You have to wonder about the quality of some of the economic process control that goes on for National’s politically important subsidies to the farming industry. Idling through the email this morning, I ran across an economic review of a Wairarapa Water application for second stage feasibility funding from the Irrigation Acceleration Fund for the “Black Creek” and “Tividale” irrigation schemes.
The review was commissioned by Fish & Game and came to me via Greenpeace.
It is a proposal to irrigate 10,000 hectare area, a process that would cause ecological and environmental damage to a significiant area and its waterways (something that this analysis doesn’t cover). I’m not particularly a conservationist, however any degradation in the environment, especially one funded by taxpayers should carry significiant and obvious economic returns. This one clearly does not, and never did. The executive summary states (the review authors bold)…
The economic assessment in WW’s IAF funding application is based on analysis from a 2014 report by Butcher Partners1 (the ‘Butcher Report’). This report assumed a long run farm gate milk price of $7.07 per kilogram of milk solids (kgMS), which leads to a further assumption that 55% of the irrigated area will be intensive dairy farms or dairy support. Whilst a long run milk price above $7.00 kgMS was questionable in 2014, given changes in international dairy markets it is a completely unrealistic basis for decision making in 2016.
Say what! They are planning this project on the basis of a sustained sale return that is far higher in real terms than any that has ever been attained by the international dairy industry. That is an assumption that can only be described as being crackpot!
A few years ago we had a couple of farmgate spikes in milk solid payouts (see graph from interest.co.nz) because of the drought and a later rapid uptake in China. But there has is hardly sustained growth over the last 15 years especially after you factor out the accumulated inflation and currency fluctuations.
The review author’s analysis is deadly accurate. It focuses on the dairy because even the WW’s analysis indicates that the irrigation for horticulture would be of minimal use in expanding horticulture in the region.
The crux of economic viability is in the milk solid prices, and the prospects for that are quite limited.
21. Over the past two years there has been significant turbulence in international dairy markets, with near record low prices. It is my view there has been a structural change in international dairy prices, driven the following:
a. The end of EU milk quotas, which means Europe is now an unconstrained dairy exporter with the intention to ‘grow with the market’
b. The emergence, over the past decade, of the US as a formidable dairy exporter – especially in terms of skim milk powder (SMP)
c. China promoting import substituting domestic production
d. Very low stock feed costs making feedlot production internationally competitive.
22. In terms of the long run farm gate milk price, an industry consensus on the ‘new normal’ is yet to emerge. My best professional estimate of a credible medium to long milk price assumption is $5.00 kgMS +/- $1.00. Whilst there is an exchange rate issue to consider, the intuition is a product mix price below $4.00 is unlikely to be economic for the majority of dairy producers internationally (so represents a market ‘bottom’) whereas prices in excess of $6.00 will attract ‘swing’ producers (such as the USA) into the market (thereby providing a ‘top’ – because at that price feedlots are internationally competitive and production can be quickly expanded).
23. Whilst prices will occur outside of this range, they are most likely to be examples of markets under or over shooting due to exogenous shocks (i.e. a drought in a pastorally-based supplier such as Australia or New Zealand). It is therefore foolhardy to assume sustained farm gate milk prices outside of the $4.00-$6.00 range.
24. The corollary is continuing to employ a 2013 milk price assumption of $7.07 kgMS in 2016 is simply not credible. This problem becomes even more pronounced as the entire proposal is critically dependent on that very assumption. The result is a highly misleading portrayal of the scheme’s economic feasibility.
This is pretty much what informed observer looking at the economics on the international dairy trade tends to think (with the probable exception of sustaining cheap feedlot feed costs). NZ is unusual in that we produce a very large exported surplus of milk based largely on cheap grass. That is why Fonterra tends to dominate the international dairy trade. However
As the review points out, for the soil types in the region this means that for most of the price range, even if the irrigation water was free, dairy would simply not be profitable.
Applying even minimal costs to water just make that far worse.
40. Given a water price of 25 cents per m3 is uneconomic, it is instructive to undertake
sensitivity analysis by discounting the water to 10 cents per m3; thereby changing the
midpoint water cost from $1,000 per hectare to only $400.
As the author of the review points out, it is damn hard to see why the Ministry for Primary Industries are even considering this request (or any previous ones).
This scheme just looks to me like a boondoggle because it is there to cause the creation or expansion of a dairy industry in the Wairarapa. Which kind of defeats the purpose of the Irrigation Acceleration Fund
“The need for more water storage projects is obvious given that nearly every part of the country has suffered through drought at some stage over the past three years.
“Providing a reliable water supply for farmers and growers has massive potential to boost growth, creating jobs and exports in provincial regions.”
Around 100,000 hectares of new irrigated areas are expected from IAF-funded projects to date, with around 36,000 hectares of that commissioned or currently being constructed.
The IAF helps support the development of irrigation infrastructure proposals to the stage where they are investment ready, which means they must be commercially robust and demonstrate a high level of community support.
The Government also supports these projects through the Crown Irrigation Investments Ltd (CIIL), which acts as a bridging investor for regional water infrastructure development. $120 million has been allocated to CIIL over the last two years with the potential to provide a further 125,000 hectares of new irrigation.
But with the ridiculous inflated assumptions for milk solid prices in this case that isn’t the case. Firstly because there isn’t a large dairy farming there in the first place, and most of that is on river flats. And to make it profitable at even moderate water prices, you’d have to assume grossly inflated returns. At those prices the resulting dairy farms will be competing directly with feedlots which don’t have the setup costs of irrigation.
This particular scheme looks to me to be a subsidy being pushed into the Minister’s neighbouring electorate, and the only benefit will be to land speculation and a few consultants hired by Wairarapa Water. It hardly fulfils the stated economic intentions of the irrigation fund. It just looks like ineffective and uneconomic boondoggle pork by National.