Dairy market update, October 2012
Dairy market fundamentals continue to indicate strong dairy product and milk prices as the national dairy herd and milk production continue to decline.
On Thursday, October 25, 2012 spot prices for cheddar cheese blocks and barrels at the Chicago Mercantile Exchange (CME) were $2.0900/lb. and $2.0600/lb., respectively. CME block and barrel cheese prices are up since late September (9/27/12), +$0.0150/lb. for blocks and +$0.0250/lb. for barrels. During the same time period, butter is down (-$0.0500/lb.) to $1.8900/lb. The CME Class III futures averages (10/27/12) for 2012 were up (+$0.1058/cwt) to $17.61/cwt, the next 12-months was up (+$0.1308/cwt) to $19.39/cwt, and 2013 was up (+$0.0209/cwt) to $18.69/cwt. These Class III futures averages correspond to potential USDA Michigan mailbox prices of $18.60/cwt (2012), $20.38/cwt (next 12-months), and $19.68/cwt (2013). Figure 1 shows the current (9/25/12) CME Class III futures averages for 2012, the next 12-months, and 2013 are at the 68th, 77th, and 88th percentiles, respectively.
Figure 1: Cumulative probability graph of USDA announced Class III prices (2007-present) and current CME Class III futures averages.
Supply: In September U.S. milk production fell 0.5 percent as compared with September 2011. This marked the fourth consecutive month milk production grew below trend (+1.5 percent, 2007-2011). Milk production the first four months (Jan-Apr) of 2012 grew by +3.9 percent as compared with 2011, but has slowed the past five months (May-Sep) growing at only +0.6 percent. September production in Michigan increased 2.8 percent compared with September 2011. The size of the U.S. dairy herd continues to shrink as dairy cow numbers declined by 27,000 head August to September and is down 76,000 head since April. The decline in cow numbers is particularly pronounced in the major western dairy states (AZ, CA, NM, WA, ID) with aggregate dairy cow numbers in these states down 16,000 head compared with September 2011. Nationally cow numbers are down by 6,000 head compared with September 2011; the first national decline since August 2011. Dairy cow slaughter numbers in 2011 ran well ahead of 2010, up 106,600 head, and are up even more in 2012 through August at +153,600 head. Average cull cow prices have softened a bit, but remain historically high at $80.00/cwt (+13.0 percent compared with August 2011). Milk production per cow in 2011 was below trend (+1.4 percent, 2007-2011) increase at +0.9 percent. Milk per cow started strong in 2012 up an average of +3.0 percent the first four months (Jan-Apr) but slowed dramatically the past four months (May-Sep) at only +0.3 percent as hot summer weather took its toll. The USDA reports an increase in dairy feed prices in September of +8.3 percent compared with September 2011. Corn and soybean meal prices have moderated a bit over the past six weeks but remain significantly higher than in early June, up 44.5 percent and 36.8 percent, respectively. September’s milk:feed ratio remained quite low at only 1.46. September marked the seventh consecutive month the ratio was below 1.50.
Demand: Total commercial disappearance of dairy products for 2011 finished the year right at trend increase (+1.5 percent, 2007-2011). So far (January-July) 2012 is off to a much better start with total commercial disappearance up 2.6 percent. Total commercial disappearance set all-time monthly records January-March and May-July; however, was down in April (-3.3 percent). The January through July disappearance of individual dairy product categories was: American cheese, +0.7 percent; other cheese, +2.3 percent; nonfat dry milk, +42.4 percent; butter, +4.9 percent; and fluid milk, -1.6 percent (through August).
U.S. dairy trade has shown trade surpluses for thirty one consecutive months. For August, U.S. dairy exports were valued at $433 million, down $70 million from May’s all-time monthly record, but 8 percent above July (+$31 million). August marked the eighteenth consecutive month exports exceeded $400 million and the twenty ninth consecutive month exports equaled 12-15 percent of total U.S. milk solids production. August exports equaled 14.2 percent of total U.S. milk solids production while January through August equaled 13.6 percent (as compared to 13.1 percent January through August 2011). So far in CY-2012 (January through August) U.S. dairy exports accounted for 44 percent of nonfat dry milk/skim milk powder produced in the U.S., 5.7 percent of cheese, 6.2 percent of butter; 48 percent of dry whey, and 66 percent of lactose.
Dairy Product Inventories: The latest USDA Cold Storage Report showed inventory decreases in September for American cheese (-4.8 percent, 608.4 million pounds) and total cheese (-4.9 percent, 994.3 million pounds) as compared with September 2011. September marked the first time in six months total cheese inventory fell below 1.0 billion pounds. September butter inventory was 29.4 percent above September 2011 at 195.4 million pounds, marking the fourteenth consecutive month butter inventory was above the same month last year.
Outlook: Dairy fundamentals continue to show strength as milk per cow and dairy cow numbers continue to decline. The dairy cow cull rate remains at a historical high at 33.0 percent, a full five percentage points above the long term average. USDA dairy cow numbers continue to fall and are down 76,000 head since April. We have not seen such a decline in dairy cow numbers since the second half of 2009 when low milk prices devastated dairy producers across the nation. Very importantly dairy cow numbers in the five major western dairy states (AZ, CA, NM, WA, ID) are down 16,000 head compared with last September. Typically those states run 30,000 to 50,000 head above last year on a regular basis. Industry reports indicate very difficult times have hit the CA dairy industry. A major dairy accounting firm in CA reports that “…10 percent of their firm’s clients sold out in the past year or two, while another 20 percent-30 percent have filed for bankruptcy.” And a recent story in the San Francisco Chronicle reported that more than 100 California dairies are facing bankruptcy, foreclosure, or sale by year’s end. Milk per cow growth since May has slowed to only +0.3 percent as compared with last year and September was down 0.9 percent compared with September 2011 indicating this year’s summer heat stress was significant and widespread. These effects will linger into fall and coupled with high feed prices will act as a governor limiting overall milk production.
Cull cow prices have fallen a bit as red meat production in July grew by about +4.0 percent as compared with last July. However, I would expect cull cow prices to rebound once this temporary glut of red meat works through the system. Thus, above average dairy cow culling rates will continue as dairy producers are squeezed by continuing high feed prices. USDA measured feed prices were higher in September than last year (+8.3 vs. September 2011). Feed prices have fallen over the past month creating some buying opportunities for producers, but corn and soybean meal prices remain +44.5 percent and +36.8 percent (respectively) as compared to mid-June. Also, just as importantly, forage prices are also at historical highs as heat and drought has played havoc with hay and corn silage yields. A recent USDA report showed nationwide alfalfa/alfalfa mixed hay production down 15.0 percent (Michigan was down 17.5 percent); the lowest production since 1953. Thus, the word is out in some areas of Michigan that hay is approaching $400/ton and corn silage $80/ton or higher. I suspect forage prices in many areas of the country will match or exceed these levels. This should keep cow numbers, milk per cow, and total milk production growth below trend well into 2013 and thus maintain higher milk prices.
The consumer confidence index rose to 70.3 in September up from 61.3 in August but remains short of the 90 level which is indicative of a healthy economy. Total commercial disappearance figures for January-July are above trend (+1.8 percent) at +2.6 percent and set all-time monthly records for January-March and May-July. American cheese and total cheese inventories are both below last year (-4.8 percent and -4.9 percent, respectively). Butter inventory is well-above last year (+29.4 percent), but is not at an unmanageable level. The all-important fall holiday dairy product sales season is just now getting underway. This is the most critical consumption period of the year for dairy products. Hopefully the higher consumer confidence will translate into stronger domestic sales this year. However, with cheese prices now over $2.00/lb and butter prices almost as high, past history has shown consumers back off and do not purchase as many dairy products at these price levels.
I expect the block/barrel average cheese price to remain in the $1.80’s to $1.90’s until early to mid-December when the holiday sales season ends as U.S. milk production will continue to decline due to lower cow numbers, the lingering effects of summer heat stress, and high feed prices. Despite high inventories relative to last year, look for butter prices to remain in the $1.70 to $1.80 range until mid-December. Hopefully we can sustain settled Class III prices in the $18.50 to $19.50 range through the end of the year and well into the first quarter of next year. It no longer appears we will see any settled Class III prices breaking the all-time high ($21.67 in August 2011). Dry whey futures prices are now at $0.60/lb. or higher from November through May which holds the potential to support higher Class III prices than indicated by cheese prices
Plenty of dairy replacements remain available to grow the national dairy herd if producers decide to do so. Dairy cattle prices are mixed. Some local Michigan dairy cow sales indicate milking cow prices are softening, but other areas of the U.S. show strengthening prices. With the potential for better margins, look for some dairy producers to seek to expand production through herd expansion. However, high cull prices and high feed prices may be able to moderate that strategy. I’m confident we will see milk production continue to grow well below trend levels into mid-2013. The key number to monitor is dairy cow numbers. If dairy cow numbers reverse the current trend and begin growing again it will indicate whether or not the U.S. dairy producer thinks he/she can produce their way to profitability.
Overall the U.S. dairy export market remains strong at +16 percent versus 2011 levels and the largest bright spot in the dairy industry. August dairy product exports marked the eighteenth consecutive month U.S. dairy exports exceeded $400 million and August exports marked the twenty ninth consecutive month U.S. exports equaled 12-15 percent of U.S. total milk solids production. August exports were up 8 percent over July and valued at $433 million. There is plenty of international dairy product demand to keep our export market strong; it just remains to be seen how much our foreign consumers will purchase at these higher prices. Oceania’s 2012-2013 production season is off to a good start with New Zealand forecasting a 4-5 percent gain in milk output and Australia +2.0 percent (versus two years ago). Early indications in Oceania show no uncommitted stocks of finished dairy products are available for export. Milk production in the EU is “declining seasonally” and “stock levels are often not at desired levels for buyer interest”. International dairy product prices have shown slight weakness in recent weeks, but CWT export subsidies are very helpful in maintaining U.S. dairy export volume. A cloud hangs over the export market due to the debt crisis concerns in many countries which could trigger another major worldwide recession. With uneven domestic dairy consumption, the current market is critically dependent upon maintaining high export volumes. Long term outlook for the export market is very bullish, but that doesn’t preclude the potential for short term problems.
Cheese prices are up since the September (9/27/12) report, blocks +$0.0150/lb and barrels +$0.0250/lb. Since the last report the average Class III futures price for 2012, next 12 months, and 2013 are all up: $17.61/cwt (+$0.1058/cwt), $19.39 (+$0.1308/cwt) and $18.69/cwt ($0.0209/cwt), respectively. These Class III prices would produceUSDA Michigan mailbox prices for 2012, the next 12 months, and 2013 of $18.60/cwt, $20.38, and $19.68/cwt, respectively. Butter price has decreased (-$0.0500/lb) to $1.8900/lb since the last report. Figure 9 is a cumulative probability distribution of all USDA Class III monthly prices from 2007-present. The figure shows the current (10/25/12) CME Class III futures averages for 2012, the next 12 months, and 2013. The graph shows the percentiles for each of these three prices indicating the percentage of historical monthly Class III prices that were at or below these levels: 2012, 68th; next 12 months, 88th; and 2013, 77th.
Producers need to sharpen their pencils, calculate their latest cost of production and seriously consider marketing some milk and purchasing some feed. Don’t wait for the pipe dream of $25 Class III futures, plus, take advantage of the lull in the corn and soybean meal prices. Class III prices should remain strong, but past history has always shown that selling milk into a strengthening market is a wise strategy. The market is currently offering very good opportunities to forward price milk. Don’t gamble on trying to hit the high and fail to pull the trigger on some forward pricing now. Don’t hesitate to market small amounts of milk as the market continues to show strength and you will be much more successful in controlling milk price risk. Despite our current bullish market there remain several factors (i.e., unexpected decline in exports, financial/political crisis here or abroad) that could have a negative impact on prices. Remember: marketing is first about price risk management and secondarily about profit enhancement. Work at increasing your overall average milk price rather than trying to hit the market high. To view a narrated PowerPoint based on this report go to my website and click on the button “Narrated PowerPoint”.