Dairy Market Update, March 2012

Dairy fundamentals point to a weaker market with downside price risk.

Prices: On Tuesday, March 27, 2012, spot prices for cheddar cheese blocks and barrels at the Chicago Mercantile Exchange (CME) were $1.4900/lb and $1.4600/lb, respectively. CME block and barrel cheese prices are mixed since late February (2/23/12), +$0.0025/lb and -$0.0400/lb, respectively. The block/barrel average did exceed $1.60/lb for three consecutive trading days. During the same time period, butter is up (+$0.1250/lb) to $1.5225. The CME Class III futures average (3/27/12) for 2012 was up (+$0.0750/cwt) to $16.14/cwt, the next 12-months was up (+$0.0950/cwt) to $16.07/cwt, and 2013 was up (+$0.1342/cwt) to $16.09/cwt. These Class III futures averages correspond to potential USDA Michigan mailbox prices for 2012, the next 12 months, and 2013 of $17.13/cwt, $17.06/cwt and $17.08/cwt, respectively. Figure 1 shows the current (3/27/12) CME Class III futures averages for 2012, the next 12-months and 2013 are at the 81st, 80th and 81st percentiles, respectively.

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

Supply: In February, U.S. milk production increased above trend (+1.6%, 1995-2011) at +4.3% compared to February 2011 (+4.6% in Top 23 dairy states). February was the seventh consecutive month milk production grew above trend increase. February production in Michigan increased 5.7% compared to February 2011. The size of the U.S. dairy herd grew by 9,000 head from January to February and is up 87,000 head compared with February 2011. Dairy cow slaughter numbers in 2011 ran well ahead of 2010, up 106,600 head, and are up in 2012 through February (+12,200 head). Average U.S. cull cow prices remain strong with February at $80.10/cwt (+10.5% compared to February 2011). Milk production per cow in 2011 was below trend increase (+0.9%), however, it has rebounded and averaged +2.9% in January and February 2012, plus February marked the third consecutive month it grew above trend. USDA reported an increase in dairy feed prices in February of +19.3% compared with February 2011. February’s income over feed cost was down 22.1% (-$1.69/cwt) as compared with February 2011.

Demand: USDA reported all categories of wholesale dairy products showed above trend increases for 2010 commercial disappearance except fluid products. Total commercial disappearance for 2011 started the year strong with January through April up 3.7% as compared with last year. However, it averaged only -0.8% May through September as compared with May through September 2010. However, October through December were excellent months averaging +2.7% as compared with October through December 2010. Total commercial disappearance finished 2011 very near trend increase (+1.6%) at +1.5%. All-time monthly records were set for each month this year except July and August. January through December disappearance of individual product categories was: American cheese, +0.7%; other cheese, +4.2%; nonfat dry milk, -3.5%; butter, +11.0%; and fluid milk, -1.7%. This year (2012) has started strong with total commercial disappearance in January up 2.8% as compared with January 2011.

U.S. dairy exports were strong in calendar year 2011with exports valued at a record $4.88 billion (+29% as compared with 2010) with a dairy trade surplus of almost $1.95 billion. Calendar year 2011 exports were equivalent to 13.3% of total U.S. milk solids production as compared to 12.8% for 2010. Imports for calendar year 2011 were equivalent to 2.8% of total U.S. milk solids production (lowest since 1996). January 2012 dairy exports were up 27% as compared with January 2011 ($425.5 million versus $335 million) and equaled 12.4% of total U.S. milk solids production. January also marked the 11th consecutive month exports exceeded $400 million and the 22nd consecutive month they equaled 12-15% of total U.S. milk solids production. In calendar year 2011, exports accounted for 49% of NFDM/SMP produced in the U.S., 4.7% of cheese, and 7.6% of butter. In 2011, one of every eight tanker loads of raw milk ended up as an exported dairy product.

Dairy Product Inventories: The latest USDA Cold Storage Report showed inventory decreases in February for American cheese (-2.4% at 606.3 million lbs.) and total cheese (-4.6% at 987.4 million lbs.) compared to February 2011. February marked the fourth consecutive month total cheese inventory was less than 1.0 billion pounds. February butter inventory was 48.1% above February 2010 at 205.3 million pounds, marking the seventh consecutive month butter inventory was above the same month last year.

Outlook: Dairy fundamentals are growing increasingly bearish as national milk production increased 4.3% in February as compared with February 2011, the largest since March 2006. The primary reason is the continuation of relatively warm weather. Alarmingly the U.S. dairy herd continues to steadily grow in size (+9,000 hd January to February, +87,000 hd vs. February 2011). The consumer confidence index rose from 61.1 in January to 70.8 in February but remains far short of the 90 level which is indicative of a healthy economy. Despite this total commercial disappearance figures for October through December were quite strong (+2.7%) and continued in January (+2.8% vs. January 2011).

Block/barrel cheese prices experienced their typical Easter/Passover/Spring Break bounce and exceeded $1.60/lb for three trading days, but are sliding back into the $1.40’s. CME Class III futures average for the 2012 and the next 12 months peaked on 3/15/12 at $16.3667/cwt and $16.2908/cwt and have retreated since then to settle at $16.1350/cwt and $16.0675/cwt on 3/27/12. Look for cheese prices to remain weak and perhaps even slide to the high $1.30 range in the coming weeks. I see only small odds of any price rallies until a clear picture of summer weather develops. There could be price rallies if wholesalers seek to refill cheese aging programs. Dry whey prices followed the recent ride up and down of cheese prices. They settled last month at $0.64/lb range, but the futures market is now forecasting dry whey prices as low as $0.44.50/lb by July. This holds the potential to erode $1.17/cwt off of Class III prices by July as compared to February. I don’t know how much of this is factored into the current Class III futures market, but dairy producers need to think about this as they evaluate current Class III prices and contemplate forward pricing their milk production.

The export market remains very strong and there is some indication of improvement in domestic consumer confidence with February’s index at 70.8 as compared with 61.1 in January. Hopefully this will translate into stronger domestic consumption as we move through 2012. However, a great deal of risk remains in the market as U.S. milk production has grown at or above trend for the past seven consecutive months and the increase in February was the largest since early 2006. Also, the U.S. economy remains fragile and economic problems continue to overshadow economies in the European Union and economic growth in China and other Asian countries remains below earlier expectations. We must remember that the U.S. dairy industry in very dependent upon the fact that over 13% of our total milk solids production is going into the export market. Any shock to our export market that would even shave just a couple of percentage points off our exports could have a very negative effect upon domestic milk prices. Data from the National Milk Producers Federation website indicates there will be MILC payments February through August if current CME Class III futures prices hold.

Even though Class III futures prices have mostly increased over the past month, there is still significant downside risk. Producers need to recalculate their cost of production and consider marketing milk. I expect milk production and cow numbers to continue increasing above trend. It is very disconcerting that February milk production grew at +4.3%, a president of a major dairy cooperative aptly commented this was a recipe for a crisis. Furthermore, cow numbers continue to grow and I expect dairy cow slaughter to slacken as dairy producers experience tighter and tighter margins. Hopefully commercial disappearance will continue to grow at or above trend rate. However, look for weakness in all dairy markets over the next two months. Feed prices continue to be quite strong, especially if you are looking to buy hay. Thus, if you are a dairy producer forward pricing milk be sure to simultaneously lock in some feed. It is possible that feed prices might drop, but I believe there is much more upside than downside risk for feed prices.