Monthly Archives: February 2015

JUST WHAT IS THE COST OF IRISH GRASS-FED MILK?

It was interesting to read the budget for 2015 for the Greenfield demonstration farm in Kilkenny in the Irish Farmers’ Journal this week. It was interesting because this is the farm to demonstrate that the grass-fed model is the way to go when done at scale [about ¾ of an average NZ dairy farm] and carrying heavy debt-for-investment loading.

The following is a summary costs of production from the Greenfield Kilkenny budget for 2015:

–  Variable costs of production – €19.58 per litre

–  Fixed costs of production – €18.19 of which:
      – Labour – all staff-related costs – €5.81
      – Depreciation – machinery/buildings – €4.07
      – Land – rental and leases – €4.34
      – Other fixed costs – €3.95

– Total costs of production are €37.76 per litre

– Capital repayments are €3.80 per litre

There may be some rounding in the above. One also has to be careful not to ‘double-count’ depreciation and capital repayments as the former is not a cash item and is included to account for capital consumption; although the question is whether there is any capital replacement going on whilst the initial debt [which presumably funded the original purchase] is being repaid [it is always difficult working with someone else’s numbers].

It should be noted that this appears to assume that many costs will be [forced] lower in 2015 than 2014. The budget also lists the cost of heifers in the budget as a variable cost without specifying how many. Likewise for livestock sales and how much of that is cull cows; thus not allowing one to work out what the depreciation cost is for the herd.

The above does include all costs and that contrasts to other information that focuses on variable and cash fixed costs and leaves out the farmer’s ‘unpaid’ labour and owned land/infrastructure costs. On this basis the cost per litre figures would be about €0.10 per litre lower [c.€27.5]; probably not atypical for the non-included costs on an average farm.

To relate this to the author’s previous posting on ‘is land and grass the new Irish milk quota?’, it is worth noting that the IFJ states that the farm is targeted at producing 127,185 kg of milk solids in 2015. This compares well to:

 –  New Zealand – 139 tonnes of milk solids and an average herd size of 401 (2012)
 –  Australia – 120 tonnes of milk solids and an average herd size of 240 (2012)
 –  United States – 111 tonnes of milk solids and an average herd size of 170 (2010)
 –  Denmark – 106 tonnes of milk solids and an average herd size of 159 (2013)

To quote from my paper “to return to the figures, what they highlight is the importance of fixed costs … Whereas the emphasis in Ireland is on the low cost of grass as a nutrient source for dairy cows, the author would be focusing more on the fixed costs of production [especially labour] and the sales value of the milk [in that for smaller producers in high labour cost countries it is about being within a supply-chain that sells high-value products to consumers]”.

To quote further:

“In June 2011 a report was published by Teagasc entitled “Study of the International Competitiveness of the Irish Dairy Sector at Farm Level”… [In the following paragraphs direct quotations from the report are presented in italics].

The report first compares Irish dairy production to that in seven pre-eastward expansion EU countries [Belgium, Netherlands, Germany, France, Italy, Denmark and the UK]. It concluded that “the position in relation to Ireland is still positive on a cash costs basis per unit of milk solids, with costs approx. 5 per cent below the average of all countries”. This, however, is based upon cash costs and excludes family labour and any land ownership costs.

Based on the competitive index of total economic costs, which compares Ireland’s position to the average position of the competing countries, Irish dairy farms had costs per unit of milk produced which were only slightly above the average of all countries… Ireland had a relative advantage in terms of particular ‘cash cost’ items, but these particular advantages were outweighed on a total economic cost basis, due to the high imputed cost of owned resources”.

- “The relatively low stocking rates and milk yields per hectare on Irish dairy farms over the period also must be considered as a contributing factor in Irish dairy farming’s high economic costs.

- The competitive advantage of Irish producers deteriorates when all imputed charges for owned resources [family labour and land costs – author’s note] are taken into consideration.

- On a full economic cost basis, high land prices are seen to adversely affect the competitiveness of Ireland

While the Irish dairy sector has low cash costs of production, it is also characterised by relatively low productivity in terms of labour, milk yields and constituents. Land costs, as measured by land rental values are high in Ireland and are a key reason why the competitive position of the Irish dairy sector is less favourable on a total economic cost basis”.

The report then went onto look at how Ireland compares against global players including NZ, Australia and the USA.

It appears that for the period 2008-2010, the competitive position for Irish dairy farms outside the EU15 was very positive when cash costs were considered in isolation from imputed charges for owned resources…This result is consistent with previous research… However, as the opportunity costs of owned resources are not included in this calculation this indication of future competitiveness can only be considered to be valid in the short to medium term. In the longer term adjustment within the sectors will be a reality. Hence, total economic costs, which include imputed charges for owned resources must be considered to gauge the longer term ability of Irish dairy farmers to compete on a global scale”.

With land and family labour costs imputed the following is concluded. “On a full economic cost basis the smaller 48 cow Irish farm ranks poorly among the countries considered. On a full economic cost basis the competitive position of Irish farms deteriorates, but the larger Irish 110 cow farm still ranks well… The lowest per unit total economic costs were shown to be in Argentina Australia and New Zealand for the period 2008-2010…On a total economic cost basis, the average size Irish dairy farm… had costs well in excess of some of the major dairy exporting regions of the world.
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When economic costs are considered, the competitive ranking of the Irish dairy sector and of the average size farm in particular, slips relative to the other countries examined… this finding could also be considered as a warning signal for the future competitive performance for the average sized Irish dairy farm in a global environment.”

Furthermore, if Irish dairy farming transforms to larger scale production units in a no quota situation and significant scale economies are achieved, the Irish milk sectors competitive position will be strengthened”.

A few thoughts to come out of this research include:

- Is it safe to conclude that the Irish dairy industry can compete globally so long as there is a very significant move towards consolidation? Just where will this leave the traditional, ‘average’ Irish dairy farm?

- Can Ireland with its highly fragmented land based actually achieve the dairy farm consolidation required?

- Recent 3.5% p.a. rates of expansion will only increase the average Irish dairy herd to 77 cows.

- Even with much faster expansion, will both global and EU competitors continue to expand at least as rapidly?

- In terms of its labour usage, all fixed costs and land costs, will Ireland with its focus on lower milk yields per cow from grass be able to compete on a total economic cost basis into the long-term?” [end of quotation]

The question is; does the budget from the Greenfield Kilkenny farm provide any reason for questioning the findings of the above Teagasc report on the competitiveness of Irish dairy farms; not least given that the Greenfield farm is operating at a scale that is going to be unachievable as an average dairy farming unit in Ireland [and it is still below that in New Zealand]? If not, how does this bode for the major processing investments made in Ireland to process ‘new’, post-2015 milk that appear to assume that Ireland is a highly-competitive, low-cost milk-producer?

The author’s paper on ‘is land and grass the new Irish milk quota?’ then goes onto look at the possible costs of milk production under various expansion / investment scenarios. [it is available as a download from the Agrifood Solutions Blog]. By and large, the total production costs given in the author’s paper are not out of line with the Greenfield farm budget; if anything that could be a little lower [they are also reliant on the accuracy of other published sources].

The following is, however, some of the conclusions. Does the Greenfield farm data contradict these? To quote:

“The author’s research suggests that there is a major issue concerning just how competitive the Irish grass-fed model is both within Europe and globally. Apparently, this conclusion is actually nothing new. More recently it appears that too much credence has been given to the low variable costs associated with grass-based systems [because grass is cheap] and too little has been given to the full costs of production. Further grass-cereal comparison may well have placed too much faith in cereal prices staying closer to their highs of recent years. Overall the major cost issues are:

 – the total cost of labour per litre that is a consequence of small Irish herd size
 – the extra capital expenditure required to expand and increase stocking rates
 – the fragmented land structure and consequentially small milking platforms
 – the rental or purchase cost of removing the land constraints on scaling-up
 – the difficulties associated with the massive degree of scaling-up required

The model is limited by grass availability but it is also limited by seasonality in terms of its capability to provide milk for a wide range of products that could increase the value of the milk ex-farm. If anything, recent developments within the dairy farming sector years are promoting more, not less, seasonality. It is about chasing spring grass. This has been further embedded by processing investments that are focused on processing more peak season milk.

Ultimately, the question is whether milk from the Irish grass-fed model will be able to compete globally against NZ’s scale and against others who are operating with average long-term grain prices that may trend upwards by, say, only 2% per annum? It should also be remembered that many commodity-focused producers operate off large-scale production units [whilst their smaller-scale farmers supply the more ‘artisan’ sector]. Ireland, by contrast, is trying to compete with them with a farm-scale that is more typical of other’s artisan product supply-chains” [end of quote].

And finally, does the Greenfield demonstration farm illustrate the cost implications of scaling-up the grass-fed model within Ireland’s unique land holding structures? Likewise, does it illustrate the implications for investing heavily in a country that has high-costs in terms of unit labour costs and, more generally, other fixed-cost factors of production?

A point the author also made in his earlier paper was that there is a difference between a ‘natural’ evolution and a ‘forced’ expansion. The latter was envisaged within Food Harvest 2020 based upon the idea that there would be an irresistible desire for dairy farmers to throw off the shackles of milk quotas [whereby the argument is that land and grass will actually now become the over-riding ‘quotas’ operating in Ireland and that they (due to the use of the grass-fed model) will be nearly as constraining as quotas were themselves; not least when considered in the context of the high capital and land rental costs associated with removing them]. Typically, expansion has happened over time and at a pace that the farmer chooses. It certainly happened within the context of affordable land acquisition and gradual investment that gave due consideration to debt loading [and the risks associated with such] and market volatility.

The major plus to the end of quotas is that it provides farmers with a greater degree of freedom to make their own decisions. One would be surprised if milk production does not rise post quota but for many farmers it will be a gradual process that allows for the rearing of additional cows and improving grassland by reseeding, drainage and improving access. It will be about making better use of the resources they have first rather than major expansion investment. In other words they will favour a more ‘natural’ evolution to expand post quota, regardless of the impacts this may have on a wider dairy industry that has invested in the expectation that expansion will be rather more dramatic.

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ARE LAND AND GRASS THE NEW IRISH MILK QUOTAS?

The full paper can be downloaded as a pdf.

Are land and grass the new Irish milk quotas

As one often reads about how robust the Irish grass-fed dairy-farming model is and how competitive the industry is as a consequence, the author decided to investigate further. It is an idea that underpins the strategic and technical direction of the industry so one would assume that this most basic of assumptions has been verified; not least when it comes to creating a vision for the future in light of the most significant dairy industry policy change in three decades.

A starting point was to revisit some information that was used in the author’s review of Food Harvest 2020. It looked at the quantity of milk solids produced per farm across a few important milk producing nations. As expected, Ireland’s smaller herd size and grass-fed milk yields place it well below New Zealand, Denmark, the USA and the UK. Further, when labour use was factored in, Ireland was well below other exporting nations. Clearly labour costs are an issue.

One was aware that international comparisons have been based upon the variable costs of production plus the fixed costs that are cash items. They often exclude family labour and land ownership costs. The former is invariably paid [as monthly drawings from profits] and the latter is ignored unless an imputed rent or return on capital is factored into the equation. The omission of farmer remuneration and a return on some capital creates the ‘robust’ impression.

This is, apparently, nothing new. A Teagasc review of the international competitiveness of the dairy sector was fairly recently completed; albeit after the publication of FH2020 [even though one would have expected this work to have been completed before the FH2020 targets were set]. This review highlighted that, whilst being competitive in terms of cash costs, Ireland’s high labour and land costs made it no more than average on a full-cost basis. A further factor in the last five years has been a high cost of grains relative to grass and this will have emphasised the advantage of grass-fed milk systems. We are now seeing the opposite side of the coin with currently lower cereal prices.

New Zealand has, nevertheless, developed a cost advantage from its grass-fed systems but it has been done on the back of scale. Whilst New Zealand’s traditional dairy regions enjoy herd-size advantages over Ireland, it has been the development of South Island dairying that sets it apart. The region has seen dairy expansion and at a scale that, at times, delivers output levels that are many times those of an Irish dairy farm. Crucially they are investing in dryers and targeting similar global export markets. It is these investments that Ireland’s ‘new’ milk will be competing with.

What is recognized by the author’s finding [and others] is that when scale is achieved the Irish grass-fed model can be competitive; but it means doubling the average herd size in Ireland. Is it achievable? If it can be done the reduction in average fixed costs, including all labour and capital costs, will mean a competitive total cost of milk production.

The conundrum is how to do this in light of a fragmented, ‘immobile’ land structure. The Irish farmer also faces some of the highest rental and land purchase costs anywhere and, realistically, the cost of removing these land access constraints is so high that the cost alone can significantly increase production costs. As lands for grass is crucial to the grass-based system, it is land access and, hence, grass that is going to be acting, post 2015, as the new ‘milk’ quota. Increasing stocking rate may be a partial answer, but that also incur capital costs and that acts as another constraint.

Various approaches have been used to assess the economics and the industry’s competitiveness. The findings are by-and-large consistent. They also suggest that a milk price recovery will be vital to the expansion plans of the overall industry. Coming up short will probably have consequences across the industry and these are discussed in the second part of this paper along with some strategic issues that may arise if the rate of expansion has been over-estimated.