Chinese dairy export window of opportunity open

The demand for dairy imports in China is forecast to grow for at least the next two years, a new Rabobank report says. According to the report, the demand comes as local milk production struggles under structural change in the supply chain.

The report, China’s Raw Milk Supply: Still Dreaming of a White River, says that China - the world’s largest dairy importer - is expected to be one of the key drivers of global dairy consumption growth over the next decade.

Imported dairy products and ingredients will continue to play an increasing role in fulfilling Chinese market requirements, the report says, despite the fast pace of development of China’s own dairy farm systems.

Co-author of the report Hayley Moynihan, Rabobank Director of Dairy Research, says China’s milk supply chain is rapidly changing, with the development of large-scale dairy farms accelerating since 2008.

At the same time, ‘backyard’ dairy farming has declined, primarily due to inconsistent milk quality and regulatory pressures.

“Milk production in China is struggling to grow as a result of small-scale farmers exiting the industry and large-scale farms still being under development,” Moynihan said. “And it is likely to be at least two to three years before the pace of large-scale dairy farm expansion in China outweighs the current contraction in ‘backyard’ sources and leads to a reduction in import growth.”

The country’s reliance on dairy imports has grown by 20 to 30% per annum in the past two years, Moynihan says. China is now expected to import almost 20% of its milk products to satisfy current domestic demand.

“The surge in Chinese buying in a shrinking global supply pool of dairy has squeezed out many other buyers and held dairy prices at high levels,” Moynihan said.

“Even when that rate of growth in imports slows, China will remain a major consumer of global dairy exports.”

While just over 80% of the Chinese dairy market is still supplied by domestic milk production, this domestic supply remains under-developed with about 60% originating from small-scale dairy farmers operating with fewer than 100 cows per farm, according to Rabobank’s Shanghai-based senior dairy analyst Sandy Chen.

Milk quality from these small-scale producers has been inconsistent, however, Chen says. In addition, milk from small producers is ‘pooled’ at collection stations that act as middle men with processors providing infrastructure, organising logistics and aggregating milk volumes.

“This structure has also heightened food safety risks along the supply chain,” Chen said.

In the aftermath of the melamine crisis, however, the Chinese government has taken steps to resolve supply chain issues and strengthen raw milk quality control. Chief among these has been the introduction of a licensing and review system for milk collection. The enforcement of this has discouraged the collection of raw milk with poor-quality consistency, especially from backyard operators.

“This difficulty, combined with the production costs of feed and labour surging faster than raw milk price increases, has forced many backyard farmers out of the market,” Chen said.

At the other end of the spectrum, the focus on milk quality in China has favoured the rise of large-scale dairy farms, accelerating their rate of growth.

“The share of production of large-scale farms, with more than 500 cows, grew rapidly from 17% of total milk production in 2008 to 27% in 2011,” Chen said.

However, Chen says, the supply from newly established, large, organised dairy farms is still at an early stage and has been unable to fully offset the reduction in supply from the exit of backyard farms.

“It is this situation which is resulting in an expanding gap between the annual supply and demand for dairy in China - from below 5% in the pre-melamine crisis years to an estimated 18% as of 2013, which is being filled by imported product,” Chen said.

For exporters to China, the window for trade opportunity is likely to remain wide open for some time, Moyhnihan says.

“And the willingness of Chinese commodity buyers to pay higher than historical average prices to source product on the world market is likely to persist, as long as this remains competitive when compared with sourcing locally from high-quality milk,” Moynihan said.

However, the Rabobank report warns, demand growth is expected to prompt Chinese buyers to seek out more diverse import options, instead of continuing to rely on one or two key product origins, such as Australia.

“And it is important to recognise that the tide of local milk production will eventually rise over time and compete more strongly with imported product, albeit at a relatively high price point due to local production costs,” Moynihan said.