October Prices Announced

October Class III milk and component prices were announced today. All prices are up significantly and showing positive trends of recovery from the last 11 months of extremely low prices. Protein, the most significant factor in the milk check recovered to $2.5584/lb., well under the $4.71 high of December 2007, but 50% above the low of $1.70 in July 2009.

Butterfat prices remained fairly constant at $1.27/lb.



As a result of these higher component prices, the Class III price advanced to $12.82/cwt, well below the December 2007 high of $20.60, but 38% above the February 2009 low of $9.31.

The National Agricultural Statistical Service (NASS) Survey of Cheese prices that is used to establish protein prices also showed nice improvement and a nice trend reaching $1.4110/lb. for the month of October.

The NASS cheese prices run about two weeks behind the Chicago Mercantile Exchange (CME) cheese prices which have advanced to levels near $1.50/lb. Because the NASS prices are based on a broad survey and the CME prices are based on only a few minutes of trades each day, the NASS prices generally follow the CME pricing but with a little less volatility. Hoard's Dairy provides a very nice graph which follows both prices. Based on the CME pricing, we can expect some lift in the NASS prices in the next few weeks which will influence the November prices.

Everything seems to be lining up for a nice recovery in dairy prices. However, before the final recovery can take place, the cheese inventories that have reached record highs will have to be reduced. This will delay a full recovery, but at least there is light at the end of the tunnel.

How Many Cows will the U.S. Reduce?

The first chart below compares Class III milk prices with the number of lactating cows in the U.S. It appears to be an inverse relationship - when the prices go down, the number of cows goes up! Obviously, this is not the case.





In the next chart, the number of cows is compared to the Class III milk prices when the prices are moved 12 months forward. In other words, when the milk prices change, how does that compare to the number of cows one year later?

A correlation now begins to show. The data indicates that the milk prices are an indicator of the number of lactating cows one year later. This makes sense, in that, as prices rise, producers begin considering expansion. By the time they execute their plans and get fresh heifers ready to milk, a year has passed. When prices drop, no one knows how long it will last or how deep the prices will fall, so there is a delay in reducing herd size. When there is a long and deep period of low milk prices, the ability to stay in the dairy business comes into play and some producers may not be able to finance refreshing their herds with new heifers.

This 12 month difference between milk prices and herd size was tested vs. other lead times ranging from 10 months to 14 months. Statistically, the closest relationship between milk prices and the number of cows occurs at 12 months. With this in mind, below is a graph which could be used to predict the future cow inventory in the U.S. If the falling milk prices experienced in the last 12 months are used as an indicator of herd size in the next 12 months, we can expect very sizable herd reductions lasting well into 2010.

Supporting this prediction, the current USDA forecast indicates a very drastic reduction in cow numbers lasting through the second quarter of 2010. While cow numbers are currently down approximately 165,000 head from their 2008 highs, the current USDA forecast will bring the number of lactating cows down nearly 400,000 from those 2008 peaks.

We are now exiting the period of too many cows and exchange rates that were unfavorable to cheese exports. It would appear that we are now entering a period of too few cows and very favorable exchange rates for exports. This is occurring at a time when grain and oilseed prices are also moderating.

The history of the dairy business is one of boom and bust cycles. It looks like we're heading into a boom period that may match or exceed the extremes of the bust we're exiting.

Why has the Make Allowance Changed so Much?

Many factors point to a recovering dairy market, however, full recovery is still in the future. Through 2007 and the early part of 2008 milk prices were very high. During that time, the cheese makers were able to get significant increases in the make allowance in the Federal Milk Marketing Order milk pricing formulas.

In the April 7 post to this blog, the formulas were reduced to the simplest form to illustrate the importance of cheese prices in the formulas. To arrive at the standard Class III milk price, one can multiply the cheese prices times 9.6, the dry whey price by 5.9 and the butter price times just .4.

Then one needs to subtract the make allowances (the cost to convert the milk to cheese, whey, and butter). For the current formulas that is $3.17/cwt of milk.

Class III Milk Price = + 9.6 x Cheese Price + 5.9 x Dry Whey Price + 0.4 x Butter Price - $3.17

Over the course of 2007 and 2008, the make allowances were increased by a significant 23%. This amounts to $.60/cwt re-allocated from the dairy producer to the cheese producers.



If the pricing formula changes were evaluated at September 2009 Class III component prices, it would make a significant change in what the dairyman receives.

(Due to rounding, the actual Class III price differs slightly from the simplified calculation.)

1. The increases in make allowances were made during a period when milk prices were high - see the chart below. The red arrows mark the dates when the make allowance changes were effective. There was no decrease in the make allowance when milk prices deteriorated. The reallocation of funds from the milk producer to the cheese producer stayed in place in spite of high losses to producers. The $.60 change is obviously a much bigger percentage to the milk producer when milk prices are low.
   
   
   
   
   
2. Cheese manufacturing has reached significant economies of scale, and new cheese plants are being built with a high degree of automation and the capability to very precisely blend ingredients. While automation is expensive, it is never used unless there is a significant return on investment through cost reduction for the expenditure. The cost to make cheese should be going down, not up.

If the U.S. is to remain a major supplier to the global cheese markets, all factors in the chain must be extremely efficient. If there is no pressure to improve, there will be no improvements. A reasonable and comfortable make allowance does not create pressure to improve.

September Prices Announced

September Class III milk and component prices were announced on October 2. The increase was primarily the result of the increase in support prices announced by Secretary Vilsack on July 31.

The Class III price for September was $12.11/cwt compared to $11.20 for August and $9.97 for July. While this is a welcome improvement, it is still far from the 2007/8 highs.


The increases are primarily the result of the higher support prices for cheese and nonfat dry milk. Unfortunately, these price supports are scheduled to expire at the end of October, and with the historically high inventories of cheese, there is little reason to believe that prices will not retreat to their former levels.

The chart below shows the transition of prices since January 1, 2000. Of particular interest is the butterfat price which has not been influenced by price supports and remains around the historical levels of $1.20/lb.

The protein price is primarily dependent on cheese prices. The U.S. and global supply of cheese has kept prices extremely low.

Although there are strong indicators of coming relief for the dairy industry (see September 21 post to this blog), these indicators must continue their trends in exchange rates (weaker USD) and reduced cow numbers before real recovery is reached . There is light at the end of the tunnel, but it is still dim.

Dairy Production in India, China, & Russia does not Influence U.S. Prices

There are a few major milk producing countries that have not been analyzed in this blog, and there are good reasons why. As the graphs below are reviewed, the reasons will become obvious.


There are three major milk producers we have not discussed. The largest, by far, is India. China and Russia are also significant producers.


Fluid milk is not a good product for international trading. Milk is 88% water and has a relatively short shelf life. In the following charts, cheese and milk powder production are analyzed.

Cheese is the international currency of the global dairy industry. India has almost no cheese production at all and, for that reason, India has not been discussed as a player in the global dairy markets. While Brazil, Russia, China, and Canada have decent sized cheese production, it is consumed within their countries and they are not major exporters.

The picture changes when skim and whole milk powder are examined.

Skim milk powder has a long shelf life without refrigeration. It is often used in cheese manufacturing to boost protein. However, Skim milk powder has a very low value, typically just above the $.80/lb support prices. That limits the range for international shipments as shipping costs can easily outweigh other higher prices.

Now for the big surprise - Whole Milk Powder. China dominates this market. The U.S. is not really a player in this market. Fluid milk made from whole milk powder does not compare to real milk. The ready availablity of fluid milk in the U.S. leaves no significant market for whole milk powder. Because of the butterfat in whole milk powder, it must be refrigerated and does not have a long shelf life. Whole milk powder is used in cooking, but this is a very small market.

The focus in this blog is always cheese. The pricing formulas are all based heavily on cheese prices and Chicago Mercantile Exchange prices are based on supply and demand in the U.S. As has been demonstrated in some of the past posts, demand does not significantly fluctuate. However, imports and exports of cheese have a tremendous impact on cheese prices and those statistics are often driven by exchange rates.

This data was compiled from the 2009 Agricultural Statistical database compliled by the Organization for Economic Co-operation and Development (OECD) and the United Nation’s Food and Agricultural Organization (FAO).

In the next post, we'll get back to the basics for U.S. pricing. This post was only to review the global milk production and explain why the focus is not on some of the large milk producing countries.