Dairy Market Update, September 2012
Dairy market fundamentals continue to indicate strong dairy product and milk prices as the national dairy herd and milk production continue to decline.
Prices: On Tuesday, Sept. 25, 2012 spot prices for cheddar cheese blocks and barrels at the Chicago Mercantile Exchange (CME) were $2.0500 pound and $2.0000 pound, respectively. CME block and barrel cheese prices are up since late August (8/27/12), +$0.1975 pound for blocks and +$0.1975 pound for barrels. During the same time period, butter is up (+$0.1375 pound) to $1.9400 pound. The CME Class III futures averages (9/25/12) for 2012 was up (+$0.1300/cwt) to $17.55/cwt, the next twelve months was up (+$0.2783/cwt) to $19.48/cwt and 2013 was up (+$0.2467/cwt) to $18.89/cwt. These Class III futures averages correspond to potential USDA Michigan mailbox prices of $18.54/cwt (2012), $20.47/cwt (next twelve months) and $19.88/cwt (2013). Figure 1 shows the current (9/25/12) CME Class III futures averages for 2012, the next twelve months, and 2013 are at the 67th, 78th and 87th percentiles, respectively.
Figure 1: Cumulative probability graph of USDA announced Class III prices (2007-present) and current CME Class III futures averages.
Supply: In August U.S. milk production fell 0.3 percent as compared with August 2011. This marked the third consecutive month milk production grew below trend (+1.5 percent, 2007-2011). Milk production the first four months (January – April) of 2012 grew by +3.9 percent as compared with 2011, but has slowed the past four months (May – August) growing at only +0.8 percent. August production in Michigan increased 5.4 percent compared with Aug. 2011. The size of the U.S. dairy herd continues to shrink as dairy cow numbers declined by 6,000 head July to August and is down 51,000 head since April. The decline in cow numbers is particularly pronounced in the major western dairy states (Ariz., Calif., N.M., Wash. and Idaho) with aggregate dairy cow numbers in these states down 3,000 head compared with Aug. 2011. Nationally cow numbers are up by only 20,000 head compared with Aug. 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/cwt (+13 percent compared with Aug. 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 percent the first four months (January - April) but slowed dramatically the past four months (May - August) at only +0.3 percent as hot summer weather took its toll. The USDA reports an increase in dairy feed prices in August of +8.9 percent compared with Aug. 2011. Corn and soybean meal prices have moderated a bit over the past two weeks but remain significantly higher than in early June, up 44.5 percent and 39.4 percent, respectively. August’s milk:feed ratio remained quite low at only 1.35. August marked the sixth 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, -1.7 percent.
U.S. dairy trade has shown trade surpluses for thirty consecutive months. For July, U.S. dairy exports were valued at $402 million, down $63 million from May’s all-time monthly record and below July 2011 (-2 percent). July marked the seventeenth consecutive month exports exceeded $400 million and the twenty eighth consecutive month exports equaled 12-15 percent of total U.S. milk solids production. July exports equaled 13.4 percent of total U.S. milk solids production while January through July equaled 13.5 percent (as compared to 13.1 percent January through July 2011). So far in CY-2012 (January - July) 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 August for American cheese (-5 percent, 615.1 million pounds) and total cheese (-5.8 percent, 1,003.1 million pounds) as compared with Aug. 2011. August marked the sixth consecutive month total cheese inventory topped one billion pounds. August butter inventory was 23.4 percent above Aug. 2011 at 204.5 million pounds, marking the thirteenth consecutive month butter inventory was above the same month last year.
Outlook: Dairy fundamentals continue to show increasing strength with the after-effects of the hot, dry summer weather seen in lower milk per cow and falling dairy cow numbers. The dairy cow cull rate remains at a historical high at 33 percent, a full five percentage points above the long term average. USDA dairy cow numbers continue to fall and are down 51,000 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 (Ariz., Calif., N.M., Wash. and Idaho) are down 3,000 head compared with last August. 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 California dairy industry. A major dairy accounting firm in California reports that “…10 percent of their firm’s clients sold out in the past year or two, while another 20 – 30 percent have filed for bankruptcy.” Milk per cow growth since May has slowed to only +0.3 percent as compared with last year and August was down 0.5 percent compared with Aug. 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 percent as compared with last July. However, I would expect cull cow prices to rebound as the 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 August than last year (+8.9 percent vs. Aug. 2011), and promise to go higher as corn and soybean meal prices have increased 45 percent and 39 percent (respectively) since early to mid-June. However, 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 16 percent (Michigan was down 17.5 percent). 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. In fact, the USDA has reduced 2012 and 2013 milk production forecasts, because of these expectations.
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 (-5 percent and -5.8 percent, respectively). Butter inventory is well-above last year (+23.4 percent), but is not at an unmanageable level. Schools are all now in session diverting manufacturing milk to fluid use. Also, in another few weeks the all-important fall holiday dairy product sales season will begin. 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/pound 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 $1.90s or higher until early to mid-December when the holiday sales season ends as U.S. milk production will remain flat 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 above $1.80 pound 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. Also, do not be surprised if we see some settled Class III prices above $21 and testing the all-time high. Dry whey futures prices are now at $0.60 pound or higher from October 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 hopeful we will see milk production continue to grow below trend levels well into 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 +18 percent versus 2011 levels and the largest bright spot in the dairy industry. July dairy product exports marked the seventeenth consecutive month U.S. dairy exports exceeded $400 million and July exports marked the twenty eighth consecutive month U.S. exports equaled 12 - 15 percent of U.S. total milk solids production. However, July exports were down over 20 percent from May’s all-time record, even though they were still valued at $402 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 beginning with New Zealand forecasting a four to five percent gain in milk output over 2011-12 and Australia +2 percent. Milk production in the EU is up about 2 percent over last year, but stocks of manufactured dairy products are not as plentiful as in past years. International dairy product prices have been increasing lately on unusually strong sales for this time of year as many buyers are quite concerned about the impact of the hot, dry weather on U.S. dairy product availability. Another cloud hanging over the export market is that 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.
Producers need to sharpen their pencils, calculate their latest cost of production and seriously consider marketing some milk. Don’t wait for the pipe dream of $25 Class III futures. 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 online.