Future Water Allocation Issues - 3 - New Zealand Agriculture and Forestry 2010

3.1 Product Market Outlook and Projections
3.1.1 Key sectors considered
3.1.2 Market analysis and commentary

3 - New Zealand Agriculture and Forestry 2010

3.1 Product Market Outlook and Projections

3.1.1 Key sectors considered

Dairy
Beef
Sheep (meat & wool)
Deer
Forestry
Viticulture
Horticulture: Kiwifruit, Apples, other fruit, vegetables
Arable

3.1.2 Market analysis and commentary

The full market analysis and prospects for each sector are contained in the appendices to this report (refer to Appendix 1: Situation and Outlook report). The following is a summary of key points:

Summary of New Zealand's Agricultural Sectors

This section provides a brief assessment of the current situation with respect to the specific sectors and identifies prospects for the future.

Sheep industry assessment

The sheepmeat industry's competitive advantages vis a vis competing countries include:

Efficient production systems with technology an increasing feature
High level of expertise in all aspects of on-farm management
High tech, efficient processing plants with an abundant labour force
High degree of customer recognition for an advanced product range
Established global marketing networks
A recognised and envied food safety system and record

Increasing profitability is expected as world supplies continue their decline, and pressure from alternative landuse increases. The urbanisation of the New Zealand population will continue to erode the skill base necessary to carry the sector forward.

On-going per animal production efficiency gains will be required to help offset the decline in total numbers. A key driver of this will be the use of biotechnology in identifying and applying genetic traits to enhance production.

The rate of decline in sheep numbers has reduced considerably in the latter years of the 1990's and on the basis of the strength in key fundamentals (market prospects, infrastructure, competitive advantage) we expect this decline to slow even further and for sheep numbers to stabilise at 2001 levels until 2005. Thereafter numbers will increase slightly in response to improved sustainable profitability.

Global wool production continues to trend down at 1,417,000 t clean, down 25 percent since 1990. NZ production has also fallen to 185,000 t clean and it is expected to fall further as sheep numbers continue to decline. Breed changes have changed the profile of the NZ clip. In 1998-2000 there has been an indicative moderate percentage increase at the finer end of the clip and a reduction in the percentage in the clip above 37 micron. Both indicative trends are favourable.

Global cotton production is expected to be stable with prices forecast to continue a firming trend in line with increased demand in East and South East Asia. The cotton industry stands to benefit from bio-technology, in particular from resistance to plant pests & diseases.

Throughout the 1980's and 90's considerable areas of farmland were converted to forestry due in part to favourable tax treatment of forestry development expenditure. The majority of this land was marginal, relatively unproductive land. In the 1990's the southward drift of dairy farming and the rapid growth in conversion of sheep and beef farmland to dairying has reduced the area of highly productive lamb finishing country, particularly in Canterbury, Otago and Southland. The combined pressures from forestry on the less productive land, and dairying on the highly productive land are expected to continue through to the 2010 period. Sheep country will also increasingly be a provider of winter grazing for dairy herds.

Sheepmeat prospects

Market prospects for sheepmeat (lamb in particular) are in the main very encouraging over the medium term with the key fundamentals positive and summarised as follows:

World supply is continuing its decline
EU sheepmeat production is set to decline further, stocks are at manageable levels and pork production is forecast to be lower than previous years. These will combine and provide strength to the EU sheepmeat markets. The FMD situation in the UK has had a significant impact on the dynamics of the EU sheepmeat markets
The WTO ruling in favour of New Zealand and Australia on the US lamb tariff will enhance the value of this market
BSE is still a major issue in Europe, with consumers looking toward healthy meat from NZ.
The continued growth in demand for NZ chilled lamb items is likely to add further value to lamb returns to farmers. Frozen cuts are also likely to enjoy strong demand from the HRI (Hotel Restaurant, Institution) market sector.
Pelt prices have doubled year on year in 2000 and are set to complement the rise in lamb prices.
An export friendly NZ currency (a 10 percent decrease in currency increases lamb returns by 20 percent (M&WES)). Prospects are for the all grade average lamb price to exceed $50/head in the 2001 season and beyond.
Within NZ the change in landuse from sheep/beef to dairying is a significant threat to future supplies of lamb.
Increased lamb supplies from Australia threaten NZ's market dominance however, New Zealand's brand strength, consistent products and quota access advantage will prove difficult for Australia to overcome.
Increased supplies from low cost producers Argentina and Uruguay following a transfer of skills and technology from NZ.
Food safety issues will remain prominent in the eyes of consumers
Personnel shortages will increase as the industry struggles to attract young people to sheep farming.

The major market fundamentals of tighter supplies of meat proteins, demand strength, favourable trading conditions (both access and currency), combined with established brand strength auger well for the future of NZ lamb in world markets. The challenge for the NZ sheepmeat sector is to provide returns sufficiently attractive to prevent the conversion of land to alternative uses (particularly dairy) and secure consistent supplies.

Wool prospects

NZ production has fallen considerably over recent years with the decline in sheep numbers and will continue to do so with a shift towards a greater focus on meat production
NZ wool makes up about 0.4 percent of the world fibre market and faces strong competition from synthetic fibres and cotton
Wool prices have declined by between 3 and 6 percent per annum in real terms over the past 20 years
Any increases in price are likely to be relatively small and dependant on niche marketing of product
Revenues from crossbred wool will continue to fluctuate however it is a co-product of sheepmeat and is still a significant income earner.
The prospects for superfine NZ Merino wool products appear bright with strong market demand flowing through to prices for producers. The Merino NZ model appears to be having considerable success in this respect, although competition from Australian supplies is expected to continue to be strong.

Beef industry assessment

In relation to other pastoral land use options, beef operations are inherently more risky and volatile than dairy, lamb and to a lesser extent venison markets. New Zealand has few real competitive advantages in international beef markets.

Farm gate prices have trended downwards over the past 10 years, governed largely by the influence of the US cattle cycle. Prices will continue to fluctuate with a volatile industry and little influence over the markets

Beef is expected to be more volatile over the longer term as it has less brand strength, greater competition and fewer points of differentiation with competition, relative to NZ dairy and lamb. NZ also has an unhealthy reliance on one export market (North America) for approximately 60 percent of its export graded boneless beef mainly from the dairy industry.

In general, the Economic Farm Surplus (EFS) from cattle policies are at the lower end of the scale. Returns from cattle polices tend to fluctuate widely (greater than 100 percent) which makes budgeting for long term sustainable profits more difficult.

Beef industry prospects

The short/medium (2-3 year) term prognosis for the NZ beef industry is promising with the US beef cycle in a rebuilding phase resulting in market strength. The longer- term outlook is much less promising as the increased herd numbers in the US move through to the markets. This will force NZ to again seek diversified markets for manufacturing grade beef, however as with past cycles the strong influence of the dairy industry on the volume and composition of NZ's beef production will limit the ability to successfully achieve this. The following points summarise the future prospects for the NZ beef industry:

Growth in the dairy herd will continue to be an important source of supply for beef processors and exporters.
The NZ kill mix will have a strong base of animals (dairy cow culls and bulls) destined for markets demanding manufacturing grade product (e.g. USA). This will continue to expose the industry to the low value commodity markets and the US beef cycle
The oversupply of beef on world markets that occurred in the mid-late 1990's is likely to be repeated from 2004-2008 as the market fundamentals have not altered. Consumption of beef in Europe is unlikely to recover from the BSE situation and supply surpluses are likely.
The threat from Lean Finely Textured Beef (LFTB) (developed by the US as a domestic alternative to imported product), will increase.
NZ's limited areas of competitive advantage will focus on food safety and traceability with these being key requirements for market access
Niche opportunities may arise, particularly in European markets, under a 'natural free-range beef' or 'organic' label. These opportunities will be small in volume terms and also be pursued by competitors in South America and Australia.
Ongoing farm management improvements will be necessary to maintain profitability
Markets will continue to be well supplied with product from a range of countries. Price and supply reliability will have the major bearing on the customer's purchase decision.
Customer knowledge of the health benefits of beef will need to increase to ensure market share is not eroded by more competitively priced alternatives such as chicken and pork.
Growth opportunities will be greatest in developing markets, particularly for products from steer and heifer class animals
Beef production will continue to come under pressure from better performing livestock options where NZ exporters have more competitive advantages.
Foot and mouth disease outbreaks in Europe and in Argentina and Uruguay pose a threat and opportunity. The threat being that stocks accumulated under a control programme could potentially destabilise markets. The opportunity will arise from reduced competition from both Argentina and Uruguay in North American and Asian markets.

Deer industry assessment

New Zealand has a competitive advantage in farmed deer (listed below) and this enterprise offers excellent growth potential via the 3 income streams of venison, velvet and co-products.

Areas of competitive advantage include:

Low cost pasture production system
High level of expertise in breeding, stock management and animal health
Efficient processing facilities providing economies of scale
Lean, versatile product with an element of the new and unusual that appeals to consumers
Exporters able to leverage off market development initiatives for alternative meat products
Established quality management systems
Recognised Cervena brand

Deer are often associated with good health and vigour and this provides an excellent launching pad for the industry's future. A key factor will be the ability of the industry to diversify markets and create consistent year round demand for venison. Limited international competition to continue

As with all livestock product, country of origin labelling, food safety and traceability of product will be the significant factors allowing access to markets. Increased specialisation will be a feature with average farm size increasing. Deer is likely to occupy a greater percentage of existing sheep and beef farms in response to higher EFS figures.

Increased supplies from growth in the national herd numbers will require careful and co-ordinated management by exporters. Farm establishment costs (fencing and costs of livestock) will act as a partial constraint on growth

Deer industry prospects

MAF forecast a price decline from 2003 that is linked to the EU's Agenda 2000 reform program. Under this system, European market prices for beef are expected to decline by 12 percent (OECD forecast), with a resulting impact on venison prices for NZ exporters.
The venison industry is somewhat exposed by its reliance on the German market (in 1999 this market accounted for 55 percent of the total venison export volume). Future growth in consumption at prices above the historical average will be strongly reliant on growth in the German economy.
A recovery in the Euro would enhance prospects for venison.
Venison supply is strongly correlated to velvet prices. Strong growth in velvet demand will reduce stag slaughter numbers.
A further recovery in the Korean economy with resultant increased consumer spending and a stronger Korean currency should lead to increased demand (and prices) for NZ deer velvet.
Stocks of competing velvet products from Canada, Alaska and Siberia are currently low.
A key factor in velvet demand will be the Korean economy's ability to generate growth while also repaying the IMF debt the country owes. Central to this will be the economic stability of the major industrial companies (chaebols).
A recovery in the US economy will offer niche opportunities for both venison and velvet (among ethnic minorities)
Growth in the nutraceuticals market and the use of deer velvet as a natural health product suggest longer-term prospects for the product are good.

Dairy industry assessment

The fundamentals of the New Zealand dairy industry are such that its future over the long-term is extremely promising. These strengths include

Scale, low cost production and processing efficiencies (particularly in the areas of breeding, pasture management, animal health and farm operations),
established distribution marketing networks,
brand strength,
product innovation using high levels of technological expertise,
ownership/succession systems.

World demand in the year 2000 grew at 2% while production is increasing at 1%. The majority of consumption growth is occurring in developing economies.

Based on this infrastructural strength, economic farm surplus figures will continue to outperform competing pastoral landuse options on a national average basis in New Zealand.

Dairy industry prospects

The following points summarise the positive outlook for the industry:

World demand for dairy products is projected to increase by 2 percent annually over the period 2000-2006, with the increases across all product categories except butter. Recovery in Asian, Latin American and Russian economies is a key factor. Research conducted by Nimmo-Bell & Co in 1997 found that demand growth in Asian economies of 3 percent resulted in a 16 percent growth in NZ production. Prior to the Asian economic crisis in 1997-98, consumption of dairy products in a range of Asian markets was increasing 6-9 percent annually. With the recovery in the economies of this region a resumption of this growth is likely.
New Zealand and Australia are the countries best placed to take up this increasing opportunity.
Growth in value-added products particularly protein extraction and fractionating products for the ingredients market is expected.
WTO dispute settlement procedures are reducing the trade risks for exporters.
Policy reforms in the USA and EU are reducing trade distortions and the OECD predicts the USA is unlikely to become a major exporter of dairy products in the medium term.
Supplies from the world's largest dairy producing region (the EU) are likely to decline gradually as reform of the Common Agricultural Policy (CAP) under the Agenda 2000 programme takes effect.
Current moves to reduce the seasonal peak milk flows may go some way to breaking the cycle of more processing facilities in response to ever increasing production.
The application of biotechnology offers both opportunities and threats. The ability to identify specific gene markers for milk proteins has widespread implications.
The weak NZ currency is likely to recover in the short/medium term however world prices are also set to continue their improvement.
NZ has an efficient production and marketing infrastructure providing ongoing earnings growth.
With approximately 35 percent of world trade and a wide range of markets, NZ has both scale and market diversification advantages that will help reduce its trade risk. Combined turnover for the NZ Dairy Board, NZDG and Kiwi is expected to reach US$10 billion in 2001 and a spot in the top 10 dairy companies in the world. The NZDB has improved its market position through an aggressive acquisitions policy to better capture the developing opportunities.
Industry payouts to farmer suppliers are expected to exceed the NZ$3.70 figure (the 10 year average real payout) over the short/medium term. The strength of the industry fundamentals are such that dairy looks to be a good long term prospect, but essential reinvestment in the processing sector is required.

Forestry industry assessment

New Zealand has a competitive advantage in being able to grow pinus radiata to maturity faster than any other country. That said, offshore markets (particularly the USA) have been slow to recognise the benefits of pine and it has struggled to lift itself from the lower end of the value ladder. More investment in promotion of the scientifically proven benefits of pine is required to improve the prospects for processed pine products

Supplies of pine are set to increase annually as trees planted in the late 1970's and 80's come on stream. Harvested volumes are projected to rise from 18.3 million cubic metres in 2000 to just over 30 million cubic metres by 2010. Returns will be heavily influenced by international market conditions and currency movements.

Skill shortages are currently impacting on the industry particularly with regard to silviculture regimes. Of the total area in Radiata, approximately 30% is unpruned.

The nature of forestry investment with its comparatively long period (27-30 years) until harvest and up-front establishment costs will continue to prove a disincentive for investors. The high rate of new plantings that occurred in the 1990's was in part a reflection of poor returns for livestock (especially on poorer land) rather than increased profitability from forestry.

Forestry industry prospects

Growth in world population will place increasing pressure on the conservation of natural forest areas means that plantation forestry will become more important to the world wood supply.
Greater consolidation of the NZ wood processing sector should provide scale efficiencies although the scale of investment required to achieve these efficiencies provides a challenge for the industry.
The United Nations Food and Agriculture Organisation (FAO) forecasts that global wood supply, at least until 2010, will be adequate to meet consumption needs. The consensus from other world studies tends towards a stable future. However, no study foresees plentiful supplies of forestry products, which is positive for New Zealand.
In global terms New Zealand is a relatively small player, accounting for only 1 percent of the world's total supply of wood for industrial purposes.
In general, a well-managed forestry development will provide a pre-tax Internal Rate of Return (IRR) of approximately 9%. Proximity to main highways and ports can have a large bearing on final returns as cartage is a major part of harvest costs.
Additional income from forests may be available in the future through the trading of carbon rights.
New Zealand is well placed to serve the growing market, as the forest industry is based on a sustainably planted, renewable forest resource rather than the harvesting of natural forests.
New Zealand's main competitors over the next 20 years are likely to be Chile and Australia. Australia does not yet have an emphasis on quality.
Interest is growing in species that provide alternatives to pine. The alternative species include Douglas Fir, Cypress and Redwoods and the areas grown in these species is expected to increase.

Viticulture industry assessment

Growth in the viticulture industry has been rapid as the industry matures, however in overall landuse terms the areas are not significant. A two-tier environment has developed with a small number of large producers/processors and a large number of small boutique producers.

Relative to other wine producing countries New Zealand is high cost producer of wine in a marginal climate zone. It is a renowned supplier of high quality white wines.

The average annual increase in planted area over throughout the 1990's decade was 11 percent, however much of the increase has occurred since 1995 when the producing area increased from 6,110 hectares to 13,637 hectares in 2000 (an average annual increase of 24 percent in the 5 year period).

In 2000, white grape varieties accounted for 73 percent of the total production area. The expectation is that this percentage will decline to 68 in 2003 in response to market signals. Varieties increasing in popularity are Pinot Noir, Merlot, Chardonnay, Riesling, Pinot Gris and Sauvignon Blanc, while Muller Thurgau, and Muscat varieties are in decline.

Year 2000 exports totalled 19.1 million litres (valued at NZ$168.6million), an increase of 15 percent in volume and 34 percent in value on the previous year. In 2000 the average value of NZ wine exports per litre increased 16 percent to NZ$8.79. Throughout the 1990's the unit value of NZ wine exports has increased in line with improved product quality.

The popularity of wine producing with investors has led to dramatic price increases in land suitable for grape growing in NZ. Returns to grape growers range from 5-8 percent and there is a significant 4-year lag until vines achieve profitability.

Viticulture industry prospects

Continued demand growth for premium quality NZ wines. Demand growth from high value international markets has outstripped NZ's ability to supply to date.
The Sauvignon Blanc variety will be the flagship for the NZ industry in world markets. Pinot Noir is an emerging variety with huge potential for NZ. Regional branding will increase in importance (e.g. Marlborough Sauvignon Blanc) as consumers associate the product with the particular region.
Increased industry co-ordination, particularly among smaller players. To date this has been successful and should prove valuable in further industry development
Increased competition from other 'new world' supplying countries particularly Australian and South American red wines. Significant plantings of Cabernet Sauvignon, Shiraz and Merlot grapes in Australia in recent years will provide increased future competition for New Zealand's Pinot Noir variety.
Further consolidation in terms of the number of industry participants as scale economies are sought.
A competitive NZ currency will continue to make NZ wines attractive in overseas markets
Further trade liberalisation will be required to ensure ongoing access to lucrative markets
Small-scale boutique wineries will come under increasing pressure and profitability will be an issue. Boutique gate prices are currently well above the average export prices.
Innovative practices in the vineyard and winery that deliver quality in a sustainable and environmental manner, will ensure that New Zealand meets a growing world demand for wines that have been produced in a 'clean and green' fashion. Adding value at the winery is crucial to the long-term success of the industry
Industry surveys project export sales possibly reaching 40 million litres and $375 million in 2005. On this basis, and taking into account domestic sales, estimated total sales could near 80 million litres and $700 million in 2005.
Future growth opportunities will lie predominantly in the export sector. Given the high costs of production relative to other new wine exporting nations, NZ exporters will need to secure premiums for distinctive high quality product in order to remain competitive. Land prices will need to be realistic to ensure profitability levels are sustainable.

Horticulture industry assessment:

Fruit production accounts for approximately 40 percent of all horticultural landuse in New Zealand and fruit exports amount to 67 percent of the total horticultural exports. Vegetable crops account for 60 percent of the horticultural landuse and 33 percent of the horticultural exports (excluding wine).

Kiwifruit and apples dominate and market prospects for kiwifruit are good, however prospects for the apple industry are uncertain at best. Recent seasons of poor profitability in the apple industry are having an impact resulting in declining production. Some apple growers are turning to alternative crops for their highly productive land.

Avocado is one sub-tropical crop with bright prospects and the area planted (dominated by Northland and the Bay of Plenty) has increased 23 percent in the 3 years 1997-2000 to approximately 1,500ha.

The area in vegetables amounts to approximately 60 percent of the total horticulture area and large vegetable processing companies have shown an increasing interest in New Zealand in recent years. This is expected to continue, particularly for organically grown produce.

Kiwifruit Prospects

The NZ brand Zespri, is now well established and is owned by growers.
The major issues confronting the kiwifruit sector in terms of its market prospects are the inter-seasonal variations in fruit size, the total supply and quality variation of the export crop (particularly with new varieties).
The exponential growth in production over a short timeframe for Zespri Gold will present challenges for marketing and the margin for Gold over Green in the medium term will be a challenge to maintain. Quality issues relating to ripening profile, storage (and therefore shelf life) have arisen and these will need to be resolved quickly for the variety to prosper to its potential.
The decision to develop year-round marketing using fruit grown under contract in Italy, Iran and California in 2000 was a proactive move by the NZ industry to preserve existing supply relationships and meet changing customer requirements. Zespri have plans to extend this programme to include France and Japan.
Strong competition from oversupplied fruit markets will undoubtedly continue to place pressure on prices however, the Zespri brand has managed to secure significant market premiums and this is expected to continue in the foreseeable future.
The production growth in China and the possibility that it may soon look to export to markets in the region poses a future threat to the NZ industry. Chile's production capability and the prospect of a free trade deal with the US pose a threat to NZ's existing trade advantage.

Apple prospects

With an oversupply of fruit products, increased competition from alternative snack foods and static demand for apples, there is a need to stimulate consumer demand for apples.
Product quality and consistency will continue to be the prominent issue for long-term market sustainability.
Growth in fresh apple supplies and the improved storage techniques employed by the developed suppliers, have resulted in a greater overlap of northern and southern hemisphere seasons. This is expected to continue.
China's rapid expansion and significant potential influence on world apple markets is a key factor in the future prosperity of more developed apple exporting industries. China is likely to play an increased role as an exporter of fresh apples and concentrated apple juice (CAJ) and will have a significant impact on other export dependent countries.
A December 2000 MAF projection to 2005 predict a continuation of difficult times for apple growers with increased price differentials between growers that meet/fail to meet more exacting quality standards.
Reflecting the depressed market prices in recent years, export volumes are tipped to decline and this could assist a small recovery in carton prices. The path of the NZ currency relative to its trading partners will be crucial.
NZ growers can expect greater supply competition from competing countries (in particular Chile), further growth in competition from snack foods that emerge from more controlled manufacturing processes, and greater price pressure from large retailers seeking to lower their supply costs.
While New Zealand is 7th in the world export volume rankings, it accounts for less than 6 percent of global trade and will struggle to obtain scale advantages in negotiations with customers.
NZ has an excellent rating in terms of competitiveness and the policy of pioneering new varieties has enabled it to obtain product premiums while many other countries are forced to accept depressed mainstream product prices. New Zealand will have to continue with this policy while protecting its investment in new varieties through international patent laws.
Grower supply groups have emerged from recent restructuring and this method of achieving critical mass and scale efficiencies is likely to continue to be popular with growers.
Food safety is likely to figure prominently, as is the role of bio-technology in the apple industry.
Bio-technology advances (as opposed to genetic modification) may be substantial, however they will have to be carefully managed to preserve a hard-earned reputation.
Trade policy issues will also likely play a role as a new round of WTO trade negotiations struggles to get underway.

Other Fruit & vegetable prospects:

Avocados have increased in popularity with the planted area doubling to approximately 2,600 hectares in the period 1994-2000. With the development of both high value niche export markets and product outlets for lower grade processed fruit, the Avocado industry is well placed for further expansion.
Cherry production has also doubled since 1994 and is expected to continue, while the area grown in onions has also increased substantially (42%) since 1994.
Processed vegetable crops are set to increase with the presence of large multi-national processors Heinz Wattie and McCain increasing their involvement in NZ. Grower contracts will be exacting but rewarding for those able to meet the requirements.

Arable industry assessment:

New Zealand is a relatively small player in world grain production terms with less than half of one percent of world production. Areas of competitive advantage are extremely limited and low cost supplies of imported product are easily accessible. New Zealand cereal grain producers are able to provide a high quality product that is sought after by food processors (this is particularly the case with wheat where the Goodman Fielder Group is a major customer domestic wheat).

The feedgrain market consumes approximately 60 percent of all grain production and of this the pork and poultry industries consume just over 90 percent.

Sixty eight percent of New Zealand's arable and process cropping occurs in Canterbury, with seven percent in the Manawatu/Wanganui and Otago regions, four percent in the Waikato and Southland regions and two percent in Hawkes Bay. In Canterbury and Manawatu/Wanganui, pressure from dairy as a more profitable landuse will intensify and the cropping area is expected to decline. The growth of the dairy industry in the South Island has already led to a shift from grain to forage crops and this is expected to continue.

Arable prospects:

The pressure from alternative landuse options (particularly in the Canterbury region) will continue to erode the volumes of arable crops produced in NZ.
Millers and end users will need to provide sufficient returns for quality to ensure their supply lines and prevent growers from switching to growing forage crops for the dairy industry
Millers/processors will be forced to look to imported product to satisfy their demands. The NZ currency will be a key factor in these decisions.
Quality control will be a key issue - particularly for those relying on imports.
Compound feed manufacturers will face declining domestic supplies