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Lack of farmer confidence on the back of low milk prices and high input costs is a real concern for the local dairy industry and consumers generally, according to WAFarmers dairy section president Phil Depiazzi.

The latest Dairy Australia situation and outlook report, released in September, indicates trading conditions will continue to be tough for the dairy sector in 2012-13 and that is impacting on the outlook of farmers.

The report predicts national milk production will grow only 2 per cent this financial year to about 9.65 billion litres, a slowdown from the 4 per cent expansion seen in 2011-12 that took total Australian milk production to 9.48 billion litres.

In WA, the latest production forecast was slightly higher (one per cent) than the previous prediction in February, at about 3.3 million litres, and herd size was predicted to remain stable at an average 250 head.

For the next three seasons, 33 per cent of WA farmers surveyed by Dairy Australia expected their milk production levels would grow.

But this comes in the wake of an estimated 7 per cent year-on-year contraction in WA production in 2011-12 when the State produced 3.37 million litres of milk.

In July, WA milk production continued to fall, down 1.8 per cent from the same period last year to 27.6 million litres. This bucked the national trend, which saw production jump 3.5 per cent in July.

Reflecting global oversupply and weakened commodity prices in global markets, Dairy Australia said national farm gate milk prices were expected to be 8-10 per cent lower in 2012-13 than last year in southern regions and average about 34-36 cents/litre.

But it said there was some potential upside in prices driven by supply corrections.

Dairy Australia said discounted retail milk - and now cheese - prices were continuing to apply pressure on margins for processors and manufacturers and the strong Australian dollar was constraining exporter returns.

It said seasonal conditions across much of Australia were favourable for producing milk but rising input costs and unstable/low milk prices were big challenges for farmers.

As a result, confidence among dairy farmers nationally had dropped by 16 per cent since February 2012 to only 53 per cent of farmers saying they were fairly-to-very positive about the industry's future.

WA dairy farmers maintained the same level of confidence in the latest report compared to six months ago, at about 46 per cent positivity.

The Dairy Australia report said WA dairy farmers overwhelmingly identified their biggest challenge for 2012-13 as the high cost of grain and hay.

Only 13 per cent of those surveyed cited milk prices as their biggest challenge for the year ahead.

Nationally, low milk prices, high grain prices and the possibility of an El Nino weather pattern were the biggest factors impacting on confidence.

Mr Depiazzi said flagging confidence among dairy farmers was a big concern for the local industry and consumers.

He said WA was fortunate to have more stable farm gate milk prices than the eastern states due to low supplies.

Price contracts negotiated by WA farmers this winter were about 2c/L higher on average than the previous year and Brownes recently announced another 2c/L for summer milk supplied between January and May 2013.

But Mr Depiazzi said these small price rises were less than the industry had expected, given the low production outlook for milk in the State, and not high enough to stimulate more production at a farm level.

"We need a minimum 10c/L price rise on average to stop declining production, encourage farmers to boost supplies and stimulate growth in the industry," he said.

"At the moment there are no price signals from processors or retailers that will make growers react."

Mr Depiazzi said consumption of milk was growing by about 4 per cent a year in WA but production was contracting by an average of about 5 per cent.

He warned this would lead to milk shortages in the first half of 2013 and more imports from eastern states.

He said the $1/L retail campaign by major supermarkets was proving to be unsustainable down the supply chain.

"It is a short-term gain for consumers who need to be made aware of the cost of producing each litre of milk," he said.

"And it is having a detrimental effect on processors and their bottom lines, so that they can't pay prices that will stimulate milk production.

"That campaign has devalued a nutritious product."

But Coles merchandise manager John Durkan has continued to defend the supermarket's pricing strategy, telling the National Farmers' Federation annual congress last month that it had helped to increase milk consumption by about 10 million litres a week.

He said most of the cost of the $1/L campaign had been borne by the retailer, not farmers.

Mr Depiazzi said WA dairy farmers were also very concerned about high grain prices, given the past six months had been dry across many production zones and the need for supplementary feed was great this spring.

"Grain will be a big impost this year and irrigation water supplies may be low and also costly," he said.

"Dairy farmers will not be carrying extra stock through summer and we could see high numbers of heifers being shipped offshore to reduce herd numbers and generate cash flow."

Mr Depiazzi said producers had been in this situation for the past two years and the heifers shipped out of WA during this period were now lost to the State's milk production base.

He said any recovery in production would face a lag time and this was unlikely to start in 2012-13 without the price signals to encourage producers to lift supply.

Mr Depiazzi said WAFarmers was continuing to make milk processors and retailers aware of the margin squeeze on producers and the stimulus needed to lift production levels.