RaboResearch Food & Agribusiness February 2017

New Zealand

Agribusiness Outlook 2017

NZ Agriculture Faces a 'Moment of Truth' in 2017

An industry traditionally characterised by a liberal operating environment, and a key beneficiary of several decades of a global shift to freer trade, faces a period of heightened regulatory uncertainty and change on both fronts.

2017 has ushered in a period of considerable change and uncertainty for NZ agriculture, much of which will impact the operating environment which has shaped the industry.

• A shift to global protectionism: The election of Trump has effectively ended hopes for a TPP agreement in its current form, and brings the risk of escalation of the trend of rising protectionism already evident in many parts of the world throughout the last few years.

• With TPP off the table, the importance of negotiating an improved FTA with China (first round of discussions due in the first half of 2017) becomes all the more important, while discussions for an FTA with the EU and the UK will likely commence.

• At home, environmental regulations will continue to tighten, with significant plan changes in the Waikato and Southland regions having the potential to increase costs and restrict intensification in 2017 and beyond.

• 2017 will also see a general election, the results of which look less certain following the resignation of popular PM John Key in December 2016. Environmental regulation, greenhouse gas liabilities, resource use taxes, use of GE and rules around foreign investment could all potentially become election issues, and may be subject to change should a coalition including Labour, NZ First and the Green Party win government.

New Zealand’s agricultural industry has the chance to influence all of the above in some form. How it navigates through this period will go a long way to shaping its prospects for many years to come.

In the meantime, the raft of changes and heightened uncertainty will come on top of the usual risks that characterise the market environment for agriculture, including volatile prices, adverse weather and geopolitical events. As such, the case for cautious investment in agriculture is stronger than usual in 2017.

What to watch

• We will learn a lot about the appetite of NZ dairy farmers to invest further in expansion when the 2017/18 season gets underway. Farmers will likely be looking at a profitable season, but may choose to prioritise debt repayment, particularly given the uncertainties noted.

• The potential for recent corporate changes in the animal protein sector to trigger structural change in the processing sector. Optimists see plant rationalisation and improved access to China yielding ongoing benefits for suppliers. Others are concerned that cooperative principles may erode.

Sector Driver

DairyMarket fundamentals will support further commodity market recovery in 2017. Rising farmgate milk prices will help the industry to move on from two difficult seasons, though a slower growth era awaits.

BeefRecord global beef production in 2017 will see weaker world beef prices translate into downward pressure on New Zealand cattle and export prices.

Sheepmeat While we expect Chinese demand to be strong, and better in market prices for certain cuts in the UK and EU markets, the strong NZD is going to be the major headwind for greater returns during 2017.

WoolImprovement in crossbred wool prices is unlikely through the first half of 2017, as production volumes swell seasonally and Chinese buyers remain quiet.

Horticulture Another strong year of production and export growth is expected from New Zealand’s leading horticulture export industries in 2017.

Wine Given the stable outlook for production in 2017, and ample wine company inventory for the current demand trajectory, wine grape pricing is expected to hold steady in the coming year.

Fertiliser Rising global prices have seen retail prices start to increase with potentially more upside to come in 2017.

FX We forecast the NZD/USD falling towards 0.69 on a 12-month view as fiscal stimuli in the US become a reality.

Commodity outlook

There is a chance of above-average temperatures for the east of both Islands and the top of the North Island through to March 2017. The rest of the country can expect average temperatures across the same period.

Rainfall for the three months to March 2017 looks equally likely to be either in the average or below-average range for the North Island and the top of the South Island. The remainder of the South Island is likely to receive normal rainfall.

Soil moisture levels are likely to be below-normal for the top of the North Island through to March 2017. The remainder of the North Island has an equal chance of having normal or below-normal soil moisture levels, along with the east coast of the South Island. The rest of the South Island is likely to have normal soil moisture levels.

Climate

What-to-watch

• The impact of dry conditions on supplementary feed prices in the North Island. The wet spring resulted in plentiful feed availability earlier in the season but with expectations for dry conditions to continue, particularly for the top of the North Island, prices will change direction.

• At the other end of the scale, farmers further south will be on the look-out for warmer days. The run of cold weather over the last month has made weight gains challenging for finishing stock, particularly for lamb.

Source: NIWA, Rabobank 2017

Soil moisture anomaly (mm), 22 January 2017

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Dairy

A Much Needed Upturn for ProducersFarmgate margins for dairy farmers will improve through 2017. There is scope for higher farmgateprices in the back half of the 2016/17 milk production season as global supply struggles to recover lost ground, leading to a return to profitability.

The latter half of 2017 will see a lift in milk production as profit margins are restored. With farmers back in the black, milk production will return to growth—weather conditions dependent. However, the level of milk production growth in 2H 2017 will be dependent on strategic decisions made in the coming months. With many farmers having accessed additional working capital over the past 18 months to manage reduced margins, and bearing in mind that commodity price volatility is here to stay, farmers will have to decide between paying down debt versus investing for growth.

Furthermore, the 2017/18 season will bear witness to the beginning of a new era for New Zealand dairy: a slower rate of milk production growth emerges. Constraints through increasing environmental regulation, the availability of resources and increasing social pressures on farming practices will hamper milk production growth in 2017 and beyond.

Dairy processors will enjoy selling into a rising market, hence are eager to maintain milk supply share. The processing sector continues to evolve with additional capacity upgrades and new processing facilities to be commissioned in 2017, leading to increased competition for milk supply.

What to watch• The General Election in the second half of 2017. Capital gains tax, new environmental regulations

and overseas investment are likely hot topics of debate, with the direct impact and effect on the dairy sector dependent on the winning party.

• China-New Zealand FTA upgrade. In particular, an increase to the ‘safeguard’ level for dairy products imported into China on a lower tariff rate as part of the transition to complete tariff elimination in 2024 would be a boon to the industry.

A Supply Crunch is Driving a Price Recovery

Global dairy prices

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The biggest driver of the recovery so far has been a supply contraction across the major dairy export regions. This will continue through the first half of 2017; with support from improved import demand in some regions, including China. Rabobank sees further upside in the current upswing; however, the scope for further gains is somewhat limited, and with different dynamics at play across the commodity complex.

Beef

Global Supply PressuresThe New Zealand cattle industry is likely to be challenged by record global beef production in 2017, which will see weaker global beef prices translate into downward pressure on New Zealand cattle and export prices.

Countering this expected global supply increase is a recovery in New Zealand cattle supplies, as well as our expectations of further herd rebuilding from Australia, which should provide some support to prices. Rabobank forecasts total cattle production in 2017 to decline by 2% YOY, to around 600,000 tonnes cwt and while we expect higher average carcass weights to partly offset the fall, lower cow slaughter compared to the past two seasons is likely to underpin the decline.

New Zealand cattle slaughter since the start of the 2016/17 season (Oct – Dec) is tracking 12% or around 60,000 head lower YOY, with cow slaughter (down 23% YOY) underpinning this decline. The lower supply is supporting prices, with the NI bull price averaging NZD 5 kg/cwt as at mid January, although the big headwind remains the key US export market. With beef production in 2016 increasing around 5% YOY and forecast 2.5%-3.5% growth in 2017, as well as increases in pork and poultry production, animal protein supply pressures are clearly evident.

What to watch• Beef and veal production in Australia will again contract in 2017 after a significant drop to

2.1m tonnes in 2016 from the drought-induced near-record beef production of 2.5m tonnes in 2015. This reduced competition in key exports will help support demand for NZ beef.

• Growing presence of South American beef. Increasing market share and improved market access, particularly of Brazilian beef, is challenging NZ competitiveness in key export markets. Brazilian exports are forecast to reach 2m tonnes in 2017—the highest level since 2007. Furthermore, it is expected that Brazil will try and open other markets such as Japan and Korea.

NZ and AU Beef Production to Contract and Chinese Beef Market Returns under Pressure

Chinese beef imports and average import price

Source: MLA, GTA, Rabobank 2017Source: Stats NZ, MLA and Rabobank forecasts 2017

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Sheepmeat

Mixed Drivers for Lamb MarketHeading into the 2017 season, demand fundamentals are looking more positive compared to the previous year and encouraging seasonal conditions in most regions are also helping. However, the strong currency relative to other key export markets, notably the UK and EU, is expected to be the major impediment to improved returns in 2017.

A slow start to the 2016/17 season from a slaughter perspective has provided some support to farmgate prices. Between October and the end of December, slaughter is back around 12% or 600,000 head YOY. For the 2016/17 season, Beef and Lamb NZ forecast export lamb slaughter to decline 1.8% YOY, to 19.5 million head. This is a reflection of a 2.4% fall in the lamb crop and an increase in retention of lambs, which should support steady sheep numbers in 2017.

The reduced domestic supply will drive greater procurement pressures, but any notable farmgate or export price improvement will be largely determined by export demand and currency movements. While Chinese demand is forecast to be strong following a few seasons of high inventory levels, as well as better market prices for certain cuts in the UK and the EU market, the strong NZD is going to be the major headwind for greater returns during 2017. As at 24 January, the NZD/USD and NZD/EUR are both 12% higher YOY, while NZD/GBP has surged 27% over the same period.

What to watch• UK market. UK demand for NZ lamb is expected to be weaker in 2017 given a combination of

an expected 2% increase in lamb production in 2017 and a weak currency (making NZ imports less competitive). As a result, total EU quota fulfillment is likely to fall after rising to 76% in 2016—from a low of 68% in 2014.

• Australian supply forecast to contract in 2017. MLA forecast a 2% YOY fall in lamb slaughter (and production) as a result of fewer lambs available from fewer ewes available. Exports, however, are likely to decline 4% YOY as a result of strong AU domestic consumption—somewhat helping to reduce competition for NZ lamb.

High Currency Limiting Returns, Lamb Slaughter to Contract

New Zealand dollar indexed

Source: RBNZ, Rabobank 2017 Source: NZ Meat Board, Beef and Lamb NZ, Rabobank 2017

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Wool

Swings and Roundabouts For WoolFollowing two strong seasons, the first half of 2016/17 has been a tough one for New Zealand crossbred woolgrowers, with the fine and coarse crossbred indicators both dropping to multi-year lows. Improvement is unlikely through the first half of 2017. Production volumes will swell seasonally and crossbred stocks in China are reported to remain high, with buyers both selective and quiet.

The 2016/17 season’s auction clearance rate has averaged 75% to December compared with 90% over the same period in 2015. Lack of Chinese buying has been a major factor in the poorer clearance rates, evident also in the export figures, which show a 49% YOY decline in volumes shipped to New Zealand’s largest market (Jul-Oct). With Beef and Lamb NZ forecasting steady production in 2016/17, stocks are likely to build locally if low prices persist.

China’s demand for merino wool has been a different story. Imports from Australia and South Africa are up YOY. Prices continue to strengthen as a result, providing encouragement for New Zealand merino growers.

The Australian Eastern Market Indicator lifted to a record high in January as strong gains were achieved from 17-24micron. While supply of superfine types has been falling, which is expected to continue, mid-micron merino has seen a boost as the season has improved. Overall, a modest 2.2% forecast lift in supply, following last season’s 6% fall, should help to support fine wool prices.

What to watch

• The merger of Cavalier and NZWSI scouring has overcome its final appeal hurdle, with Godfrey Hirst announcing they will not be pursuing any more action to stop the merger. With 73% of New Zealand’s wool exported as scoured wool, the success of this business is crucial for wool exports.

Soft Demand to Present Challenges For Crossbred Wool in 2017

Source: Beef and Lamb New Zealand, Rabobank 2017

Average crossbred wool indicators have seen a swift decline following two strong seasons

China’s share of New Zealand exports continues to slide in 2016/17

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Horticulture

Full Steam AheadAnother strong year of production and export growth is expected from New Zealand’s leading horticulture export industries in 2017, which in many cases comes hot on the heels of record production and earnings in the year just gone.

Avocado producers are completing their biggest ever harvest, which has been met with strong demand and pricing. Meanwhile, apple growers are gearing up to harvest another record crop, estimated at 21.5 million cartons this summer. For the kiwifruit industry, production of gold kiwifruit is set to continue to climb strongly as new orchards mature and PSA-related disease pressures are muted by a relatively dry growing season thus far. Given recent strong export pricing for SunGold, this should go a long way to compensating for significantly lower volumes of green kiwifruit in 2017.

Rising demand from Asian markets continues to be the primary source of growth for New Zealand’s horticulture exports, with Free Trade Agreements assisting to bolster competitiveness and terms of trade. Beyond the major fruit export crops, other industries such as processed potatoes and fresh onions are capitalising on market development efforts in South-East Asia, delivering much needed demand and diversification away from traditional markets in Europe and Australia.

Investment continues to flow into the principal New Zealand horticulture sectors. Consolidation in the apple post-harvest sector is advancing, while the planting/re-planting of new orchards is directed towards meeting the demands of new export markets. Kiwifruit orchard values have been rising to record levels, with proposed new tenders of SunGold production licences likely to be hotly contested.

What to watch NZD 3 billion. New Zealand fruit exports increased by 17.7% in value to NZD 2.723 billion in

the 12 months to November 2016. Given the growth anticipated in apple and gold kiwifruit production in the coming year, a successful marketing year will bring the NZD 3 billion mark well within reach, especially with some help from other fruit industries such as cherries and berries. Higher volumes will always make maintaining export prices a challenge without some added help from a lower New Zealand dollar.

Fruit Exports Edge Up towards NZD 3 billion

Source: Statistics NZ, Rabobank 2017

Following a long period of stagnation, fruit exports have surged in recent years, as investment has been directed to meeting new demand in Asian markets and the kiwifruit sector has recovered from the PSA outbreak.

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Wine

What to watch ‘Premiumisation’ in the US market. For five years now, growth in the US wine market has

steadily trended towards more premium price points, very much assisting the growth of New Zealand wines in the market given their more premium price positioning. While it must be said that New Zealand wines are in demand for more reasons than simply their price, there are growing reasons to question how long this ‘premiumisation’ trend can endure, especially in the absence of a more broad-based recovery in US wages growth.

A Year to Take StockGiven the stable outlook for production in 2017, and wine company inventory still ample for the current demand trajectory, wine grape pricing is expected to hold steady in the coming year.

The Kaikoura earthquake on 14 November 2016 struck a little too close to home for many Marlborough wine producers. An estimated 20 percent of storage capacity was damaged in the event. While the majority of repairs will be completed in time for harvest, it is expected that some wine companies will be left to operate at below full capacity.

At this early stage, yields of sauvignon blanc across the Marlborough region appear to be tracking around average levels, which still might require earthquake affected wineries to source some alternative means of processing. Across other New Zealand wine growing regions, spring/early summer growing conditions have been generally favourable, despite what has been a cooler start to summer, with nothing to suggest any major deviation from average vineyard yields.

Global shipments of New Zealand wine have continued to follow a steady upward trajectory as volumes from the large 2016 harvest have become available to meet demand, particularly from North American markets. For wine companies, average export prices have been falling back over the past six months from what were elevated levels, with some room still to go unless further assistance from a significantly lower New Zealand dollar is forthcoming.

Source: NZ Winegrowers, Rabobank 2017

Average Wine Grape Prices to Hold Steady

Average wine grape prices might need at least another year before again testing their pre-GFC highs.

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Fertiliser

Retail Prices Beginning to RiseFrom late 2016, global urea prices are starting to show some signs of life, having spent 12 months weighed down by excess supply and sluggish demand. A subtle shift in supply and demand fundamentals and rising raw material costs, have been the main driving forces. Global prices for the other main nutrients have so far largely remained unchanged with markets well-supplied.

The likelihood of a major spike in global fertiliser prices in 2017 is low, with the recovery challenged by headwinds. Most crop prices are expected to remain depressed through 2017, leading to sluggish global demand for inputs. Also, excess inventories still exist in some regions. Nevertheless, global fertiliser markets have bottomed, and as a rebalance occurs and raw materials prices rise, nutrient markets could shift higher.

Global pricing dynamics kept fertiliser affordable for New Zealand agricultural producers but the challenges facing the New Zealand dairy sector did lead to sluggish local demand. Retail prices have already increased marginally to reflect global price movements, and will continue to move in line with global markets and (possible) shifts in the New Zealand dollar.

As always, the timing of farmgate purchases for the 2017 season will be important given the lead times required to import product and to ensure adequate product availability. Dairy farmers are likely to be in a better financial position which will underpin an improvement in demand for inputs.

What to watch• The biggest driver of local retail prices is still likely to be movements in currency and

freight rates. If the local currency drifts lower, as many expect, and freight rates improve, retail prices will be driven higher.

• Four major takeovers/mergers have been announced across the global farm inputs sector in the past two years. As the deals progress there will be implications for all value-chain participants. For farmers, industry consolidation could deliver new products and services.

Global urea prices have been the first to bounce. There is potential for further price recovery in the coming 12 months but global markets look more likely to be well-supplied due to sluggish demand, further capacity additions and high inventories leading to minimal price rises.

Global Markets to Remain Well Balanced

Source: Bloomberg , Rabobank 2017

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Rates & FX

What to watch

Going Up?The Reserve Bank of New Zealand’s cash rate is unlikely to move any lower in 2017. In fact, the Reserve Bank remains somewhat predisposed to raising rates to keep key risks in check.

Another year on, and considerable uncertainties still cloud the horizon of the global economic outlook, led by the prospect of the new Trump Administration upsetting the global trade apple cart vis-à-vis China—New Zealand’s largest trading partner. While more details are coming to light following President Trump’s inauguration, the difficulty in getting a handle on policies and their likely impacts threatens to create an elevated degree of volatility in US dollar cross rates and financial markets over the first half of the year. The same applies to Brexit and the British pound.

Assuming the status quo holds to a large extent, which is all that we can do at this stage, the progress that the US economy made last year and the degree to which the EU economy has stabilised, provides enough reason to expect a modest step-up in global GDP growth over the coming year. China’s stimulus policies show no signs of abating, and despite being unsustainable in the longer term, they can hold the course over the shorter term without any major risk of derailment.

New Zealand’s economy remains in reasonably good shape entering into 2017, especially relative to most of its OECD cousins. Strong population growth, stabilisation in the dairy sector’s performance, a moderate rate of underlying inflation and wages growth, and a buoyant residential property market in Auckland and some regional centres all contribute to the RBNZ’s slight tightening bias.

• We forecast the NZD/USD falling towards 0.69 on a 12-month view. The recent rally in the New Zealand dollar, triggered by financial markets wavering in their belief in the fiscal stimulus to be enacted by the Trump Presidency, is expected to fade over the coming months. Further policy details should be forthcoming to alleviate some of this doubt, after which, attention will inevitably return in fair measure to the work of the US Federal Reserve.

• We believe the Fed has one rate rise in store towards the end of this year, which will act to stifle the carry trade in NZD.

Source: Statistics NZ, Rabobank 2017

NZD to Give Up Recent Gains in Coming Months

The new year rally in the NZD/USD is expected to fade over the course of Q1 2017, sending it back under the USD 0.70 mark.

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Food & Agribusiness Research and Advisory

Tim HuntHead of Food & Agribusiness Research and Advisory, Australia and New Zealand+61 3 9940 8406Tim.Hunt@Rabobank.com

Marc SoccioSenior Analyst – Wine, Horticulture & Rural Economics+61 3 9940 8437Marc.Soccio@rabobank.com

Michael HarveySenior Analyst – Dairy and Farm Inputs+61 3 9940 8407Michael.Harvey@rabobank.com

Georgia TwomeyCommodity Analyst+61 2 8115 2446Georgia.Twomey@rabobank.com

Angus Gidley-BairdSenior Analyst – Animal Proteins+ 61 2 8115 4058Angus.Gidley-Baird@rabobank.com

Blake HolgateAnalyst – Sustainability & Animal Proteins+64 3 955 4603Blake.Holgate@rabobank.com

Emma HigginsDairy Analyst+64 3 961 2908Emma.Higgins@rabobank.com

Maddie ArmstrongBusiness Coordinator+61 2 8115 4157Maddie.Armstrong@rabobank.com

Rabobank New ZealandNearest branch call 0800 722 622www.rabobank.co.nz

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