Learning from the dairy crises

In the past 10 years there have been 2 crises in the dairy market. The first took place in 2009, when prices plummeted to a low point. From November 2007 to May 2009, the farm price in the European Union (EU) fell by more than 50%. Things went wrong again after 2013; from November 2013 to July 2016, the price fell again by more than 50% and was below the long-term trend price.

The causes of the crises were very different. During the first crisis, the demand for food suffered a setback from the financial crisis in 2008 and that led to a drop in demand in the market. The reason for the second crisis was the import ban imposed by Russia on European agricultural products as a result of the crisis surrounding Ukraine. But the real causes lay even deeper. The first crisis was preceded by a high price spike, as a result of strong demand (mainly from China).

The second crisis was also preceded by a large price peak. However, this was followed by strong production growth in the EU, partly in response to the abolition of the milk quota. When the demand for products in Asia (particularly China) subsequently fell, the dairy market went into a down mood and a supply surplus arose; again resulting in extremely low prices.

Adverse reaction from dairy farmers
It is striking that prices fell, but that this did not lead to a decrease in European milk production. Economists call this an 'adverse supply response'. You usually expect rising prices to increase supply and low prices to do the opposite, but that didn't happen. What will have played a part in this is the fact that the milk price was high prior to the crises. The rapid ramp-up of production meant that the crises were further deepened. You could say: high peaks lead to deep troughs.

The EU tried to help dairy farmers through various measures (such as buying up intervention stocks and special aid packages). Initially, these seemed to help little, because the milk price remained low and even fell below the safety net level in the Baltic Member States. One of the last measures of the European Commission (EC) was to pay farmers money if they voluntarily produced less. According to some, this was effective and partly led to a turning point in the crisis and a cautious recovery in prices.

Learning from the crises
What lessons can be drawn from the experiences? First of all, that a crisis situation does not have to be far away. We've had 10 of these in 2 years now. They were extreme, but in less extreme form they are even more common. Every year, approximately 30% of farmers and market gardeners in the EU experience a drop in yields of 20% or more. Agricultural markets are volatile and it is the farmer who bears the price risk.

Also, the weather conditions are different every year and due to climate change they are becoming more and more irregular, with more extremes. Drought is an example of this, also in 2018. The difference between a deficit and surplus is often small. Sometimes it's not too bad; the outlook for the 2018 dairy market around this time last year seemed worse than actual practice has shown.

A second lesson is that the farmers initially seem to react 'the opposite'. They try to maintain their 'cash flow' and are more likely to produce more than less. This does not only happen in the Netherlands, but in almost all member states (except France, Greece and Croatia). The third lesson is that policymakers try to help when there is an extreme crisis, but that Brussels is no longer able to solve the problems for dairy farmers.

Risk management and liquidity management as a strategy
Crises are painful and therefore require sufficient resilience from companies. Risk management and liquidity management are becoming increasingly important for sound business operations. Increasing production when prices are low is probably not a smart collective strategy. It can work temporarily for individual companies, but if it lasts too long or the crisis gets too severe, it can also go wrong and get companies into trouble.

Since 2017, ABN Amro, together with Wageningen Economic Research (WUR), has been reporting the liquidity barometer every quarter. We do this for dairy farming, but also for other sectors. We hope this will provide entrepreneurs with insight and support in managing their liquidities. The margins in the sector are narrow and the step from 'current account growth' to 'current account contraction' has been made quickly.

Roel Jongeneel is senior expert Scientist and Market Outlook at Wageningen Economic Research (the former LEI). Pierre Berntsen is director Agricultural Companies at ABN Amro.

Pierre Berntsen

Pierre Berntsen is director Agricultural Companies at ABN Amro. Through his work, he has a lot of experience in translating sector developments into business development in the agricultural sector and agribusiness.

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