Monday, March 5, 2018

"Déjà Vu" - Inventories, Inventories, Inventories

February 2018 Class and Component prices were consistently negative from the prior month.  Why?  Inventories were up again.  The only exception was butter, where inventories were at prior year levels.  The inventory data that is available is for the end of January.

Chart I - Dairy Commodities and Component Prices
In spite of decent exports and reduced imports of cheese, inventories of cheese continued to grow vs. the prior year (See Chart II).   The growth rate could be acceptable if there were not already excess inventories.  As covered in the prior post, if this production rate is continued, exports must increase dramatically and imports must continue to shrink to reduce the inventory.

Because cheese prices are so closely linked to Class III milk price, the cheese inventory must be reduced before producer milk prices can improve.

Chart II - Cheese Inventory
Butter inventories (Chart III below), continued very close to the year go levels, it is difficult to say why the current price is lower than twelve months ago.  That said, there is no perfect market.  Butter production is up vs. the prior year, which could be playing into the lower prices.  At any rate, butter inventories continue to be more is line than other dairy commodities used to price producer milk.

One element preventing big increases in butter production is the issue of what to do with the skimmed milk that is left when the butterfat is removed. Increases in butter production could throw more skimmed milk on the market, which if dried would make the very high nonfat dry milk inventories (Chart IV) even higher.

Chart III - Butter Inventory
Nonfat Dry Milk/Skimmed Milk Powder (NDM/SMP) inventory is extremely high (Chart IV).   The inventories are around 40% higher than "normal."  To bring these inventories down to "normal" levels, exports would have to double for one month.  Of course, that is impossible.  A combined effort of reduced production and significantly increased exports would be needed to reduce these levels during the full year of 2018.  We can therefore expect high inventories and low NDM/SMP prices for all of 2018.
Chart IV - NDM/SMP Inventory
Dry whey inventory is also high, but down considerably from the Q4 2017 levels.  As mentioned in the February 5 post to this blog, because this inventory can be reduced quickly by drying less whey, inventory can recover quickly.  Dry whey is primarily an export items and is subject to global price fluctuations. 

Chart V - Dry Whey Inventory
In addition to the four commodities used to price producer milk, the inventory Chart VI below for whole milk powder is included in this post.  Whole Milk Powder (WMP) is strictly an export product.  While WMP is a very large category globally, there is very limited need for it in the U.S.  Because it does include butterfat, it requires refrigeration or an oxygen proof environment to prevent rancidity.

While the WMP category is about 1/10th the size of NDM/SMP, it does provide an opportunity to store excess milk because WMP properly packaged does have a relatively long shelf life.  The increased WMP inventory is nearly 50% larger than the prior year.

 Chart VI - WMP Inventory

Producer dairy prices are subject to extreme price volatility and it is very difficult to manage a business with extreme volatility (Chart VI).  The price changes result primarily from inventory fluctuations of the commodities used to price milk components.  Some of these fluctuations come from changing consumer consumption in the U.S. and producer over-production.  However, most of the inventory fluctuation can be traced to variations in exports and imports as dairy commodities are increasingly traded globally.  Current examples of events that could increase milk-pricing volatility are changes in NAFTA, possible changes in tariffs countering U.S. tariff changes, and changing weather that could impact production in dairy exporting countries.  As dairy commodities are increasingly traded internationally, milk pricing will increase in volatility.

Chart VI - Long-Term Trends in Component Price
Table I below provides another view of this volatility.  By far, the volatility is greatest in the price of other solids.  Over the last five years, the price of other solids have varied from $.03/lb. to $.50/lb.  The price of other solids is calculated based on the price of dry whey.  Dry whey is heavily exported and that makes the pricing dependent on international events and prices.  Fortunately, the price volatility of other solids has a small impact on the Class III price.  

Butterfat has varied from $1.32/lb. to $3.25/lb.  While the price has been very volatile, the volatility has been lower than either of the other two components, which make up the Class III price.  The price of butterfat is based on the price of butter.  Most of the increase in price has come from the increased per capita consumption, both domestically and internationally.  Meeting this demand has led to an excess of skimmed milk which in-turn is feeding inventories of NDM/SMP.    Fortunately, the price volatility of butter has a small impact on the Class III price.

Table I - Price Volatility of Milk Components
Milk protein pricing is unique because the formula used to calculate the value of milk protein is based on two variables, the price of cheese and the price of butter.  As the cheese price goes up, milk protein goes up in value.  As the butter price goes up, milk protein goes down in value.  As a result, milk protein prices are more volatile than butterfat prices.  The price volatility of cheese has a huge impact on the Class III price as shown in Chart VII.

Chart VII - Correlation Between the NASS Cheese Price and the Class III Milk Price 
Can milk component prices be accurately forecast so producers can "adjust?"  Obviously, no, they cannot be accurately forecast.  There are too many global variables that can change unexpectedly.  News on future price changes are consistent only in the fact that they are inconsistent and contrary.  As one expert predicts higher cheese prices, another predicts lower cheese prices, etc.

As analyzed in a prior post, the best producer strategy is to always manage for maximum component levels with a consistent strategy.  Strategies that chase the uncertain market with changing management strategies is a hopeless and frustrating effort. 

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