ABCC Special Feature Article by Robert Petit (General Manager – Dairy Australia)

Brazil’s Dairy Industry: Is a Giant Stirring?

Does it offer opportunities for investment and what are the implications for the Australian dairy industry?

Brasil is the fourth largest milk producing nation in the world, following India, USA and Russia. Production in 2008 is estimated to have grown, as a result of very favourable prices for raw milk in the twelve months to June 2008, by up to twenty per cent – to thirty billion litres. By way of comparison Australia’s milk production in 2008 is estimated at slightly over nine billion litres with approximately 45 per cent exported in a wide variety of dairy products and specialised food ingredients. Australia by value is the third largest dairy exporting nation.

Nick Renyard, a dairy farmer and industry representative from Timboon, south-west Victoria and Robert Pettit, Dairy Australia visited Brasil in the first two weeks of September. The purpose of the Visit was to understand and analyse dairy developments that will occur within Brasil in the next ten years and their commodity market impacts.

Nick Renyard –Florianopolis, SC in background

The visit focused on the five main milk producing states of Brasil. They are the tropical ‘heartland’ of Minas Gerais, the largest milk producing state and the adjoining state of Goias, a major milk producing region and the three states of temperate south Brasil; namely Parana, Santa Caterina and Rio Grande do Sul where dairying is the most progressive and organised and the family farm structure because of European settlement is strongest. Collectively the five states accounted for almost two-thirds of estimated Brasilian milk production in 2006 (16.067 billion litres) compared to 59.5 per cent in 1990 and 65.4 per cent in 2000. While Minas Gerais/Goias share peaked in 1999 at 41.3 per cent the combined share of the three southern states has been continuously rising since 1996, from 22.9 per cent to 27.7 per cent in 2006. The compound annual average growth rates of production in the seventeen years to 2006

Holsteins are the dominant breed in the South

Brazil’s is an agricultural power-house being a major exporter of a wide range of agricultural products. Their dairy industry, however, is the least developed of all the major agricultural sectors.

Their dairy sector is characterised by:

• Fragmentation in terms of wide diversity in farm size including tiny holdings of cross-bred Zebu cows that are only milked, if the returns are more favourable than beef, during the wet season and number and size of processors including those that are not inspected by Government authorities

• Low cow yields that averaged slightly more than one thousand litres per annum compared to over 5,000 litres per annum in Australia

• Low productivity from labour inputs; while labour can be challenging to obtain in certain dairying regions, the labour laws making hiring relatively expensive and firing difficult

• Large informal sector where raw milk is sold for household fluid consumption or made into cheese

• Infrastructure bottlenecks that hamper the ability to chill milk and efficiently move milk off-farm to plants for processing and dairy products to the domestic market-place and ports for export

• Lacking a coherent industry decision making structure that constrains the ability to secure optimum policy outcomes from respective state and Federal governments

• Raw milk (farm gate) monthly price volatility that creates considerable cash-flow uncertainty for farmers and

• Relatively high interest rates, reflecting the collective memories of policy makers of the pre-August 1994 period of hyper-inflation, that discourages use of other than retained earnings to undertake risk-taking, productivity enhancing investment

The dairy sector though has made major strides in recent years and is favourably endowed by a:

• Willingness of all participants in the dairy supply chain to learn, possibly the single most important factor if allied to persistence to succeed

• Extensive support by respective state governments in terms of providing farm services and market analysis, though the quality can be patchy

• Export ambitions that offer an alternative (risk management) outlet to the domestic market

• Potential for growth in per capita dairy product consumption as the Brasilian economy grows and more people are lifted out of poverty

• Abundant land and water in stark contrast to most or possibly all other agricultural exporting nations

• Land particularly in the southern states can support treble cropping; for example winter pasture, spring corn and summer soy with a fresh feed deficit only apparent in the six weeks from mid to late April

• Feed inputs are plentiful and generally in close proximity to dairying. Grass can be grown, depending on region either all year round (southern Brasil)

• New large-scale investments in state-of-the-art factories particularly by cooperatives

• Presence of large cooperatives in processing who have built up substantial domestic brand business and frequently export sales channels for pigs and poultry i.e. awareness of the potential for export is established within the company

• A growing professional and entrepreneurial dairy farmer class who see milk as a viable long-term business

Trade:

Brasil was a very large dairy importing nation in 1995! Imports in volume terms totalled 310,212 tonnes placing the country as the third largest importer after Japan and the United States but thirteen years later in 2008 exports, on a milk equivalent basis, are estimated to reach one billion litres and the upside potential for future growth is very(By way of comparison Australian origin dairy exports in 2008 are estimated at 4.25 billion litres, milk equivalent).

An emerging dairy exporter

The more ambitious members of the cooperative sector believe that Brasilian origin exports can rise from an estimated one billion litres of milk equivalent in 2008 to ten billion litres in 2020. If this target was reached, Brasil could emerge as either the second or third largest dairy exporting nation after New Zealand and possibly the United States, assuming EU nations are treated individually for comparative reasons. Brasilian origin product would have an important influence on dairy commodity prices, particularly if the interminable Doha Round of multilateral trade negotiations is concluded and mandates the elimination of export subsidies and genuine cuts to domestic support measures.

A more realistic scenario is that dairy exports, on a milk equivalent basis could reach up to six billion litres milk equivalent by 2020, rivalling the achievement of a revitalised Australian dairy industry.

Salient developments in the dairy sector’s emergence included:

• 1991 removal of Government price supports i.e. a highly regulated sector had to stand on its own two-feet

• Mid 1990’s collapse of cooperative involvement in dairy processing as they struggled to come to terms with removal of price regulation, the sole large-scale exception being Itambe who process milk in the tropical states of Minas Gerais and Goias

• 1997 introduction of normative standard no. 51 that established milk quality rules for raw milk and will be fully implemented in all states by end 2012

• 2000 acrimonious dispute with Mercosur neighbours Uruguay and Argentina (and EU and New Zealand) over pricing of their exports milk powder and UHT to Brasil: Mercosur partners shifted their export focus to other markets

• 2002 first year when there was a net balance between imports and exports on a milk equivalent basis

• 2008 surge in export volumes potentially signalling the beginning of a new era of export participation

The Future
While milk production has grown at a compound annual average growth rate of 3.7 per cent between 1990 and 2007 and more quickly in the milk surplus states that will likely form the backbone of a Brasilian dairy export surge, there are a number of challenges that persist and require resolution for sustained growth to continue, including:

• Degree of use of confinement of cows along the lines of US style barns that will hinder taking advantage, particularly in the southern states, of Brasil’s capability to maximise grazing of cows, the most cost-effective form of feed

• Dampening potential profitability: if for example the confinement rather than grazing milk production system becomes the preferred form of milk production then the dairy farm rate of return from milking and consequent ability and confidence to undertake risk-taking investment may be un-necessarily curtailed

• Payment system is monthly, that is unlike Australia there is no season (twelve month) base price to assist with cash flow and debt management

• Feed inputs can be of varying quality, for example sugar can be high in fibre but very low in protein, thus impacting upon milk production

• Herd health has been impacted, for example by feeding shocks that arise as a result of sudden, major dietary changes resulting in problems such as lameness
• Labour availability and quality i.e. productivity is potentially exacerbated by the long-term trend of population drift from rural to urban

• Milk quality is improving as a result of Federal Government regulation but a large informal sector remains unregulated; between one-fifth and one-third of total supply and companies have only moved this decade to institute payment based on components rather than volume

• Societal tolerance to adverse environmental externalities is declining sharply and is likely to result in restrictions on access to natural resource, for example streams et al in addition to regulation of effluent run-off (so far dairy has “escaped” attention unlike pig and poultry farmers). This will constrain the potential for dairy industry growth at least improved processes are fully installed. There is also the competition with other intensive animal production systems for use of resources and environmental assimilation capacity. In the future every dairy farm will need an environmental licence according to government legislation.

Pictorial exemples of some of the challenges

Growth in state of the art processing capacity is impressive to say the least. The plant capacity only covers the five major milk producing states. Capacity coming on stream in 2008 is estimated at around 1.8 billion litres per annum; by 2014 an additional (to 2007) 7.8 billion litres of plant capacity is planned to be operational. The chart also does not include the marked expansion in whey processing capacity; of sufficient size that will likely result in Brasil moving from being an important importer of whey proteins to an export role in the next five years.

New Plant Capacity

The new plant also dos not include current under-utilised capacity

Logistics (delivery to market-places) or ‘Custo-Brasil’

‘Custo-Brasil’ is a term widely used here in Brazil to mention all “additional” costs that Brazilian production has to carry due to inefficiencies along the production chain, such as: bad road, lack of railways, slow ports, complicated paper work requirements, legislation, etc, that makes Brazilian products less competitive in world markets. Brasil has the second largest, after the USA truck fleet in the world but secondary and tertiary roads are not nearly as well developed and truckers frequently take the less well-constructed roads to avoid tolls. An example is the 150 kilometre line of trucks waiting to unload at the Paranagua harbour in the southern (and milk surplus) state of Parana.

Human resource capability will be tested by the rapid expansion of the Brasilian dairy industry and agricultural sector per se. While institutions are in place, for example the Government funded SENAR to deliver rural extension education services the requisite quality, timing and output are major challenges.

Institutional arrangements notably a more stable method for determining the farm-gate price of milk compared to the current monthly (and volatile) price setting process and a coherent industry decision making structure that will advocate and achieve favourable outcomes from government policy actions are essential for the sector to prosper

Opportunities gained or lost – 4 Scenarios?
Four scenarios are possible for the Brasilian dairy sector up to 2020. They are:

• The new agri-business star characterised by major investments in new industrial plants, which stimulate an increase in milk production to rates above historical average. Even with a substantial increase in domestic consumption the surpluses for export will be considerable and Brasil will become a major player in the world dairy commodity trade. The current five major producing states will continue to be the main producing basins with Brasil being able to match the cost and efficiencies of dairy production in New Zealand and the manufacturing milk states of the United States.

• Family farming that is globally competitive reflects milk production increasing more quickly than the historical average but the focus will be on family farming as opposed to the more corporate ‘agri-business star model. The cooperatives grow in importance, the relationship between producers and manufacturers is civilised and the sector, via sound investment, innovation leading to value adding, generic promotion and pre-competitive research is able to take advantage of domestic and international market opportunities. The family farming structure is most suited to the southern tier states of Parana, Santa Caterina and Rio Grande do Sul.

• Continuous but ‘mundane’ growth means that the dairy sector while maintaining a growth in milk production based the on historical trend does generate an exportable surplus but is not able to move, in a substantive manner, beyond existing constraints on growth. The sector maintains an innovation level that is sufficient to develop the market in a competitive way and achieves some success in sustainability initiatives, for example generic promotion. In a nutshell a gradual rather than rapid evolution of the Brasil dairy sector.

• The wasted future reflects the dairy sector not being able to overcome the present challenges in a coherent and productive manner. Investment will not be attracted in sufficient volume to the sector and industry policy making structures will remain fragmented; resulting in very little influence on important issues such as food safety, trade, and direct government support. Brasil’s status in the world market will be little altered compared to 2007 i.e. a very small net exporter. Lack of cohesion and cooperation between the main players in the industry; farmers, processors and regulators (and consumers) will persist.

In summary the strength of the following five natural resource and people factors favour the continued growth of the Brazilian dairy sector at a rate that expands export availability over time. The factors are:

• Willingness to learn and adapt along the whole of the supply chain

• Growing confidence and associated willingness to undertake entrepreneurial (risk taking) behaviour along the whole of the supply chain

• A risk management approach that factors in supplying both domestic and export markets

• Abundant land that is used productively as a result of growing expertise and

• Plentiful rainfall that underpins the expansion i.e. neither water quality or availability becomes an issue hampering expansion

Conclusions

Brasil will play a much bigger role than currently in dairy trade in view of the:

• Natural resource and in certain instances attitudinal constraints that exist within ‘traditional’ dairy exporters (EU, New Zealand, USA and Australia) in terms of expanding production sufficiently to take advantage of a growing world trade volume, and

• Consistent with the country’s big picture view of being the only nation able to challenge (and best) the United States in terms of agricultural export availability and overall competitiveness

Implications for the Australian dairy industry are:

• A more competitive dairy trade environment because Brasil is and will likely retain the capacity to be low-cost milk producer and a

• A less Oceania focused export environment, particularly when compared to the period 1990 to 2005, meaning investment flows and technology transfers are increasingly likely to be directed toward the Americas

What are the opportunities for investors in the Brasilian dairy sector? The opportunities are considerable in a world where disposable household incomes are rising in the medium-term plus but the overseas investor needs to factor the following issues into decision making, namely:

• Government regulations for example labour laws largely prevent firing and costs of hiring including an unemployment levy double the wage bill

• Business etiquette and regulations i.e. insider knowledge is needed of the Brasilian system given the labyrinth of taxation measures and production influencing regulations, for example environmental

• Cultural factors for example a lack of full understanding of local attitudes and an educational system that may not deliver labour in the required skill-sets or numbers

• Borrowing money can be relatively high cost because of the perceived need by policy makers to keep a lid on inflation in view of Brasil’s experiences of hyper-inflation pre-August 1994. Additionally overseas investors supporting a venture may have varying expectations in terms of time frames on achieving targeted rates of return-on-capital

• Persistence, that is a medium-term plus viewpoint is needed to make the most of the available investment opportunities

• Competition for available land is increasingly intense particularly where infrastructure is reasonable and in relatively close proximity to processing

• Market access including delivery to market (infrastructure) is important in terms of Brasil’s production capability. The fate of the stalled Doha Round of multilateral trade negotiations and success of bilateral and regional trade initiatives are important to export growth

• Macro issues, for example:

• Brasil has apparently the most number of taxes (57) of any nation in the world and the Government tax take rivals that of Belgium as the highest in the world in terms of percentage of GDP and

• A Latin American wide shortage of export credit as a result of the second half 2008 credit crunch compounded by softening commodity prices is reducing the Government tax take and consequent budget outlook

Contact is Robert Pettit
Dairy Australia
Email: rpettit@dairyaustralia.com.au

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