodities is that milk is not like oil: You can't stick it in barrels and stockpile it. It goes sour. Even in powder form, the most commoditized version, milk has a shelf life. As a result, only about 7 percent of all the milk produced globally is traded across borders. The rest is consumed in domestic markets, which are protected by geography and just as often by tariffs or subsidies.

Big buyers like chocolate makers and grocery stores buy their milk under long-term contracts, and so can smooth out sudden spikes or dips in prices. Thus, the full impact of the global shortage varies from country to country, and not all consumers are yet suffering the full impact.

But because of the local nature of the market, there is very little spare capacity. In the past, the world could always count on the United States and Europe to fill shortages by exporting some of their subsidized stockpiles of cheese, butter and milk powder. But the United States has drawn down its butter mountain and other stockpiles; the same is true of the European Union, which started cutting dairy subsidies in 1993 and will be finished this year. Rising dairy demand in the United States and among the EU's new members, moreover, is sucking up supplies. As a result, said Hemme, "This storage capacity is empty now."

Australia, a major exporter, is suffering a multi-year drought that has devastated its milk production by killing off the grass that milk cows eat. Many in Australia worry that, far from being a temporary problem, the drought is the result of global warming and that dairies will never be the same.

At the same time, rising demand for biofuels is pushing up the price of corn and other grains, which is what farmers in the United States, Europe, Canada and Japan use to feed their cows instead of grass. Rising feed costs are therefore helping to push milk prices even higher. Production is growing in emerging markets like China, but demand there is growing even faster. The average person in China now consumes more than 25 liters, or 6 gallons, of milk a year, up from 9 liters in 2000, according to IFCN. So while China is now one of the world's top milk producers, it is also the world's largest milk importer.

In other emerging markets, rising prices have prompted governments to step in to control prices. In Argentina, for example, the government has imposed a tax on dairy exports. India, the world's largest milk producer, this year banned exports of milk powder.

Rising milk prices are contributing to accelerating inflation worldwide, from Brazil to Australia, vexing policy makers and sparking allegations that there is more behind it than supply and demand. The authorities in South Africa are investing allegations of price-fixing in the country's milk market; in Germany they are looking into the rising prices of milk and butter; and the U.S. Congress has started an inquiry into alleged price-fixing in the nation's market for cheese.

But rising milk prices have not been an unmitigated boon for producers, not even in New Zealand. Payments to farmers here are on track to rise another 24 percent this year, putting an extra $76,000 into the average farmer's pocket. But rising exports, property prices and farm incomes have all contributed to rising inflation in New Zealand, prompting the central bank to push its benchmark interest rate up last month to 8.25 percent. That has helped push the New Zealand dollar to its highest point against the U.S. dollar in 22 years. As it rises, earnings from milk sold abroad decline when converted back into local currency. New Zealand's export boom has also created a labor shortage that is pushing up the cost of hiring farm hands.

Rising costs also hurt New Zealand's ability to increase production in response to rising demand. The country's sheep farmers, for example, are trying to convert to dairy, but there is a two-year waiting list for milking sheds, according to Peter Buckley, president of the Waikato Federated Farmers, which represents farmers in New Zealand's prime dairying area. Higher land costs are also making it more expensive to buy new pastures.

As a result, experts say the growing demand for milk will have to be met in countries like China and Argentina as higher prices trigger greater investment in lifting milk yields. India has announced plans to lift its ban on milk powder exports next month.

Some see the United States as another main source of additional milk supplies. International prices have now risen above the subsidized price of milk there, making it profitable for American dairies to export their milk. "There's a real opportunity for the U.S. to export without government support or subsidies," Goode said.

Hemme at IFCN estimates that both the U.S. Midwest and Europe could multiply their milk production. But it would take one or two years and require using more costly corn and grain. So even if milk supplies keep up with demand, the price will stay high.

"Even when prices start easing back, we don't expect them to go back to where they were," said Hayley Moynihan, a dairy analyst at Rabobank in New Zealand. "The cost of production and ongoing demand is going to see prices eventually settle at higher levels than they did in the past."