This article is taken from our IEG Vu platform dated 15/05/20.

The global coronavirus (Covid-19) pandemic has hit the global dairy markets like a wrecking ball. The dairy business was just recovering from the weight of intervention SMP that was holding down global prices, while New Zealand posted a big production recovery from a disastrous milk season a few years ago. What lies ahead, now that the majority countries have passed the peak pandemic period, is still unknown.

But there are certain factors that indicate that the global dairy demand is to suffer from multiple factors, ensued by the onset of Covid-19. Among them the collapse in foodservice industry and the dependence on how quickly it might recover in one of the fastest-growing markets - Asia. But the effects of this recovery will be short-lived, as the world readies to face an economic crisis which will have more significant reasons to push down demand.

Chinese lockdown - a means stock up and consolidated industry

The pandemic has resulted in a nearly complete collapse of the foodservice industry. Starting with the Chinese lockdown in January, countries around Asia quickly followed suit, with restaurants shut and consumers almost completely reliant on e-commerce retail channels.

What is more, lockdown measures coincided with the upcoming Chinese New Year celebrations in early February, which is usually marked by a seasonal upsurge in demand for many food categories, as consumers stock up for the holidays. Imports in February, after a 30% year-on-year plunge in January, rebounded. This meant that China had enough dairy stock to last through the pandemic - if the situation had completely deteriorated.

Several Chinese companies have temporarily boosted their inventory of imported milk powder, and some have even stored enough for half a year's use, despite there being little concern about milk powder supply. In addition, not long after China lifted the lockdown off of the last province, Chinese dairy industry's consolidation efforts continued. Last month, Yili announced two major dairy projects: one organic milk farm and one processing facility. The most recent consolidation activity was seen earlier this month, when New Hope Dairy, a mid-size northwestern dairy company New Hope Dairy acquired its peer operating in nearby regions.

The fact that China is currently well-stocked on dairy and was even able to maintain local dairy market activity might act as a prerequisite to slower global dairy demand in Q2. Though a slight recovery is expected in the second half of 2020 (H2), as the restart of the foodservice industry will make up for some of the losses made in Q1.

Signs of recovery seen in Asia

At the time of writing, it is already mid-May, which means there should be plenty of full Q1 data to reflect upon. IEG Vu has decided to look at dairy import trends across big Asian importers to try and predict what lies ahead. Asia is a deliberate choice, as it was the first area to be affected, its dairy consumption is dependent on the functioning of the foodservice industry, and it is the first to announce lockdown/state of emergency measures to lessen the effects of Covid-19 on the population.

Dairy imports are showing positive dynamics in China, with March data securing good gains.

March was the last full month of China's lockdown, as the country proceeded to witness positive contagion dynamics, eventually lifting the lockdown by early April.

It was also the first month of easing logistical issues in Chinese ports, following reports of congestion and overfilled coldstores and warehouses.

March dairy imports saw an 11% rebound on the same month last year, driven specifically by surging volumes of cheese and butter. Most cheese in China is used in the foodservice industry and to manufacture ready-made western-style meals, while growing demand for butter is led primarily by the baking industry.

Elsewhere, for example in Japan, where the state of emergency was instilled later than everywhere else - in the beginning of April, the ever-growing dairy import demand was reversed. Total Q1 imports were down 8.5%, driven by declines across all categories, with cheese - also popular in foodservice - suffering the biggest drop, at 10%.

However, the state of emergency across Japan is scheduled to be completely lifted just before May 31, while most areas now report zero to a few cases. This might serve as an impetus to stock up on dairy import losses seen in Q1 - but there might be a curb along the way.

Japan was one of the countries that was quick to announce Covid-19 mitigation measures for the dairy industry. According to official reports, in March, SMP and butter stocks have risen 16% and 27% respectively, compared with the same period last year. In this way, IEG Vu expects Japan to make good use of the existing FTAs it has with various cheese-producing countries and will replenish what was lost after the state of emergency is lifted - at the cost of additional butter and SMP.

The other big Asian importer Korea, which was among the first countries hit by Covid-19 after China, is seeing the emergence of a completely different trend. With the country's 2020 data now available for the first four months of the year (January-April), dairy imports remained constant. Supplies had a 0.8% rise, thanks to a 9% and 6% increase in cheese and liquid milk, respectively offsetting a 12% dip in imports of whey.

Among the growing global dairy importers, Korea is one of the only ones where cheese consumption is having an insurgence as a snacking novelty, which would explain the growth in imports.

Korea did not settle for a full lockdown and restriction of movement at the time of the peak of the outbreak and instead relied on population's voluntary cooperation.

Oil prices plunge to historical lows

The relationship between dairy and oil prices has been a constant dynamic since at least 2006. The correlation between oil and WMP, in particular, has been vivid between 2006 and 2020, according to Rabobank.

The two commodities' relationship is due to a number of factors: susceptibility to global macroeconomic dynamics, milk's utilization of energy in processing and transportation, and the reliance of dairy import markets (Algeria, Mexico, Saudi Arabia) on oil as a source of income.

Naturally, when one commodity falls, the other follows. From January to May, dairy prices have fallen significantly, while US crude oil's crash peaked when May contracts were trading negative for the first time in history.

What is more, cheap oil equates to a weaker economy, which results in lower purchasing power, especially in import-relying markets. Accelerating this are currency depreciation and rising unemployment rates - prerequisites of a global economic downfall. So, ahead of the strongest recession that is to hit countries post-coronavirus - as recently forecast by the EU - even if the foodservice industry recovers by the second half of the year, the demand for dairy, same as with many other food commodities, will fall.

Conclusions

Lockdown and other Covid-19 restrictive measures have not only resulted in the collapse of foodservice industry, but also had a positive effect on countries' own domestic capacities. Based on the example of the world's largest dairy importer China, it is clear, that the demand recovery will rely on how fast the country goes back to normal.

However, in the time it took for the lockdown measures to be in place, China (same as other important Asian dairy importers) managed to stock up on its own dairy production. In particular shelf-stable products, which could distort foodservice's quick bounce back. However, cheese will be the first product that China runs out of, as the country does not have the sufficient production capacity to fill that gap with its own produce. This is where global cheese producers might see an opportunity, in case the recovery for milk powders takes a while.

In the example of some big Asian importers, we see that total dairy demand was sustained and did not suffer big losses.

Nevertheless, IEG Vu suggests that global dairy demand is to slow down in Q2, but the recovery of virtually all foodservice across the globe will balance out the losses made in Q1 and Q2. So, we are looking at dairy import demand increasing in full year 2020, but at a slower pace than in previous years. Imports are to be sustained by the Asian continent, as it previously was and will continue to be the main dairy demand driver for the foodservice industry.

However, the upcoming recession will weigh on dairy demand in the long run. Low oil prices, currency depreciations and high unemployment rates are to reduce global demand for dairy, especially in oil-importing countries.

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This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.