Archive: Will an increase in UK retail sales increase farmgate prices?

Published 11 December 14

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As UK farmgate prices are currently under pressure, farmers are rightly wondering how the situation might recover. One question that DairyCo have been asked is how much would UK sales of dairy products need to increase in order for there to be a significant rise in farmgate prices?

 Our commodity dairy product prices are linked to EU and global wholesale markets, through the fact we import and export those products.  Our UK commodity prices will be roughly in line with EU ones otherwise we would be swamped by imports and unable to export.   This can be seen in the graph below with our wholesale prices following EU ones.

EU and UK wholesale and farmgate price trends (2006-14)

UK sales increase 12.14

The farmgate value of milk is linked to the wholesale price of the end product, and most raw milk from GB farms can be switched between different products.

This ability to switch raw milk to different products means natural competition will lead to suppliers facing falling values attempting to undercut existing suppliers in other currently higher value markets.  This would gain them a slightly higher price than staying where they are but leads to lower prices in the new market as suppliers move around or existing ones drop their prices to keep contracts. For example, if the SMP/butter market catches a cold, that cold will spread to cheese markets and to unaligned liquid milk eventually.  This can be seen above with the farmgate price broadly tracking the wholesale market.

The only sector which is partially or totally immune from this is if your end user will guarantee to isolate you from competition and the markets and no undercutting is possible. This is what dedicated liquid milk retail chains do with COP contracts. 

So if UK retail sales went up what would happen?  Could this market mechanism change?

To break the link described above, we have to have very little milk going in to commodity-type products which we either import or export.  At that point there would be minimal link between EU/ world wholesale markets and the UK markets.  The UK farmgate price would be driven by supply and demand for British milk, and if retail demand for liquid milk or British cheese increased, the price for raw milk from farm would increase (if supply remained static). So the question is how much of our milk currently goes in to the commodity markets?  How much extra milk would we have to sell as liquid or branded cheese to break the link? It is a difficult figure to calculate as it is not possible from the data to precisely split all the usages in to the right category.  However, a range of between 4 – 6 billion litres is probably in the right ballpark.  So, as an example, we would have to sell circa 70% more liquid milk to break the link.  Unfortunately although we will continue to see growth in the liquid milk market due to population expansion - it does not seem conceivable that we could see that sort of change in the short term.

Although it is unfortunate, the most likely scenario that will lead to UK farmgate prices recovering is when global demand and supply come in to better balance, possibly in later 2015 – subject to weather in large dairy producing regions and wider economic conditions.  Hopefully when the market does turn we will see prices return to the historic highs we experienced before this year’s crash because global demand is still set to expand.  Although not easy we will need to learn how to better manage this significant volatility we are experiencing.  This might be through having more direct chains or other mechanisms such as futures markets, or putting money away in the good years to see us through the tough ones.