Sunday, October 27, 2019

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.

Sunday, October 13, 2019

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.

Wednesday, October 2, 2019

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.