As Mark Twain said ” rumours of my death are greatly exaggerated”. The Dairy sector is far from dead but sleepwalking towards destruction might be a better metaphor. As shocking as it sounds the impending death of the NZ Dairy sector should be taken seriously.

The NZ Dairy sector is extraordinarily important to NZ’s export earnings and the livelihood of more than 40,000 people directly involved with many more in related sectors. It is mind blowing to think that an industry with revenues exceeding $NZ20b could be at risk but that is exactly the situation in 2024.

I studied the Dairy sector back in the ’90’s for post graduate research and this was just before Fonterra became a thing. Arguably before that there were innovative Dairy companies like Bay Milk Products and some just really big co-ops like Kiwi. Consolidating into an a single industry player was very beneficial to give NZ Inc. the ability to compete at scale. Note – 95%+ of NZ’s dairy is exported and actual fresh milk is just a very tiny part of that. But now we need some smaller innovative startups like mini Bay Milks to look at the future of the industry. One company that is doing that is Daisy Lab.

One of the annoying but true things that you learn during MBA studies is to ask the “what business are you in” question because over time this can change quite dramatically. So is NZ Dairy in the fresh milk business? Not really when 95% of its revenue comes from drying out the milk to make milk power for the ingredients business. For NZ customers Fonterra is still in the fresh milk business but for international customer it is not.

Arguably NZ dairy is the “best of the best” due to our emphasis on pastoral farming. Grass fed milk and beef just tastes better and if we can sell it into high value vertical markets as some farm businesses do then that is a big win for those farmers and NZ Inc. as a whole but most of the dairy sector is commodity driven.

The net result is that when dairy auctions are going well the sector goes well and when prices are down there is a fair amount of pain. Despite what anyone else says about the wider sector of farming it is quite risky with more volatile weather, water use constraints, energy costs and environmental degradation not to mention even more pressure when intensive methods are used. Farmers have to be incredibly resourceful and experts at managing all kinds of risk.

The really short summary of how to blow up a sector like dairy is to concentrate everything on one giant bet and pretend that it is business as usual. That is not smart at all. Climate change is triggering massive instability around the world and NZ is not immune from those pressures. We might have a bit of a buffer if we target the premium, high value parts of each market but that only gives us time to manage the transition.

It’s the transition that will kill the sector.  You only need to disrupt less than 10% of the market to reduce and even remove profitability for some parts of the market and then the flow on effects will do the rest. For intensive dairy systems such as in the US that are grain fed with higher cost structures they have much more risk. Hopefully we can learn from some of that.

We assume that Fonterra is a good corporate customer but on energy they are absolutely terrible. In NZ most of our electricity comes from renewables such as hydro with wind, solar and other (geo-thermal) sources too but for Fonterra it is still coal. “Fonterra uses approximately 800 GWh per annum of grid electricity, and also 200 GWh per annum of electricity generated by our third-party co-generation partners. This combined annual electricity usage of approximately 1,000 GWh is the 4th largest industrial use in New Zealand.

Read Pressure mounts on Fonterra to ‘bite the bullet’ and quit coal.“Fonterra has resource consent from regional council Environment Canterbury to keep burning coal at the site until December 2045” but that is not is not something that should continue in my opinion. As a company they should be looking at energy use and other headwind factors and downsizing in certain regions along with their shareholder farmers. Not an easy option but far batter to do voluntarily than as a result of trade barriers or other risks that have become unconscionable.

Milk powder seems like a very good product for export but the reality is that drying out all that fresh milk has a huge and unsustainable cost. Fonterra are working on reducing coal use but are decades away from that at present. That is literally a giant black mark on the industry.

And that is not the only black mark against the sector. Infometrics says sector growth has flat lined.

“The dairy industry’s extended growth march is heading straight into a wall of regulation, which laudably seeks to mitigate the negative effects of intensive agriculture on the environment. The Essential Freshwater package seeks to reduce runoff of sediment and nutrients into waterways and protect wetlands, which will be achieved by reducing farming intensity and reducing the area being farmed. These changes are potentially very significant, with conservative estimates for Ashburton District suggesting an 80% reduction in farm profitability.

On top of these water standard changes, inclusion of agriculture into the emissions trading scheme from 2025 onwards will add further costs to the industry. Given this outlook, further investment in farm conversion or intensification seems unlikely.”

I hope this is true but I live in Otago and travel around here plus Southland and Canterbury* a fair bit and the South has had a huge increase in dairy conversions and intensive irrigation to match. All of those dairy farms are expensive to develop and right now I believe we need to go the opposite direction. * Canterbury,Otago and Southland have added roughly 2m dairy cows in the past decade or so.

Furthermore an August 2023 reports says “These shifts take the average farm from a solid profit in 2021/22 to barely breaking even in 2022/23. Across the dairy farming industry, this amounted to a drop in revenue of $2.0b.”

Without even mentioning precision fermentation* yet it is very clear that the Dairy sector is a very tough place. Back in 2019 Bernard Hickey wrote The day the Fonterra dream finally died. That was promoted by huge losses in. China from Fonterra’s adventurism investments there. Even then the debt loading on the industry was dangerously high. Fonterra can make some adjustments but try negotiating with a bank if you are a farmer in trouble.

* Precision fermentation feedstock. See What’s brewing? Precision food proteins from fermentation from the CSIRO in Australia who are ahead of NZ institutions in that research space. And this note below on actual feedstock. Less land, less water, no cows, less energy makes a compelling proposition to supplement and unbundle protein from the dairy sector.

“In advanced fermentation methods, microorganisms are optimised for the end product, and can be fed with any type of feedstock, whether liquid or solid. For example: wood, agricultural products, paraffin wax, or municipal solid waste.”

The real risk to the dairy sector is that cows are just not needed any more. Certainly not the close to 5m that we have. I can’t find it now but there was aa suggestion of paying $21b to dairy farmers to close down. We can lose the costs, environmental impacts and mush of the flow on damage. I haven’t even mentioned bobby calves being killed each year yet , although some positive news on that front more recently.

RethinkX has written an extensive report which is based on US numbers and the NZ scenarios will be different because we don’t have so much of the highly intensive grain fed farms as they do but we cannot avoid the massive disruption that is coming.

What many miss about the impact of precision fermentation based products on dairy sector is that it is more likely to come from replacing b2b ingredients that are used for manufacturing rather than artificial meat and milk. I’m not a vegan and I have no real interest in alternative milks like oat milk or vegan cheese or meat substitutes but clearly many people are. When the products from dairy business becomes less profitable because some of the ingredients are substituted as they reach price parity or become even cheaper the profitability of the entire industry is at high risk. To quote from page 25 of that report – (RethinkX – Food & Agriculture)

“The disruption of the cow is not just a simple one-for-one substitution – a conventional sausage or burger replaced by a novel alternative (though that will happen). New production methods only need to disrupt key ingredients, not entire products, in order to render the cow entirely redundant. The direct, end-user product substitution is, in fact, just one of four main ways in which the cow will be disrupted over the next decade and beyond. All of these disruptions overlap, reinforce, and accelerate one another. They fall into two broad categories:
What we eat:
1. Substitute ingredients. The one-for-one substitution of animal-derived ingredients with those made using modern production methods. This is a business-to-business (B2B) disruption, where consumer preference is not a key driver.
2. Substitute end products. This is a business-to-consumer disruption:
»» Proteins produced using new production methods are mixed with other ingredients to form the end product. This is not, therefore, a one-for-one substitution.
»» Cell-based meat enabling the one-for-one substitution of complete, complex food products made from animals.”
The way we eat:
3. Fortification. The addition of ingredients made using modern production
methods to existing food products.
4. Form factor. The replacement of existing forms of food with entirely new forms.

An MPI report from 2nd of May 2019 doesn’t even mention precision fermentation at all. That is how wrong it is. Potential market failures and remedies. Competition for the dairy protein market from a non-milk source is an “off the grid” risk. That doesn’t mean it doesn’t exist – just that those researchers who are scanning the horizon are the equivalent of the see no evil monkeys we are all familiar with.

On a more positive note – one of the interesting things to come out of the milk industry is that NZ has ( or had) some of the cheapest stainless steel infrastructure in the world – precisely because of dairy. That gave our wine industry a huge boost since we could use the same vats and and many of the same skills to build wineries and breweries to leverage all that stainless steel. One of the key inputs for precision fermentation will be large scale vats and fermenters which makes NZ ideally placed to. This is an opportunity I hope we as a country will take up.

There are also intangible factors at work. I was talking with a retired engineer who worked on many dairy projects. His view was that the Chinese market liked buying from NZ in part because they didn’t trust many of their own local suppliers. Fonterra’s investment in China failed because of similar trust issues. Oceania (Yili Group – Mongolia) and Synlait is 51% owned by Bright Dairy out of Shanghai. Also note Theland Farm Group which owns at least 29 farms and was farming 30,000 cows as one of NZ’s largest corporate dairy businesses is Chinese owned too.

From various conversations already I know this topic is contentious but we need to seriously understand the sector risks and act accordingly. I hope dairy as a sector in NZ can act smarter and leverage precision fermentation. Much better to understand the threat than be blindsided by it later on.

Hat tip to Gathadair who points out I missed this story from 2022 Fonterra takes first step into non-dairy products who says Fonterra is keeping an eye on the space. I liked the comment by one of those farmers mentioned which says “Waikato dairy farmer Pete Morgan said at its core Fonterra was a food company. If it looked decades into the future, it would see precision fermentation was part of the answer to feeding a growing world population.” Which in a way answers the what business is Fonterra in question?

I have some history on startups and corporate venturing and an external startup like Daisy Lab is probably going to be more successful as a separate entity entirely. I note that one of the founders there used to work for Fonterra so have no doubt they are keeping an eye on the precision fermentation space. Newculture is mentioned in that article. They make cheese using precision fermentation and one of the founders is from NZ even though they are based in SF now.

“At New Culture, we are making cow cheese without the cow. Dairy cheese is unsustainable and plant-based cheeses don’t work. Ours are sustainable, healthy, ethical, and indistinguishable from current dairy options in taste, texture, and function.”

And that is the state of play now so Fonterra need to take it seriously and recognise that they aren’t really a dairy company more of a food company.

UPDATE: 4 months later and this story reinforces many of the ideas I explored earlier.
Scientists find new way to make cow’s milk substitute, could have radical effect on New Zealand’s dairy industry

What I find interesting here is the defensiveness from the Federated Farmers rep. It is very simple. Most of NZ’s dairy product is turned into simple commodity and is very vunerable.

“…Benny said New Zealand was vulnerable because three-quarters of our dairy exports could be replaced.

“The types of products that precision fermentation will produce are ingredients and powders. The types of products that we specialise in…..

But Benny said it’s New Zealand’s high-value dairy products like lactoferrin – a protein derived from milk – that are most at risk of disruption.

“When you’re competing a dairy-extracted protein versus something that can be made in a tank, that’s the same as mother’s milk, there’s not really any contest there.”

There are opportunities for ( please excuse the MBA waffle) for NZ farming to move up the value chain. but I fear that the incumbents will miss it because turning around (so to speak) the equivalent of an aircraft carrier is not easy and the real estate drama might just be too much.

However keep an eye out for Anna Benny and Prof Hugh Campbell.

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