Australia's worst drought in a century combined with less irrigation water available resulted in reduced pasture for dairy herds and higher fodder costs for farmers. Many farms have dried off cows early and cut herd numbers in anticipation of continued drought conditions over summer.
As a consequence, Australian milk production is forecast to fall by almost 11 per cent to 9bn litres in 2006-07, according to the latest figures from the Australian Bureau of Agricultural and Resource Economics (ABARE).
This would be the lowest in a decade and means that the country that typically exports around half of its total output will have much less on the global market.
Processors, facing strong competition for milk, will be forced to focus on high-value markets. The situation may also drive up prices in lower value markets and potentially offer new opportunities to European firms looking to expand internationally.
The ABARE report suggests that the overall value of Australian butter exports will fall by 46 per cent to A$121 million while cheese exports will drop by 34 per cent to A$554 million.
Whole milk powder will be down 27 per cent to A$244 million, it predicts, while casein will fall 17 per cent to A$74 million and skim milk powder by 16 per cent to A$446 million.
In addition, dairy exports may also be affected by some loss of price competitiveness as a result of an assumed higher Australian dollar against the currencies of some major trading partners, warned the ABARE economists.
After rising by 5 per cent in 2005-06 to average 33 cents a litre, Australian farmgate prices for milk are forecast to fall by 3 per cent to 32 cents a litre in 2006-07. The forecast price decline reflects lower US denominated world dairy product prices for butter and cheese and the additional effects on producer revenues of a higher Australian dollar.
But Rabobank senior dairy analyst Tim Hunt told The Age newspaper that despite falling prices, pricing would remain firm in coming years because of strong global demand.
Global demand for dairy products is expected to rise by almost 3 per cent a year over the medium term, with 80 per cent of this growth coming from emerging markets.
China, one of the fastest growing dairy markets in the world, is already a significant buyer of Australian dairy. And other important markets like the Middle East, south-east Asia, Japan and Korea will continue to rely on imports.
Hunt also said that price cuts had made dairy more competitive against other ingredients such as rising vegetable oil prices.
"The global market will need its (Australia's) surplus production for the foreseeable future," Hunt told the paper.