OREANDA-NEWS. Growth in global milk supply continues to delay a recovery in milk prices, Fitch Ratings says. This has been compounded by weak demand growth globally, mainly due to subdued Chinese demand and a Russian embargo on major Western dairy exporters.

Fitch believes the recent volatility in global dairy prices is likely to continue in the medium term. Prices reached record highs in the 2013/14 season that ended 31 May 2014, but the average GlobalDairyTrade price fell by around 38% in 2014/15 and around 20% in the 2015/16 season to 15 March 2016.

Changes in regulation, geo-political factors and global demand patterns since 2014 have created an imbalance in global demand and supply of milk. The absence of short-term incentives and only a modest supply response so far are likely to prolong a recovery in prices beyond 2016. Longer term, we believe the fundamentals of dairy demand remain strong.

The removal of milk production quotas in Europe is the main reason milk supply has been slow to decrease. EU exports increased by 6% in milk equivalent in 2015, even though Russia, which used to import about 1.5% of European milk output, closed its doors. European manufacturers continue to increase production to utilise manufacturing capacity and expand international market share. A decline in supply remains unlikely in the short term with the European Commission forecasting further growth in milk production in 2016 of around 1.4%. The EU remains the world's largest dairy exporter, accounting for 32% of global export sales on a milk equivalent basis.

In contrast, milk production in New Zealand, the world's second-largest dairy exporting nation, fell in the first eight months of the 2015/16 season as farmers reacted to lower milk prices by reducing feed and increasing herd culling. New Zealand's largest manufacturer, Fonterra Co-operative Group Limited (A/Stable), reported a decline of 4% year-on-year in New Zealand milk collected to date in the 2015/16 season. Australian dairy producers have responded similarly, with Dairy Australia forecasting a decline in milk production of 1%-2% in the 2015/16 season. In the US, dairy production continues to increase, although strong domestic demand has reduced dairy exports.

Declining demand from China and Russia, the largest and formerly second-largest dairy importers, continues to compound the global dairy market imbalance. Chinese demand for whole milk powder declined by 47% in the 12 months to October 2015, which was a major contributor to the 8% decline in overall Chinese dairy import demand. The embargo on Western milk imports to Russia resulted in a 75% decline in imports over the same period. The embargo has now been extended until August 2016. Increases in demand in other markets, which are typically more price sensitive, such as Japan and south-east Asia, have only partly offset these large declines.