Dairy Market Update, August 2011

Dairy market fundamentals and prices remain strong, but a great deal of risk remains in the market

Prices: On Friday, August 19, 2011 spot prices for cheddar cheese blocks and barrels at the Chicago Mercantile Exchange (CME) were $1.9000/lb and $1.8625/lb, respectively. CME block and barrel cheese prices are both down since late-July (7/28/11), -$0.2550/lb and -$0.2613/lb, respectively. During the same time period, butter decreased (-$0.0075/lb) to $2.0875/lb. CME Class III futures averages (8/19/11) for 2011, the next 12 months, and 2012 were $18.12/cwt (-$0.36/cwt), $17.73/cwt (-$0.70/cwt), and $16.98/cwt (+$0.17/cwt), respectively. These Class III futures averages correspond to potential USDA Michigan mailbox prices for 2011, the next 12 months, and 2012 of $19.11/cwt, $18.72/cwt, and $17.97/cwt, respectively. Figure 1 is a cumulative probability distribution of all USDA BFP/Class III monthly prices from 1995-present. The figure shows the current (8/19/11) CME Class III futures averages for 2011, the next 12 months, and 2012 are at the 93rd, 92nd, and 87th percentiles, respectively. 


Figure 1: Cumulative probability graph of USDA announced monthly 
BFP/Class III prices (1995-present) and current CME futures averages.

Supply: In July U.S. milk production increased below trend (+1.6%, 1995-2011) at +0.7% compared to July 2010. July was the fourth consecutive month milk production grew below trend increase. July production in Michigan decreased -1.5% compared to July 2010. The size of the U.S. dairy herd grew by 7,000 head June to July, and is up 80,000 head versus July 2010. Dairy cow slaughter numbers in 2011 continue to run well ahead of last year, up 87,500 head compared to last year (through 7/23/11). Average U.S. cull cow prices remained very high in July at $74.40/cwt (+25.9% compared to July 2010). Milk production per cow January through July was below trend increase (+0.7%). The USDA reported an increase in dairy feed prices in July of 67.7% compared to July 2010; however, income over feed costs were up 24.6% (+$1.70/cwt) due to an increase of $6.20/cwt in the “All-milk” price.

Demand: The USDA reports total commercial disappearance in 2010 increased 3.3% over 2009, well-above the 1995-2009 average increase (+1.6%). All categories of wholesale dairy products showed above trend increases in disappearance for 2010 except fluid milk products. Total commercial disappearance has weakened, but remains above trend in 2011, up 2.6% through May. All-time monthly records were set for January, February, March and April, but May was down 1.4% compared with May 2010. Through May, disappearance of individual product categories was: American cheese, +3.7%; other cheese, +6.9%; nonfat dry milk, -7.5%; butter, +12.7%; and fluid milk, -1.4%.

U.S. dairy exports for 2010 totaled $3.71 billion, up 63% from 2009. U.S. dairy imports in 2010 were the lowest since 1997. U.S. dairy exports continue strong in 2011 with January, February, March, April, May and June totaling $335 million, $348 million, $421 million, $403 million, $401 million and $423 million; +49%, +55%, +42%, +40%, +40% and +24% compared to January, February, March, April, May and June 2010. January through June 2011 exports were equivalent to 13.1% of total U.S. milk solids production; while imports were equivalent to only 2.7% (the lowest since 1996). In the first six months of CY-2011, exports accounted for 48% of NFDM/SMP produced by the U.S., 5.0% of the cheese, and 9.4% of the butter. So far in FY-2011 (Oct-Jun), U.S. dairy exports are valued at $3.341 billion (+43% versus FY-2010) with a dairy trade surplus of $1.16 billion.

Dairy Product Inventories: The latest USDA Cold Storage Report showed an inventory decrease in June for American cheese (-1.3% at 619.0 million lbs.) and an increase for total cheese (+1.3% at 1,051.2 million lbs.) compared to June 2010. Both cheese inventories set all-time monthly highs for each of the months from January through May, and total cheese also set a monthly record high for June. However, both increases in June were the lowest versus the same month last year since May 2008 (American cheese) and June 2008 (total cheese). June butter inventory was 3.5% below June 2010, marking the eighteenth consecutive month butter inventory has been below the same month in the previous year. Butter inventory declined March to April for the first time since 2004.

Outlook: Wholesale dairy product prices are mixed; however, they all remain above historical averages for this time of year. CME Class III futures prices are mixed with price averages promising to drop sharply beginning in 2012. The 2011 and next 12-month price averages are down (-$0.3625/cwt and -$0.7017/cwt, respectively), but 2012 is up (+$0.1650/cwt). Summer heat in most areas of the country has taken a toll on milk production, both volume and components. Some processors are reporting milk intakes down by as much as 10-15%. However, some major dairy areas (for example, the major western dairy states) have not experienced above average heat and its effect on milk production. Declining milk components means it takes a greater volume of milk to produce manufactured products (e.g., cheese and butter). Also, schools are beginning to open which mean more milk usage in fluid markets. This too will decrease milk available to flow into manufacturing (cheese, butter, powder) plants. However, in late summer and early fall wholesalers, in earnest, begin building cheese and butter inventories for the fall/winter holiday sales season. Also, mozzarella cheese consumption is down which has shifted more milk into cheddar production. According to industry analysts this is the culprit causing recent declines in the CME block and barrel cheese prices. This situation should be self-correcting with the exodus of students back to university class rooms over the coming weeks. Therefore, I would expect cheese prices to strengthen 6-12 weeks, which should translate into a strengthening of Class III futures prices.

Even though feed prices are higher, margins for dairy producers are improving over last year (July income over feed cost +$1.70/cwt versus July 2010). High feed costs, high cull cow prices, and increasing replacement cow prices should keep growth in milk per cow below trend rate for the rest of 2011. These factors should keep national milk production from getting ahead of commercial disappearance. World prices for dairy products has been weakening which is somewhat typical for this time of year. U.S. dairy products at current prices remain competitive in the export market. Oceania has yet to begin its 2011-2012 production season in earnest, and therefore, has little if any uncommitted stocks of manufactured dairy products available for export. EU stocks are also low with 2011 milk production running less than 1.0% above 2010. Therefore, the strong export market for U.S. dairy products should continue. This is critical since domestic U.S. dairy market demand is sluggish. Consumer confidence is low, gasoline prices and unemployment remain high, restaurant traffic has slackened, and mozzarella demand is slow. All of these factors are likely also related to a weak summer vacation travel season which always negatively affects domestic demand for dairy products. In order to maintain or strengthen current dairy product and milk prices, it is critical to maintain our strong export market.

The U.S. dairy market is now, undoubtedly, part of the global market. For the past 18 months over 13% of total U.S. milk solids production has entered the export market. With domestic dairy product demand lagging, it is critical for U.S. dairy exports to remain strong. If so, dairy producers will continue to be rewarded with milk prices above historical averages. The current CME Class III futures average ($18.12/cwt) for 2011 is at the 93rd percentile of historical Class III prices (1995-present). This means that only about 7% of the monthly actual Class III prices since 1995 have been higher than $18.12/cwt. All things equal, the current market should hold together, and may even strengthen, from now until mid-November when the 2012 holiday sales season in the wholesale dairy market will end. As we move into 2012 Class III futures prices are now $2-$4/cwt lower than nearby futures prices. However, I would expect the 2012 prices to strengthen as we approach the end of 2011, because plenty of potential exists for strong export sales. This is not to say that there is no risk in the milk market. A good deal of risk exists on the demand side. Recent history has shown us that world events, whether natural disasters, political upheavals, or economic shocks, can have dramatic negative effects on commodity markets. With this in mind, dairy producers should give serious consideration to using price risk management tools (e.g., futures contracts, forward contracts, put options) to market some of their remaining 2011 milk production and reduce their milk price risk exposure. Feed prices continue to show great volatility, but the final verdict is still out on the 2011 crop. Given the recent strengthening in feed prices, particularly corn and hay prices, it is hoped dairy producers have already forward priced feed into the last half of 2011 and the first quarter of 2012. Dairy producers should remember that milk marketing is about price risk management first; profit enhancement is only a secondary consideration. To view a full report and other dairy marketing information go to my web site at: http://www.msu.edu/~thomasc. This site also features a narrated Dairy Market Update powerpoint presentation. Both of these reports will be updated in late August. For assistance in calculating your cost of production send me an e-mail request (.(JavaScript must be enabled to view this email address)).

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