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.