Friday, October 26, 2018

Class I Milk Crash Accelerates

There are lots of headlines in the dairy news that milk production is continuing to grow.  There may be fewer cows, but the remaining cows are producing more milk.  This post will look at the other side of the supply/demand ratio, specifically, the decline in milk consumption.  In the May 26 post to this blog, the declining consumption of fluid milk was analyzed based on consumption data.  Not only was it declining, but the decline also appeared to be accelerating.  This post will update the fluid milk "disappearance" by analyzing Class I milk production in the Federal Milk Marketing Orders.

Fluid milk is perishable and requires refrigeration.  It cannot be frozen or economically stored for long periods of time.  Therefore, the link between production of fluid milk and consumption is firm and tightly linked.  What is produced must be sold within a very limited time.

Chart I below shows the monthly production of Class I milk.  For years per capita consumption has been declining, but population growth has keep the Class I milk category stable.  But, starting in 2017, the total Class I milk  category started a decline.  As we get more data on the decline, it becomes obvious that the decline is accelerating.  The trend line in Chart I was extended through 2019.  By the end of 2019, Class I milk will be down to about 3000 million pounds per year by this analysis.  Compared to 2016, that would represent a 13 percent drop.  Declines typically shrink in pounds as they reach a new plateau.  The decline in dairy milk is not following that pattern.  Its volume decline is increasing with time.

Chart I - Class I Milk per Month
Class I milk is always the highest paid milk.  The FMMO formulas are designed to assure this pricing structure.  The "Uniform" milk price is the weighted average of the four calculated milk classifications.  Producers are essentially paid by the  "Uniform" price through procedures such as the Producer Price Differential.  As less Class I milk is produced, the "Uniform" producer price will therefore decline.  Chart II below shows the reduction in the percentage of Class I milk in the total producer milk.  The trend line shows a decline from around 33% of Class I milk in the mix to a level around 28% by the end of 2019.

Unless something changes, the decline will continue and Class I milk will have a reduced impact on the "Uniform" price and, all other things equal", the "Uniform" price will decline.

Chart II - Class I Milk as a percent of Total Milk
Chart III is the most important change.  It shows the increasing rate of volume decline.  In 2016, Class I was not increasing or decreasing.  By year-end 2017, it was decreasing by more than one percent per year.  By year-end 2018, the volume of Class I milk will be decreasing by about three percent per year.  If the trends continue, by year-end 2019, the rate of decline will be about 6 percent per year.  These numbers are lower than those calculated by the using consumer consumption data in an earlier post.  However, both sets of data do show a rapidly increasing reduction in Class I milk.

Chart III - Class I Milk Reduction from Prior Year
The biggest problem is that there is weakening domestic demand for milk while the supply side keeps growing.  Can exports make up the difference?  Exports have shown growth in inexpensive products, but exports of high quality dairy products like cheese have not grown. Due to the water content in Class I milk and the limited shelf life, Class I milk is not a good export item.  The volume of Class I milk is strictly dependent on domestic consumption.  Export activity is not currently helping producer milk prices.

The decline in drinking milk appears to be the start of a long-term trend and the depth of the trend is growing.  It has to be faced directly and plans made to insure the financial future of the dairy industry with less Class I milk.

Sunday, October 14, 2018

Cheese Exports are "Stuck in the Mud"

August dairy export and import data are now available.   In order to increase producer milk prices, cheese inventories must be reduced.  Domestic cheese consumption grows every year at about 2% annually.  However, cheese production is geared to also provide cheese for export in increasing amounts.  That is not happening.  For a review of the importance of the cheese price on producer milk prices, see the later half of this post.

Chart I below shows cheese exports over the last 19 years.  From 2004 to 2014 cheese exports were on a very nice growth curve.  Then the bottom dropped out and cheese exports declined dramatically.  They recovered some in 2016, but have not grown since then.

Chart I - Cheese Exports Since 2000
Chart II shows cheese exports by year for the last five years.  There is no growth.  In fact the current year is lower than the prior year and lower than 2014.

Chart II - Cheese Exports by Year
Chart III compares cheese exports by country.  There is some minor growth in cheese exports to South Korea, Japan and a few other countries, but there is essentially no significant growth in cheese exports to any country.  Overall, cheese exports are not seeing any growth.

Chart III - Cheese Exports by Country
NDM/SMP has seen continuing export growth (Chart IV).  The growth is nothing new.  It has been steady for nearly 20 years.  With increased consumption of butter, more nonfat milk is available for drying and there always seem to be a market if the price is right.  As covered in the prior post,  the price of NDM/SMP has been in a slump for the last three years,

Chart IV - NDM/SMP exports Since 2000
Most of the NDM/SMP goes to Mexico (Chart V).  It does not require refrigeration and is very inexpensive.  Can more be absorbed in Mexico?

Chart V - NDM/SMP Exports by Country
Comparing cheese and NDM exports, there are some similarities but also major differences.
  • Mexico is the biggest buyer of both U.S. cheese and NDM/SMP.
  • Cheese is relatively expensive and cannot be afforded by many Mexican citizens.  It also requires refrigeration, which is not available in parts of Mexico.  The Mexican market may be saturated with expensive cheese.  
  • NDM/SMP is very inexpensive and does not require refrigeration.
Chart VI - Butter Exports by Country
Butter exports remain miniscule.  Domestic consumption demand for butter leaves little available for export.  What is exported does not have far to travel as most all butter exports go to Mexico or Canada.

Exchange rates are always a factor in international trade.  A weak currency improves a country's competitive position.  

The exchange rates for the two largest international dairy competitors, Europe and New Zealand, are both showing a strengthening of the USD.  In 2018, the USD has strengthened by more than 10% against the NZD, giving New Zealand a more competitive position in commodity sales.  The USD has also strengthened by slightly less than 10% against the Euro.

Chart VII - Exchange Rates for USD/Euro
Chart VIII - Exchange Rates for USD/NZD
When selling to our two biggest dairy customers, Mexico and Canada, the USD is also showing increased strength of about 5%.  This makes products sold to these countries 5% more expensive. 

Chart IX - Exchange Rates for USD/Mexican Peso 
Chart X - Exchange Rates for USD/CAD
There are lots of headlines about the impact of 25% tariffs, but in reality, exchange rates can have a bigger impact.  For instance, in 2008/09, when the USD strengthened by over 50% vs. the NZD, U.S. producer milk prices fell from $20/cwt. to $10/cwt.  Exchange rates don't make headlines, but they can be very impactful.

Monday, October 8, 2018

Class III Milk Prices Break $16/cwt.

September Class and Component prices were announced on October 3.  As shown in Chart I below, most price changes were positive.  Why did prices improve?  It may be the news that a revised NAFTA agreement, now known as USMCA, has been finalized and is ready for ratification by congress.  Some of the fundamentals, which are reviewed below, are showing significant improvement.
Chart I - Dashboard of Price Changes
While Chart I shows a positive view for August, there are still lingering issues that have been discussed in prior posts to this blog.
  • There is still too much milk in the system.
  • Class I milk is showing serious and significant declines in consumption.  Because this is the highest paid milk, the Class I decline both reduces the amount of milk needed and lowers the average (Uniform) milk price.
  • The increasing consumption of butter leaves a lot of nonfat dry milk to market.  By the formula linkages and the laws of supply and demand, Class IV milk will continue to plagued by low prices. 
  • Exports gains are mostly in low value products that do not significantly impact producer prices.  For instance, in the most recent month for export data, exports were up 12%.  However cheese exports were down 7%.
Cheese is reviewed first, because cheese prices are the most important factor is the Class III price calculation.  Exports will be briefly reviewed in this post, but more details will be provided in the next post.

Cheese inventories remain high.  They are reviewed in Charts II and III below.  August inventories were down from July, but were still a record for the month of August (Chart II).  Chart III shows the long-term view.  The trend line in Chart III illustrates the "normal" growth rate.  It shows that cheese inventories are still well above the "normal" growth rate and are at levels above normal seen only occasionally in the past.   

Chart II - Cheese Inventories by Year
Chart III - Cheese Inventories Long-term
August exports of dairy products were up significantly.  However, cheese exports were down, not up.  With inventories high, production high, and exports low, one would not have expected to see a 6.4% increase in the price of cheese.

Chart IV - Cheese Price
The enthusiasm of a new North American trade agreement may have provided a boost to future expectations and cheese prices.

The price of butter and butterfat were down slightly.  Butter was down 2% and butterfat was down 2.2%.  That price point is still within the narrow band of the last 12 months.  The current price of butter is $2.27/lb. and over the last 12 months the price has ranged from a low of $2.11/lb. to a high of $2.37/lb. (Chart V).  The September price for butter appears to be just a normal fluctuation, not a trend.

Chart V - Butter Price
Inventories of butter are very tight.  As seen in Chart V, they are below 2016 levels and very close to 2017 levels.  Butter consumption is increasing (see the March 31 post) but inventories are not keeping pace.  The slight reduction in the price of butter is surprising with these tight inventories.

Chart VI - Butter Inventory
Nonfat Dry Milk/Skimmed Milk Powder (NDM/SMP) remains low priced.  The price has remained near or below $1/lb. for three years.  While there is a slight uptick in September, the price of NDM/SMP remains low with no major up or down trends.

Chart VII - Price of NDM
This has kept the Class IV milk price lower than the Class III price. Class I milk is priced based on the higher of the Class III or Class IV milk price.  For the last three years, Class IV milk price has been below the Class III milk price most of the time.  Cheese prices will therefore dictate both the Class I and Class III milk price.  With pricing for the two largest classes dependent on the price of cheese, getting cheese inventories down, which will drive Class III prices higher, should be the highest priority.  Instead, excess milk is being stored in cheese.

Chart VIII - Class III and Class IV Milk Prices
The next post will review August exports and imports in detail.  There have been headlines about how exports grew by 12% in August.  In the fine print, there is a slight mention of the reduction of 7% in cheese exports.  What is needed for producer prices to grow is higher exports or reduced production of cheese.  Either one will reduce inventories and improve cheese prices and thereby raise Class III milk prices.  But month after month, that does not happen.