Dairy Industry

“The New Zealand dairy industry has a long history, with the first dairy cow, Shorthorns, introduced into New Zealand in 1814. As the nation developed and with the introduction of refrigeration

in the early 1880s (the first refrigerated meat left New Zealand for England in 1892), small dairy factories began to be built around the country to process butter and

cheese. In September 1872 the first dairy co-operative was started in Otago for the purpose of cheese making. By 1890 there were 150 factories nationwide, 40% being co-operatives. The Dairy Industry Act 1894 brought a regulating system of factory inspections and export quality grading system for milk payment. The number of factories peaked at about 600 in 1920, with around 85% being operated under the co-operative arrangement. With technology improvements, refrigerated transport, and processing efficiencies, the dairy industry experienced continued growth with the merger of small factories and the appearance of larger co-operatives.

Fig 4: New Zealand Dairy Farm

Source: DairyNZ Factsheet

In the late 1990s, four remained: the New Zealand Dairy Group, Kiwi Co-operative Dairies, Westland Milk Products, and Tatua Co-operative Dairy Company. The Dairy Group and Kiwi Co-operative absorbed the New Zealand Dairy Board, and in 2001, became Fonterra Co-operative Group” (The Encyclopedia of New Zealand, 2012).

Other competing dairy producers, websites, the date they were founded, and litres of annual milk production are: Tatua Co-operative Dairy Company (http://www.tatua.com) (1914, 190m litres); Westland Milk Products (http://westland.co.nz) (1937, more than 500m litres); Open Country Dairy Ltd (http://opencountry.co.nz) (2004, 900m litres – the country’s second largest processor); Synlait Milk Ltd (http://www.synlait.com) (2000, more than 500m litres); Miraka Ltd (http://miraka.co.nz) (2011, 210m litres), and New Zealand Dairies Ltd (2006, 150m litres). New Zealand Dairies Ltd went into receivership in June 2012 due to the bankruptcy of its parent Russian owner. Fonterra was given Commerce Commission approval to purchase the assets in September 2012.

“In 2009-10 Fonterra, the country’s leading milk producer, collected 89% of national production but sold 4% to competitors with rights of access to raw milk” (Stringleman, 2011). Fonterra’s global homepage says that it collects about 16 billion litres of milk each year from its farmer shareholders (https://www.fonterra.com/global/en).

An array of safe top quality products are made by the New Zealand dairy industry from grass-fed cows on farms that are highly automated with the latest technology and stringent health and safety standards. Holstein-Friesian is now the prevalent dairy cow breed making up 43% of total dairy cows. Other breeds include Jersey and Ayrshire, plus several other various breeds. Products include whole milk, milk powders, cream,

cheese, butter, protein products (e.g. casein), yoghurt, ice-cream, organic dairy products, and infant formulas. According to Business New Zealand, in 2011 dairy industry exports totaled $12.1 billion making it the country’s largest export earner with approximately 95% of all production being exported. China holds 18% share of exports, with the Philippines, Algeria, Australia, and Saudi Arabia each holding 4% share in 2011. Contributing 25% to New Zealand’s merchandise export earnings, over a third of the world’s dairy trade comes from New Zealand dairy exports. “Key dairy industry facts are outlined as follows:

 For the year ending 30 June 2011, New Zealand dairy farms processed 17.3 billion litres of milk, the average herd size is 386 cows, 24% of herds have more than 500 cows and over 450 of these herds have more than 1,000 cows.

 There were 4.5 million cows being milked in 2011 or an average of 11,658 herds.

 In 2010 there were approximately 1.5 million hectares used for dairy farming.

 On average, New Zealand dairy cows produce 3,800 litres per head per year.

 The majority of dairy herds (76%) are in the North Island, with 30% in the Waikato.

 In 2010, 65% of dairy farmers who invest in farm businesses were owner operators. The remaining 35% have a part share or equity partner.

 For the year ended 30 June 2011, dairy export revenue came from whole milk powder (37%); with the rest comprising butter, AMF (Andhydrous Milk Fat) and cream (18%); cheese (14%); skim milk, buttermilk, powder and infant foods (16%); casein, protein products and albumins (12%); and other dairy products (3%).

 New Zealand produces approximately 2% of total world production of milk at around 16 billion litres per annum.

 Main dairy exports are concentrated milk (58% share), butter (21%), cheese (11%), whey and milk products (6%), and not-concentrated milk (2%) in 2011.

 New Zealand’s cow population is rapidly growing (4.5 million), at a rate faster than the country’s population (4.4 million).

 Approximately 95% of all New Zealand dairy production is exported.

 Dairy production has increased by 77% during the past 20 years”

(http://www.dairynz.co.nz).

According to the Food and Agriculture Organization (FAO) of the United Nations, by country the largest producer and consumer of milk in the world is India with 16% (110 billion litres per annum). More than half or approximately 55% of India’s production is buffalo milk.However, New Zealand is the world’s largest global milk exporter even though it only produces approximately 2% (16 billion litres per annum) of global production. New Zealand milk production per thousand kilograms of milk solids is shown in Appendix 1. “It takes about one kilogram of dry pasture eaten by a cow to produce one kilogram (about a litre) of milk. In New Zealand, cows are generally milked twice a day taking about two hours per milking. Mature cows eat about 17 kilograms of dry pasture each day and drink up to 50 litres of water. Grazed pasture costs less than five cents per kilogram to produce. Including capital farm costs, the cost of producing one litre of milk is 10–12 cents. In 2007/08 New Zealand farmers were paid more than 90 cents per litre” (The Encyclopedia of New Zealand, 2012). To build a complete picture of the New Zealand dairy industry, three areas require additional

commentary. They are (1) an awareness of the median price of a typical dairy farm (a possible entry barrier to many younger generation farmers with aspirations of owning their own farm); (2) factors such as payouts to dairy farmers and the effect profitability may have on their ability to enhance electricity efficiency on the potential for base-load savings through exploring alternative clean energy options; and (3) an analysis of the distribution of dairy farms around the country and what this means for the future of dairying.

The 2008 global financial crisis (GFC) and more recently the European sovereign-debt crisis resulted in significant monetary constraints on all sectors of society. Debt funding is a reality in modern day dairying and it is well known that New Zealand dairy farms are heavily indebted enterprises. Many farmers are servicing too much debt and such pressures, together with sensitivity to interest rate fluctuations has made a profitable lifestyle increasingly difficult for many farmers. Indeed, a number of dairy farmers appear to be relying on future capital gains from farm sales as their primary source of income and financial security over the long-term. “New Zealand dairy farmers had an estimated $10.6 billion of term debt (mostly in mortgages) by the end of the 2002 season. By the end of the 2009 season, this had risen to about $28 billion. The nearly three-fold increase in debt over a mere seven years is cause for concern to the industry.

In the 2009 season, farmers’ interest and rent accounted for 33% of gross farm revenue, up from 12% in the 2002 season” (Morrison, 2010). The risk of lower dairy returns, particularly as a result of increased global competition, will negatively impact on debt servicing and farmer drawings. Put simply, it affects not only farmers’ standard of living but other areas such as the retail sector in rural communities and the New Zealand

economy in general because of a reduction in discretionary spending power. As New Zealand’s top export earner these concerns are critically important. Figure 5 indicates that nearly one-third of dairy farmers’ income will be used to service interest borrowing costs of the 19% of farmers with debt in excess of $30/kgMS.

Figure 5: Closing Term Liabilities per kgMS

Source: DairyNZ Economic Group, 2008-09 Owner Operators

Kilogram of milk solids (kgMS) is the industry standard measurement for determining comparative milk price, payouts from processors to farmers, and milk production output. “Assuming that one cow is milking 25 litres of milk, the fat percentage is 3.85%

and protein is 3.45%. To convert to milk solids, the first step is to convert the litres of milk to kg. The multiplier 1.03 converts litres to kilograms. The example demonstrates that 25 litres x 1.03 equals 25.75kg of milk (5.5 gallons). The next step is to add the fat and protein percentages, i.e. 3.85 + 3.45 = 7.3% solids. Therefore, the fat and protein content of the milk is 7.3% of 25.75kg/day or 1.8kg of milk solids per cow per day”

(Kennedy, 2010). One mechanism of determining the return of capital investment in dairy farm land is to calculate how much milk solids per hectare can be produced, rather than focus on milk per cow. This is achieved by multiplying the stock rate (i.e. three

cows per hectare) by the milk solids per cow. “On average, New Zealand dairy cows produce 3,800 litres per head, which is equal to 10.4 litres of milk per cow per day” (Go Dairy, 2012). The following calculation shows the total milk solids per hectare that a typical New Zealand dairy farm produces. “The average size of a New Zealand dairy farm is 172.2 hectares” (Land Information New Zealand, 2012).

Step 1: 10.4 litres x 1.03 kg = 10.7 kg of milk

Step 2: 10.7 x (3.85 + 3.45) 7.3% = 0.8 kgMS/cow/day (292 kgMS/year) Step 3: 3 cows x 0.8 kgMS = 2.4 kg MS/hectare/cow/day (876 kgMS/year) Step 4: 876 kgMS x 172.2 = 150,847 kgMS

This means the average annual production from an average size dairy farm herd is 150,847kg of milk solids, per hectare (876kg) and per cow (292kg). “Fonterra is revising its milk payout forecast range for the 2012-13 season down 30 cents, to

$5.25/kgMS from $5.50/kg. That means $500 million less for the New Zealand economy than predicted for this dairy season. The opening season forecast was $5.65 -

$5.75 before retentions for a fully shared-up farmer. Westland Milk Products also downgraded its payout forecast earlier this month. The West Coast co-operative is now forecasting a $5.00 - $5.40/kgMS payout instead of a budgeted $5.70 - $6.10. Given farm working expenses before interest and tax were around $4.20/kgMS, Fonterra’s key milk price forecast of $5.25/kgMS leaves little or no free room” (Fox, 2012). For example, using these calculations a typical dairy farmer is left in the following financial position.

Statement of Income Revenue

Sales Revenue – Fonterra $791,946

150,847kg/MS x $5.25/kg

Operating Expenses

COGS, SG&A, Depreciation etc. $633,557

150,847kg/MS x $4.20/kg

Earnings Before Income and Taxes (EBIT) $158,389

Europe’s debt problems continue to affect milk prices for New Zealand farmers. “The final milk price for 2010-11 was $7.60/kgMS with a dividend of $0.65 per share before retentions. Fonterra’s 2011-12 final payout to farmers was $6.40/kgMS, down 19% on the previous year, with the high New Zealand dollar and increased production by other countries having eroded global market returns. This comprised a farm-gate payout of

$6.08/kg for milk solids (down from $7.60 last year) and a $0.32 dividend per share.

New Zealand milk output rose to a record of nearly 1.5 billion kilograms or 11% on the previous year, and Fonterra reported a profit of $642 million for the year to July, despite one-off tax credits of $202 million” (Executive News, 2012).

Some of the smaller dairy co-operatives competing against Fonterra are beginning to make in-roads on increasing production output and farm-gate payouts. “Small Waikato dairy co-operative Tatua has reported a near doubling of profit to $200 million and announced a payout to farmers of $8.00/kgmMS, far above Fonterra’s $6.40 /kgMS”

(Executive News, 2012). Turning to farm ownership affordability, Figure 6 shows that the median sale price for dairy farms as at June 2011 was $30,000 per hectare, considerably lower since the height of around $42,000 in June 2010. Farm sale prices for dairy units are still healthy with a 67% or $12,000 per hectare price difference

premium attainable for dairy farms over all other farm sales as at June 2011. The higher sales price for dairy farms reflects the importance of this industry to the economy.

Figure 6: Farm Sales, Median Price

Source: ANZ, National Bank, REINZ

“Fonterra, New Zealand’s largest co-operative with 10,500 farmer-shareholders, confidently predicts that the Chinese dairy market will treble over the next decade. The dairying regions of Canterbury, Otago and Southland, are growing by as much as 5% a year. In July 2010, China’s Bright Dairy invested $82 million in Canterbury’s Synlait Milk Ltd to expand its milk-processing plant. Fonterra will build a $150 million milk powder plant at Darfield in Canterbury to meet additional future milk volumes” (NZ Listener, 2010). With these factors taken into consideration, a focus of this study will be on exploring how this energy-intensive business can find ways to develop and introduce energy savings tools to reduce

costs and GHG emissions. New initiatives are underway, for example in 2010 a pilot Dairy Energy Action Programme from Fonterra, the Energy Efficiency and Conservation Authority (EECA) and the Ministry of Agriculture and Forestry (MAF) launched a pilot programme over 150 dairy farms, which included an energy audit with the aim of

helping farmers cut their energy spend by at least 10%. This would be worth around

$16 million annually if achieved throughout the sector. “Dairy farms account for nearly 2.5% of the country’s electricity use, with the average dairy farm consuming

Figure 7: Regional Distribution of Dairy Cows 2010-11

Source: DairyNZ

88,000kWh per year (costing around $14,000). A 10% reduction in electricity use and associated CO2 emissions spread across the 150 pilot farms, would deliver annual savings of around $210,000 per year” (Rural Bulletin, 2010). The pilot programme found:

 Dairy farmers could save 16% on power consumption and cost-effective annual energy savings of at least 68.4mkWh in the dairy shed.

 The average farm milking operation, including irrigation, in the sample used 112,100kWh of electricity in the 2009/10 season.

 Water heating accounted for 24% of consumption, water pumping 22%, refrigeration 17% and vacuum pumps 15%.

 Over 70% of savings opportunities relate to water heating and EECA is now looking at how electricity efficiency can be enhanced, primarily by heat recovery technology.

 Farmers in the pilot have been quick to take up savings ideas with 23% already adopting at least one recommendation delivering at least 161,000kWh of total annual savings.

 With 42% of participants reporting they will probably adopt recommendations over the next three years, savings from the audits could rise to 297,000kWh.

 Audits contracted individually can cost between $1,500 and $2,000 so Fonterra is looking at achieving economies of scale by clustering audits in districts to save travel time and costs.

 A post-pilot survey showed 46% of farmers will adopt savings technologies if their costs can be recouped within three years (NZ Energy & Environment Business Week, 2012).

“Energy efficiency usually comes with a very attractive payback. Typically, every dollar invested in an energy audit brings a return of $7.50 in savings” (New Zealand Management, 2011). “What is given by the land should return to the land” is a well-known proverb about showing mutual respect for the land and what it has to offer all living beings. In return, those who reap a living from the land have an obligation to return something to the land and leave it in the same or better condition than when they took control of it. It is encouraging that the dairy sector is beginning to take environmental and sustainable dairy practices seriously by improving energy performance. Fuel cell technology may go some way to help the industry achieve a reduction in operating costs through improved energy efficiencies, a corresponding reduction in CO₂ emissions, and increased stability to energy costs.