Cheddar Cheese Pricing Rules the Dairy Industry. - Here are the Details and Dynamics.

As covered in many past posts, the cheese price is the most important element in calculation of the Class III milk price.  The Class III category is the largest of the four milk Classes.  An overview of domestic dairy consumption was reviewed in the September 8 post to this blog and showed an annual growth rate of between two and three percent for domestic cheese consumption.  In the prior post, "Exports Show Limited Growth," cheese exports were shown to be stagnant. This post will cover some of the details in the changing dynamics of U.S. per capita cheese consumption and the impact these dynamics have on dairy pricing.  The important commodity in pricing dairy milk and components is specifically Cheddar cheese as it is the analytic used to represent the overall price of cheese.  See this post for details on the linkage between the cheese price and milk prices.

DOMESTIC CHEESE CONSUMPTION

Cheese domestic consumption is the bright spot in consumption of dairy products. The growth rate has slowed somewhat with the maturing of the U.S. cheese market, but it is still growing at a healthy rate.

Chart I shows the growth of per capita consumption of cheese by type of cheese.  All types of natural cheeses have increased per capita consumption with the exception of processed cheese products.  Since 2000, per capita consumption of natural cheeses has increased from 30 pounds per year to 38 pounds per year.  Processed cheese products have decreased from 8 pounds per year to 7 pounds per year.  Cheddar and Mozzarella make up 64 percent of the total 2018 natural cheese category.  Mozzarella has the biggest share at 33 percent.

Chart I - Per Capita Consumption of Cheese

Over the last 19 years, the mix of different cheeses has remained relatively stable.  Cheddar and Mozzarella have dominated the cheese category.  In 2000, Cheddar and Mozzarella represented 67 percent of total natural cheese consumption (Chart II). By 2018, those two cheeses represented 64 percent of the hard cheese market (Chart III).  Cheddar cheese has lost over four percent of the market share of natural cheeses. What cheeses took that market share from Cheddar?   Mozzarella has gained one percent in market share and 20 "other" cheeses that have small shares individually, but collectively have seen significant gains in market share to capture the other three percent.

Chart II - Makeup of the Cheese Category in 2000

Chart III - Makeup of the Cheese Category in 2018

Since 2000, natural cheese consumption has increased by 28 percent.  Table I below shows the growth by cheese type.  The American cheese products other than Cheddar include Colby, Monterey, Jack, and curd cheeses.  The Italian cheese products other than Mozzarella include Provolone, Gorgonzola, Ricotta, Asiago, and Parmesan cheese.  All the American and Italian "other" cheeses just listed constitute the real movers in the growth of cheese.  While they are all relatively small players, altogether they account for 21 percent of total cheese consumed in 2018 and consumption of these cheeses has increased 48 percent since 2000.  Swiss, Blue, Muenster, Brick, and others have also seen significant growth.  

Mozzarella and Cheddar remain the biggest players.  Mozzarella consumption has increased by 34 percent since 2000 and is now the largest individual cheese consumed.  Mozzarella has grown with the growth in Italian foods.  Cheddar has increased volume by 14 percent since 2000 but now commands only 31 percent share of the current market. 

Processed cheese products have decreased by 12 percent during the last 19 years as consumers tend to eat more natural cheese than processed cheeses.  Much of the processed cheese uses Cheddar as the base ingredient and have thereby also decreased Cheddar consumption.

Table I - Growth of per Capita Cheese Consumption 

The important fact from the above paragraphs is that Cheddar cheese is an increasingly smaller piece of the pie.  However, it is still used as the basis of the CME auction pricing and the NASS survey to establish the overall price of cheese.  Because Cheddar cheese is an increasingly smaller part of total cheese production, using the Cheddar only methodology for pricing cheese can increase unintended volatility.

WHOLESALE AND RETAIL CHEESE PRICES

Chart IV shows the wholesale and retail prices of Cheddar cheese since 2000.  The dotted lines are trend lines.  They are all based on year end prices for each year.  The retail price has increased 43 percent over 19 years while the NASS wholesale price has increased by only 27 percent.  The spread between the retail price and the wholesale price has increased from $3/lb. to $4/lb.  The consumer marketing of cheese has helped grow the retail price.  In the last decade, the linkage between the retail and wholesale prices has lost any correlation.  As an example, in 2018, the retail price of cheese went up while the wholesale price of cheese went down.

Why is this important?  Keep reading.  Please note that in 2016 and 2017 the retail Cheddar prices were below the trend line.

Chart IV - Retail and Wholesale price of cheese - $/lb.

PRICE ELASTICITY OF DEMAND

There is price elasticity of demand for cheese.  When cheese is cheaper, more is consumed.  When cheese is expensive, less is consumed.  In 2016 and 2017, the retail prices were below the trend line and Cheddar cheese consumption was up by 6.6 percent in 2017.  In 2018, the retail price of Cheddar cheese rose by eight percent and the Cheddar cheese consumption increased by only one percent, far below the prior year's increases.

Chart V - Cheddar Cheese Price Elasticity of Demand

With the current higher milk prices, cow numbers and milk production are increasing.  However, the growth in cheese production has continued to decline as shown in Chart VI.  The data used for Chart VI is not a fleeting month, but a moving 12-month average compared to the prior 12 months.  The green line represents the total production of cheese which has slowed to a one percent growth rate in 2019.  Cheddar cheese production growth has declined to two percent less than the prior year.  All "non-Cheddar" cheese growth is also slowing but is still above a two percent annual growth rate.

The decreasing production is beginning to bring total cheese stocks down.  At the end of October, the stocks were down 2.4 percent vs. the prior year.  However, that is still a relatively high inventory level of cheese.

Chart VI - 12 Month Average Growth in Cheese Production

WHAT DOES ALL THIS MEAN?

November Class and Component prices were just released.  Class III milk is at $20.45/cwt. and milk protein is at $3.91 per pound, three times higher than the prior year!  Yes, milk protein has increased from $1.34 per pound in November 2018 to $3.91 per pound in November 2019!

The rapid increase in milk prices is driven by the blue line in Chart VII.  Cheddar production has taken a major dive during 2018 and 2019.  In early 2018, the annual growth rate of Cheddar cheese production was near eight percent.  In October 2019 it was near a negative two percent growth vs. the prior year.  Although data on Cheddar cheese inventories is not publicly available, changes in production obviously drives changes in inventories.

Chart VII - Protein Price vs. Growth in Cheddar Cheese Production

What does this mean for 2020?  If Cheddar cheese production stays low and therefore Cheddar cheese inventories do not grow, milk and component prices should remain very positive in 2020.

Exports Show Limited Growth

Export and import data is now available for the third quarter of 2019.  This post will cover cheese and butter, the most important commodities in the Class III price calculation.  By comparison, the first half export/import analysis can be seen here.

CHEESE

Cheese net exports (exports less imports) are shown cumulatively in Chart I for 2018 and 2019.  The two parallel each other very closely.  Through the third quarter of 2019, net export volumes of cheese were up by just one percent compared to the prior year.

Cheese exports reduce cheese inventories and cheese imports add to inventories.  The two combined as net exports measure the total impact of exports and imports on cheese inventories.  A growth of only one percent in net exports is a slower growth rate than domestic cheese production and consumption which are running between a two and three percent annual growth.   Therefore, cheese net exports are a shrinking portion of cheese "disappearance."

Chart I - Net Exports of Cheese

Cheese exports (not net exports) are shown in Chart II.  For the first three quarters of 2019, exports were up three percent over the prior year.

Chart II - Cheese Exports

The biggest export market for U.S. produced cheese is Mexico (Chart III).  Cheese exports to Mexico are down seven percent YTD in 2019 vs. the prior year.  However, there have been nice increases in cheese exports to South Korea and Japan, which largely offset the decline in exports to Mexico.  The tariffs on exports of cheese to Mexico are no longer in place, but the volume of exports to Mexico have not increased.

Chart III - largest Cheese Export Markets

Imports of cheese, Chart IV, have increased strongly in 2019, impacting the weak net export data.  Imports of cheese are up six percent YTD through the third quarter of 2019.  Most all of the increase has occurred in the third quarter of 2019.  If this trend continues, it will have a significant impact on cheese inventories.  There are typically significant increases in cheese imports in the fourth quarter holiday season.

Chart IV - Imports of Cheese

Chart V shows where the imported cheese is coming from.  The largest increase in cheese imports has come from the largest cheese import supplier, Italy.  Imports of cheese from Italy are up 30 percent over the prior year.

Chart V - largest Cheese Import Markets

BUTTER

Butter net exports have declined significantly in 2019 compared to 2018 (Chart VI).  Net exports had fallen to negative numbers in late 2018 and that decline in net esports is now increasing.  That means that the U.S. is a net importer of butter.  The negative net exports increased from four million pounds of butter to 26 million pounds of butter in 2019 YTD.  The change is the result of both lower exports and a surge in imports.

Chart VI - Butter Net Exports

Exports have been small for some time due to the strong U.S. consumer demand for butter.  In 2019, those exports have dropped by another 45 percent (Chart VII).

Chart VII - Butter Exports

Butter exports to the two largest butter export markets, Canada and Mexico, fell sharply in 2019 (Chart VII).  Exports to Mexico dropped by 72 percent, and exports to Canada dropped by 41 percent.  Butter exports to other countries were small.

Chart VIII - Butter Exports by Country

But, the real story impacting the huge drop in butter net exports is the continuing increase in butter imports (Chart IX).  Butter imports YTD are up by 25 percent over the prior year.

Chart IX - Butter Imports

Imports of "Irish" butter are up 27 percent from the prior year and YTD make up 44 percent of all butter imports.  The consumer demand for this cultured butter is strong and growing very fast.  It is impossible to brand a competitive U.S. product, because the product is typically branded as "Irish" butter with names like "Kerrygold".  While consumer consumption of butter is growing nicely, nearly half of the growth is in imported "Irish" butter.  That reduces the demand for production of domestic butter.

CONCLUSION

The hope of all dairy producers is that exports will expand to keep pace with milk production expansion.  That would solve the problem of milk over-production which causes increased inventories primarily of cheese.   Large inventories of cheese decrease cheese prices and in turn decrease the Class III milk price.

However, the increase in cheese exports remains anemic and an expanded cheese export market is not happening!  Cheese net export increases of just one percent will not soak up excess milk that results from over-production and falling dairy consumer demand.

Increased production of butter for export would also increase the production of nonfat dry milk (NDM).  NDM is primarily an export item and the international market for NDM is crowded.  As a result, there are limited increases in butter churning.

Perhaps with approval of the new trade agreements like USMCA, there will be increased growth of U.S. dairy exports.  As of this date, those approvals seem to be held up by political squabbles. 

Milk Prices Continue to Increase - Now $18.72

Class and Component milk prices continued their climb in October.  The Class and Component price announcement can be reached at this link.

Charts I and II below show the movement of prices of Class III milk, components, and the commodities that are used to calculate dairy prices.  Chart I compares October prices to the prior month and Chart II compares the October prices to the prior year.  Both show very similar patterns.  Butterfat is down, milk protein is up, "Other Solids" are significantly down. and Class III milk is up.  In the commodities that are used to price producer milk, cheese is up, Butter is down, dry whey is down, and nonfat dry milk is up.

The biggest influence on the Class III and milk protein prices is the price of cheese.  See the recent post for detail on the link between the price of Class III milk and the NASS cheese price.  The NASS cheese price drives the Class III milk.

Cheese is up 25.6 percent vs. the prior year.  That is a huge change considering that inventories have changed minimally. 

Chart I - Dashboard of Dairy Prices vs. Prior Month

Chart II - Dashboard of Dairy Prices vs. Prior Year

Chart III below shows the 20-year movement of component prices.   Milk protein prices have traditionally been higher than butterfat prices.   Between January 2017 and September 2019. butterfat was more valuable than milk protein.  In the last two months, milk protein has again attained a higher price than butterfat.

Chart III - Long-term Trends in Component Prices

CLASS III MILK and CHEESE

The Class III milk prices (Chart II) reached $18.72/ cwt. in October.  That is an increase of 36 percent since the start of 2019.  That change is based entirely on the increase in the price of cheese (Chart V) which has increased 43 percent since the start of 2019.  Just by comparing Charts IV and V, one can see the tight linkage between the cheese price and the Class III milk price.

Chart IV - The Class III Milk Price over the Last Ten Years

Chart V - The NASS Cheese Price over the Last Ten Years

Typically, cheese prices are determined by inventory levels.  Inventory levels are down one percent from the same month in the prior year, and are even with the prior month (Chart VI).  Based on the most recent data, cheese inventories are still at a high 36-day supply and are only one percent lower than the prior year.  Comparatively. in December 2014, cheese inventories were at a 30-day supply.

Chart VI - Cheese Cold Storage Inventory levels by Year

The inventory levels can be expected to grow with increases in consumption, but as shown in Chart VII, those inventory levels are still above the trend line of normal growth.

Chart VII - Long-term Growth Trends for Cheese Inventories

See the October 13, 2019 post to this blog for a more detailed analysis of cheese inventory levels.

BUTTERFAT

Butter prices are down 5 percent since the start of 2019.  The drop-in butter prices were a surprise as cold storage inventory levels have not increased.

Chart VIII - Butter Prices Over Ten Yeats

OTHER SOLIDS

The price of "Other Solids" is way down from the 2012 to 2014 period.  From highs of $.50/lb. in the mid 2014, the October 2019 price is $.14/lb.  The "Other Solids" price is driven solely by the price of dry whey.

Chart IX - Other Solids Prices for Ten Years

Dry Whey is primarily an export item.  The current price of $.34/lb. is half of the high price in 2014.

Chart X - Price of Dry Whey

SUMMARY

Milk prices are up for only one reason, cheese prices are up.  For a review of why cheese prices are up, read the recent post to this blog.  There is significant risk to the current and future expectations in cheese prices.

With Higher Milk Prices, Milk Production is Growing. Will Over-Production Result?

Milk production and cow numbers for the first half of 2019 were reviewed in the July 15, 2019 post to this blog.  Data for the third quarter is now available.  Class III milk prices have increased (Chart I), and expectations of improved dairy pricing are showing in the futures market.

Chart I - Class III Milk Prices

Inventories of cheese have fallen a little to a 36-day supply in August (Chart II).  However, the inventories are still well above the 2014 levels which reached a 30-day supply.

Chart II - Days Inventory of Cheese in Cold Storage

With the higher milk prices, milk production is already heating up. There are clear warning signs of possible over-production of milk on the horizon.  With cheese inventories already relatively high, excess milk could quickly bloat the cheese inventories and impact pricing.

MILK PRODUCTION

With the Class III milk prices above $20/cwt. in 2012 and 2014, there were significant increases in milk production as producers had the cash flow and desire to increase capacity.  The increases in capacity brought milk production increases that resulted in over-production, and inflated inventories of cheese in cold storage.  With the inflated inventories, cheese and milk prices dropped.

With the current higher milk prices and forecasts for even higher milk prices, the 2019 decrease in milk production (Chart III below) has changed to an increase in milk production in the third quarter.  The change in milk production was a decrease of .35 percent in May 2019 and by September 2019, that had changed to an increase of 1.27 percent.

Chart III - Milk Production Changes vs. Prior Year.

Chart IV below shows the same milk production data expressed as 12-month moving averages.  The 12-month moving averages smooth monthly fluctuations and seasonal changes.  With the lower milk prices that started in 2015, production increases dropped to zero growth at the end of 2016. While milk prices were very low in 2018, the 12-month average milk production began to decrease.  It slowed to .25 percent.  However, the 12-month average milk production increases have not dropped to zero and have now plateaued at .25 percent.  With the September increase at 1.27 percent, the 12-month averages will soon start to grow.

Chart IV - Milk Production Percent Changes -12 Month Moving Average

COWS

The number of dairy cows is down by 1.3 percent from its peak of 9,428,000 in January 2018 (Chart V).  Cow numbers had grown quickly following the high milk price periods shown in Chart I.  The decline from the high has occurred steadily for the last 21 months and is now at 9,315,000.  That would be a decline of .7 percent annually or about 65,000 cows annually.

Chart V - Number of dairy cows in the U.S.

Chart VI shows the percent change from the prior year in cow numbers.  The growth rate of total cows turned negative in mid 2018 as cow numbers declined.  The decline reached an annual rate of about a one percent in early 2019 for a few months.  As milk prices have improved, the rate of decline in cow numbers has fallen from 1.06 percent in March 2019 to .57 percent in September 2019.  The current rate of decline is not adequate to avoid an over-supply of milk.

Chart VI - Percent Change in Number of Cows

The rate of decline in cow numbers does not correlate directly to a reduction in milk volume.  For decades, the milk productivity of cows has increased by about one percent per year (Chart VII).

Chart VII - Annual Milk per Cow

As covered in a recent post to this blog, component levels are also rising, especially butterfat (Chart VIII).  Butterfat productivity grew by 1.6 percent in 2018, from 3.82 percent of milk to 3.88 percent of milk.  Protein levels are also up in 2019 with higher protein prices.  Only components are needed for every dairy product except fluid milk.  Therefore, the increased component levels also reduce the milk volume needed for processors.

Chart VIII - Monthly Butterfat Content for all FMMOs

The combined increases of cow productivity delivering more milk and higher component levels in the milk, the equivalent milk supply will grow by about two percent annually.

SUMMARY

As covered in the June 5, 2019 post to this blog, the overall demand for milk, driven by domestic consumption, is growing at about .5 percent annually.  Fluid milk and a few other dairy products are declining, and cheese is growing.  Considering increases in both cow productivity and component improvements, the same number of cows can deliver about two percent increase annually in the equivalent milk supply.

By the chain of logic linked in this summary, cow numbers need to decrease by over one percent annually.  Cow numbers were going down briefly at an annual rate of one percent in early 2019.  However, the current higher milk prices have provided an incentive to slow down the reduction in cow numbers.  As there are still excesses in dairy inventories, a depletion level above 100,000 cows per year is needed to reduce existing cheese inventories.  That would require an accelerated reduction in cow numbers to relieve the current excesses.

Some "industry buzz" suggests slowing the growth in cow productivity of milk and components.  That will not make milk production lower cost.  The key to the capitalistic system that has made the U.S. a low-cost dairy producer is to manage the business to produce efficiently.   Only fewer, but more productive cows will achieve this.

Class III Milk Prices Rise and Milk Protein Prices Rise as Cheese Prices Rise. -Will it last?

August Class and Component prices were very good news to struggling producers.  Class III milk prices have increased consistently in 2019.  For the first time in 32 months, milk protein is worth more than butterfat.  Milk protein for September was worth $2.86/lb. and butterfat was worth $2.50/lb.  The Class III price was $18.31/cwt., the highest price since November 2014.  Will these prices hold?  Will they continue to grow?  Or, is this just a short break from low prices?  Predicting the future can be tricky, but the reasons and analytics behind the increases can shed some light on the future.  This post will provide some of that light.

Chart I below shows the history and trends of component prices since the inception of the current pricing system at the beginning of 2000.  The protein price had been consistently higher than the butterfat price until three years ago.  The pricing inversion started in January 2017 and has lasted until September 2019.  The primary cause that can be identified for the low component and milk prices, is the excess milk that was processed into cheese and held in cold storage.  That in-turn swelled cheese inventories and lowered cheese prices.  As shown in the two formulas below, the cheese price is the main factor in calculation of the milk protein price and the Class III milk price.   (See the June 12 post to this blog for details.)

Milk Protein = 3.22 x Cheese Price - 1.27 x Butter Price - $.43

Class III Milk Price = 9.6 x Cheese Price + 5.9 x Dry Whey Price + 0.4 x Butter price - $3.20

Chart I - Long-term Trends in Component Prices

The growth in cheese inventories can be seen in Chart II.  In some months, over the last five years, cheese inventories grew as much as 14 percent over the prior year.  Cheese consumption has been growing between two and three percent.  With excess cheese production, inventories have grown.   Fortunately, the growth has slowed in 2019.  The inventories are still high, but at least they are not growing.

Chart II - Cheese Inventory by Month.

Chart III shows the days of cheese inventory in cold storage (the red line in Chart III).  The NASS price of cheese is shown in blue.  When inventories are high, prices are low.

In 2014 when cheese and milk prices were high, cheese inventories averaged a 32-day supply.  In 2017 and 2018, the days supply in storage rose to a 37-day' supply, a 15 percent increase.  Year-to-date in 2019, cheese inventories are still at a 37-day supply.

Chart III - Days of Cheese Inventory vs. the Price of Cheese

Even with the significant inventories of cheese that still exist, cheese prices have escalated to $1.91/lb. in September and are continuing to increase on the CME.  Historically, inventories would have to fall to a range of 32 to 34 days of inventory to reach the current cheese price.  Why are cheese prices high when cheese inventories are still at 37 days' supply?

The answer to that question is based on what really constitutes the cheese price.  The NASS price of cheese is not really the overall cheese price.  It is the price of cheddar cheese only, although it is typically referred as "the cheese price".

Inventories of just cheddar cheese are not publicly available.   However, production data is available.  Chart IV below shows the growth and shrinkage of cheese production as a 12-month moving average.  Twelve month averages eliminate seasonal variations.  The green line in Chart IV shows the change in the production of total cheese.  In 2016, cheese production increased at around 2.5 percent annually. In 2017, total cheese production ended the year at a three percent annual increase.  In 2018, overall cheese production reached four percent above the prior year clearly adding to cheese cold storage inventories as demand is significantly lower than production.

But the real story is about cheddar cheese production, the blue line in Chart IV.  In 2017, through early 2018, the 12-month average growth of cheddar cheese production was extremely high, reaching a level of over eight percent annual growth.  The eight percent growth is not a fleeting month of a high, but a 12-month average growth! Because consumption does not fluctuate this much, the extremely high levels of cheddar cheese production had to bloat cheddar cheese inventories.  With very high inventory levels of cheddar cheese, the NASS cheese price crashed and in-turn, the Class III price crashed.

The production level of "all other" cheese (non-cheddar), the red line, reached a zero-growth level during the same time period that cheddar production skyrocketed.  This would increase cheddar cheese inventories while lowering the "all other' cheese inventory.  But for calculation of the NASS cheese price, only cheddar is considered.

Now that cheddar cheese production has decreased and in July is showing no growth over the prior year, the milk has been diverted back to "other cheeses", the red line.

Chart IV - Production of Cheddar Cheese, Total Cheese, and All Other Cheese

The good news is that the green line in Chart IV,  which shows the growth in total cheese production, is decreasing in 2019.  The amount of growth in production is now somewhere near the level of domestic consumption growth.  That means that the inventories will not grow.  That does not mean the days of inventory in Chart III above will quickly come to normal levels.  To deplete the overall excess cheese inventories, a further reduction in cheese production is needed.

The really good news is that cheddar cheese production growth, the blue line in Chart IV, is now negative.  With one exception, every month in 2019 has seen a decreasing growth level of cheddar cheese production.  Inventories of cheddar cheese have to be decreasing, and with that decreasing inventory, prices are increasing.

Production of "all other" cheeses, the red line in Chart IV, increased tremendously starting in 2019 as cheddar cheese production was reduced.  The current bloat in cheese inventories is centered in non-cheddar cheese inventories.

Because NASS uses only cheddar cheese prices to represent the overall cheese price, the price of cheddar cheese is up significantly, which increases the Class III price and the price of milk protein.

 SUMMARY

Many published articles are predicting "momentum" milk price increases in 2020.  Hopefully, that is the case.  What could derail the price increases?  It is really all about the cheese making industry and how any excess milk production is handled.  If milk production does increase more than total  disappearance, that excess milk would likely be used for cheese production, and that can disrupt the "momentum" of price increases.

An even bigger influence is how much excess milk is used for cheddar cheese production vs. non-cheddar cheese production.  If the current trends reverse and major amounts of milk go into cheddar production, inventories of cheddar cheese could again climb, and the milk and milk protein prices could tumble.

Which Federal Orders Will Grow and Which Ones Will Shrink?

Milk needed in each of the 11 Federal Orders will increase or decrease based on their mix of the four different classes of milk.  Those heavy on fluid milk will shrink with the declining domestic consumption of milk and very limited export opportunities.  Those heavy in cheese will grow as the domestic consumption of cheese increases.  For review, the four Classes of milk are defined below.  All Class I milk must be included in the FMMO pool.  Milk in all other Classes can be de-pooled and are then not subject to FMMO pricing or reporting.

Class I - The milk we drink

Class II - The milk used to make soft dairy products like yogurt, ice cream and sour cream

Class III - The milk used for hard cheese

Class IV - The milk used for butter, nonfat dry milk, and whole milk powder

Altogether, the 11 Federal Orders produced 98,337 million pounds of milk through July of 2019.  Chart I shows the breakdown by Class.  Class III milk for cheese now consumes nearly half of the total milk supply and the category is growing.  Class I milk for drinking now makes up only a quarter of the milk supply and that category is declining.  Class IV milk for butter and nonfat dry milk make up a healthy 16% and Class II for soft dairy products like ice cream and yogurt is the smallest category and shrinking.

Significant amounts of milk for cheese and nonfat dry milk are de-pooled.  The de-pooled amounts are not included in the FMMO numbers in Chart I.  If they were included, Class III would be over 50 percent.

Chart I - Milk for all Federal Orders by Class

The data for the Federal Orders now includes California.  This data below covers only the reported milk from the Federal Orders.    Table I below shows how the Federal Orders rank by reported volumes.  The Upper Midwest is by far the largest at 21.8 percent of the total.  The Northeast is second in size and California is third and adds significantly to the total milk from the Federal Orders.

As mentioned above, some of the Class II, III, and IV milk is not included as the producers can and do de-pool from their Order when financially desirable.  De-pooling has become huge in the new California Order.

Table I - Ranking of Federal Orders by Size

Table III shows the volumes paid on the "Component" system and those paid on the "Advanced" system.  Those paid by the component system comprise nearly 90 percent of the milk and considering that some of the Class III and IV milk is de-pooled, the real number is in excess of 90 percent.

Table II - Component and Advanced Payment Systems Ranked by Volume

Cheese consumption is growing, and fluid milk consumption is decreasing.  In which Federal Orders will milk volume increase and in which Orders will milk volumes decrease?

The biggest winner will be the Upper Midwest (Chart II).  With nearly 90 percent of the milk used for cheese, increased milk volume will be needed for the increased domestic consumption of cheese.  They are the largest Federal Order and will grow with the growth of cheese consumption in the U.S.  In 2018, milk reported in the Upper Midwest increased by over three percent

Chart II - Upper Midwest Milk by Class

California has the second largest Class III volume with nearly 50 percent of the milk going to cheese (Chart III).  California also has a significant volume of Class IV milk which is also growing.  Class I milk is a relatively low volume.  That reduces the uniform price and contributes to de-pooling in the California Order.  Also, when Class IV prices are higher than Class III prices, it is often advantageous for Class IV producers to de-pool.  This is one of the main reasons that a significant amount of California milk is being de-pooled and is not in the California numbers in this post.

Due to de-pooling, the volumes of Class III and IV milk vary significantly month-to-month as significant volumes of milk is de-pooled.  As an example, in 2019 the lowest monthly volume of Class IV milk was 53 million pounds and the highest monthly volume was 1175 million pounds.  If all the Class IV milk was reported, it would nearly double the reported volume of Class IV milk.  Class III milk ranged from a low of 320 million pounds per month to a high of 1416 million pounds.  See the July 2018 post to this blog which explains in detail the huge impact of de-pooling in California.

The total milk volume reported by the California FMMO is therefore significantly understated.  If all the milk was reported through the California FMMO, California would be ranked second in size behind only the Upper Midwest (See Table I).

Chart III - California Milk by Class

The Northeast is ranked second in size of reported milk.  As shown in Chart IV below, the Northeast has a very balanced mix of the four Classes of milk.  Class II is significantly larger than other FMMOs due to the significant production of yogurt in the Northeast Order.  In 2018, the Northeast actually gained volume in Class I milk.

Chart IV - Northeast FMMO Milk by Class

The three FMMOs (Appalachian, Southeast, and Florida) in the southeast U.S. are very dependent on Class I milk volume and are paid on the "Advanced" system.  Florida is the most dependent on Class I milk for drinking with 84 percent of its milk used in Class I.  The Appalachian and Southeast Orders have 69 percent and 67 percent respectively of their milk used in Class I.  As the Class I category declines, these areas will lose the most volume.  Significant reductions in the number of cows will be needed.

Chart V - Appalachian, Southeast, and Florida FMMOs milk by Class

The Pacific Northwest is very small compared to most other FMMOs but is nevertheless exceptional in growth.  They were reviewed in the last post to this blog because of their astounding increase in component percentages.  They are also significantly growing their volume of Class III and Class IV milk.  Comparing 2018 to 2017, Class III milk increased by 24 percent and Class IV milk grew by 10%.  While their Class I volume is shrinking, the gain in Class III and IV have allowed a 12 percent increase in total milk in 2018 over the prior year.  This growth appears to be continuing in 2019.

In total, the Pacific Northwest is significantly growing component levels and milk volume with the increased milk going to cheese and nonfat dry milk.

Chart VI - Pacific Northwest FMMO by Class

SUMMARY

The dynamics of milk consumption are changing, and the milk supply must change to meet these changing consumption characteristics.  Somewhere around 75 to 80 percent of the milk needed to meet consumer and export demand requires components, not milk volume.  The components most needed are butterfat and milk protein.  Water has no value (maybe a negative value) and lactose is mostly sold as whey at a very low price.

By the data analyzed in this post and the prior post, all emphasis should be on increased amounts of butterfat and milk protein.    Increases in both of these components can have a significant impact on producer revenue and helps match the needs for production of growth dairy products.  This can be achieved with fewer cows as cow component and milk volume increase.

Geographically, those orders that depend on fluid milk will need to reduce milk production by at least two percent annually and those that produce cheese will need to grow by at least two percent or more annually.

Butterfat Components Levels Continue to Rise. Now it's Time for Protein Improvement.

Milk protein prices have been low for the last five years.  During this time, butterfat prices have been consistently high.  Diary producers and their nutritionists have done an exceptional job of increasing butterfat levels in milk to record highs, increasing producer revenue.  The market is changing, and it is now time to put a strong emphasis behind increasing milk protein levels in milk.  In August, butterfat was worth $2.66/lb. and milk protein was worth $2.45/lb. and was quickly rising.

In the first fifteen years of the current milk pricing formulas, milk protein was consistently worth more than butterfat.  For the last five years that pattern reversed, as the butterfat price increased, and the milk protein price decreased.  This is changing in 2019 with a surge in milk protein pricing (see the circled area in Chart I).

Chart I - Milk Protein and Butterfat Prices

The milk protein price is driven by the 2019 change in cheese pricing - Chart II circled in red.  The change in the cheese price is driven primarily by a significant decline in cheddar cheese production resulting in lower cheddar cheese inventories.  Butter prices have remained stable and high, while cheese prices have increased by 36 percent YTD in 2019.

Chart II - Butter and Cheese NASS Prices

Table I below shows the butterfat component levels for 2017 and 2018 by Federal Milk Marketing Order (FMMO).  Butterfat levels which were once around 3.5 percent of producer milk, are now at 3.9 percent.  Increases in the Pacific Northwest have been amazing with a 2018 butterfat average over 4 percent.  California became a FMMO in November 2018 and the yearly average is based on two of the most productive months of the year.

Table I - Butterfat Levels in 2017 and 2018

Milk protein levels shown in Table II have increased too, but at a much slower pace.  Growth in butterfat increased .06 percent while milk protein increased .01 percent.  As will be covered in some of the charts later in the post, protein levels, which have risen slowly in 2018, seem to be rising faster in 2019.

Table II = Milk Protein Levels in 2017 and 2018

FMMO statistics are dominated by the Upper Midwest Order which had 23 percent of the total FMMO milk volume in 2018.  Charts III and IV show the butterfat and milk protein levels by year for the Upper Midwest Order.  Butterfat levels in 2018 show significant increases from the prior year.  For 2018, the average butterfat level was 3.92 percent.  

Protein levels shown in Chart IV increased very slightly in 2018.  Obviously, the emphasis has been on increasing butterfat levels shown in Chart III.  The slow growth of protein levels in producer milk has left an opportunity to increase revenue by increasing protein levels while maintaining or growing butterfat levels.  In the Upper Midwest Order, many producers are paid bonuses for higher protein levels.  Well over 80% of the milk in the Upper Midwest is used for cheese and higher protein levels are needed to efficiently make cheese.  This has created an obvious financial opportunity in the Upper Midwest by increasing producer revenue with higher protein levels.  In 2019 YTD it appears that attention is now being focused on improving milk protein levels.

Chart III - Upper Midwest Order Butterfat Levels

Chart IV - Upper Midwest Order Milk Protein Levels

The second largest FMMO is the Northeast Order with 19 percent of the total FMMO milk volume in 2018.  Charts V and VI show the changes in butterfat and milk protein levels in the Northeast Order.  The Northeast Order has lagged behind the Upper Midwest in 2018/19 component level growth.  Protein levels actually declined from the previous year in the Northeast Order in 2018.  Again, there is an opportunity to increase components and revenue with a higher level of both butterfat and milk protein.

Chart V - Northeast Order Butterfat Levels

Chart VI - Northeast Order Milk Protein Levels

The Pacific Northwest is a much smaller FMMO, with only six percent of the total FMMO milk volume in 2018.  The Pacific Northwest is included in this post because they have done an amazing job of increasing component levels.  

They have the highest butterfat levels of any FMMO and have continued to increase these levels regularly.  The Pacific Northwest also has the highest levels of milk protein of any FMMO and is also continuing to increase those levels significantly.

Chart VII - Pacific Northwest Order Butterfat Levels

Chart VIII - Pacific Northwest Order Protein Levels

From the data, it appears that the market forces are causing the right things to happen.  With higher prices, milk protein is on the increase at a faster rate in 2019 compared to prior years.  While there are various factors that can increase component levels, amino acid balancing is one of the proven and most consistent ways to increase butterfat and milk protein levels.  There are more and more experts in amino acid technology that can assist producers and their nutritionists in applying amino acid balancing science in nutrition.

In 2018, butterfat percentage increased from 3.82 percent in 2017 to 3.88 percent in 2018.  That means that the amount of butterfat in the same amount of milk increased by 1.5 percent.  The amount of milk per cow has increased by 1.4 percent per year for the last 20 years.  When these increases in components levels and milk per cow increases are compounded, the same number of cows will increase total butterfat volume by nearly three percent every year.  This is far above the needed milk supply.  Cow numbers have declined recently, but the decline is not enough.