Milk Production Decreases in 2019. Is it enough?

Data on milk production and cow numbers is now available for the full year of 2019.  With the decrease in domestic consumption of milk, a corresponding decrease in the growth of milk production is needed.  When there is too much milk produced, inventories swell, and producer milk prices drop.  The good news is that milk production growth has decreased in 2019.  Is it enough?

Here's the highlights:

POSITIVE CHANGES

• The growth in milk production has slowed.  
• Cow numbers decreased in 2019.
• With the slower growth in milk production, cheese inventories have decreased.

BUT

• With higher producer milk prices in the fourth quarter of 2019, the slower growth in milk production is not quite as slow.
• While Cow numbers decreased every month in 2019, the decreases were smaller in the final quarter.

OTHER POSITIVE SIGNS

• Milk per cow has shown a one percent annual increase in 2019.  More milk with fewer cows is a very positive parameter for a lower cost of milk production.
• Component levels in milk have increased.  Producer payments are mostly based on butterfat and protein, so higher levels of butterfat and protein are a positive trend toward lower costs of component production.

This post is primarily an update of the July 2019 post on the growth of the milk supply.  Much of the data shown below is based on 12-month moving averages.  Using 12-month averages eliminates seasonal variations and short-term fluctuations.

One of the most important parameters for a low-cost producer is to make more milk with fewer cows.  In 2019, milk per cow has increased by one percent vs. the prior year (Chart I).  The level of increase is a continuation of a very long-term trend of improved productivity.  Also, as covered in a prior post, component levels are also rising.  Milk volume increases and component level increases per cow together amount to an annual increase of at least 1.5 percent in component production per cow.  This increase will likely fulfill or slightly over fulfill the needed production of milk components.  Therefore, a steady to lower number of cows will be needed for balancing supply and demand.

Chart I - Milk per Cow Percent Annual Increase

The milk supply increases and decreases with changes in the price of producer milk.  When prices are high, production increases and when prices are low, production decreases.  Chart II shows the nine year monthly changes in milk production compared to the prior year.  Milk production was decreasing rapidity in 2018 and 2019 through August 2019, but as milk prices began increasing, optimism of higher milk prices took hold and the amount of milk produced began to increase.

Chart II - Milk Production - Increase vs. Prior Year

Charts III and IV show the 12-month moving average milk production for the last nine years.  With lower milk prices, lower milk production typically goes to no growth or negative growth vs. the prior year until the excesses are reduced and the cycle begins again. Lower milk production growth can be seen in Chart III for the early months of 2019, but production began climbing again in late 2019.

Chart III - Milk Production 12-MonthMoving Average

In the current cycle, the 12-month averages of milk production increases bottomed in August of 2019 while the milk supply was still growing at .26 percent.  In the two earlier cycles shown in Chart IV, the increase in milk production went to near zero. The producer milk price increased rapidly in late 2019 and the reduction in the growth of milk production did not hit the lows experienced in prior cycles.

Chart IV - Milk Production 12-Month Moving Average - Percent Change from Prior Year

With the 12-month moving average milk production increasing at only .34 percent (Chart IV), at the end fo 2019, cheese inventories were continuing to fall.  As of the end of November 2019 (the most recent data available), there was a 35 days' supply of cheese in cold storage, down from 39 days in January 2019.  The Class III milk price and milk protein price are closely tied to the price of cheese which in-turn is tied to the cheese inventory.

Chart V - Days Inventory of Cheese

Cow numbers fell to a low of 9,315,000 in August 2019.  However, with higher milk prices in the fourth quarter of 2019, the decrease in the number of cows has reversed, reaching 9,339,000 at the end of the year.

Chart VI - Dairy Cow Numbers

Chart VII shows the growth of cows vs. the prior year.  At the end of 2019, the cows numbers were still below the prior year numbers, but the decrease was much smaller than earlier in 2019.

Chart VII - Diary Cow Numbers - Percent Change from Prior Year

IS THE DECREASE OF GROWTH IN MILK PRODUCTION ENOUGH?

As shown in Chart IV, the 12-month moving average of milk growth slowed to about .26 percent in August 2019.  The fourth quarter of 2019 averaged .33 percent growth.  The current growth level of production would reduce cheese inventories if continued.  However, cow and milk numbers started growing in the fourth quarter of 2019 with the current higher milk prices.  As long as the growth number do not accelerate in 2020, the year should see inventories and milk prices at reasonable levels.

The Formula for Class I milk changed in May of 2019. What was the impact?

Starting May 1, 2019, the pricing formula for Class I milk was changed.  It had been in discussion for over a year and was officially implemented May 1, 2019.  The proposed change was reviewed in detail in this blog in the December 2017 post.

The stated reason for the change was that when the price of Class I milk was based on the Class III price or the Class IV price, those companies that were attempting to hedge pricing had to pick one or the other well ahead of time.  Any such decision one way or the other could stand a chance of being right or being wrong.

With the new formula, using both the Class III and Class IV prices equally in the formula, they could always hedge on both Class III and IV and be covered.  Over the long term, the Class III has been higher than the Class IV and the analysts calculated that an additional $.74 was needed to make the payment equivalent over the long term.
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The "before" and "after" formulas are shown below:

BEFORE MAY 1, 2019

Base Skim Milk Price for Class I = Higher of Advanced Class III or Advanced Class IV Skim Milk Pricing Factors 

EFFECTIVE MAY 1. 2019

Base Skim Milk Price for Class I = ((Advanced Class III Skim Milk Pricing Factor + Advanced Class IV Skim Milk Pricing Factor) / 2) + $0.74
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In the last month of 2019, the new formula produced a result not experienced in the last 10 years.

Over the eight months that the new formula was in effect, the Class I price was $.12 per cwt. higher by the new formula than the old formula.  That was a win for milk producers.  However, in the last month of 2019, the Class I price was $1.40 per cwt. lower by the new formula.

Chart I - Class I Milk Price May to December of 2019

Chart II shows the change with the new formula vs. the old formula month by month.  The final month of the year ended with a huge drop in the Class I Skim Milk price due to the new formula compared to the old formula.

Chart II - Class I Milk Price Differential May to December of 2019

How big is a $1.40 per cwt. difference in the two formulas?  Chart III, which was presented in the December 2017 blog post mentioned above.  The long-term chart of the differences between the two formulas shows that the increased values of Class I milk max out at around $.70 per cwt.  However, the negative changes can dive much lower to values changing by more than $1.40 per cwt., which occurred in December.

It has been over 10 years since the spread between the two formulas has exceeded a negative $1.40 per cwt. and it has happened only five times in the 20-year history of the current pricing system.

Chart III - Monthly Changes in the Class I Milk Price with new Pricing Formulas

WHAT DIFFERENCE DOES IT MAKE?

Borrowing a political phrase, "What difference does it make?"  In a word, the difference is "de-pooling."  De-pooling has become a standard process and is now a part of the science of milk pricing.  Members of an FMMO can de-pool Class II, III, and IV milk if it is financially advantageous.  It becomes advantageous when your Class of milk is worth more than the Uniform (average) price of the four Classes.  If that is the case, milk can be de-pooled, with limitations, and not be in the pricing pool and receive a negotiated price which should be higher than the pool price.

What makes the Class III milk price lower than the Uniform price?  The FMMO structure is built around the concept that the volume and pricing of Class I milk will keep the Uniform price higher than the Class III price.  In December of 2019, the new formula calculation for Base Skim Class I milk was $11.61 per cwt., while the Skim Class III price was $12.11.  As a result, the Uniform price in most Federal Orders was lower than the Class III price.  With that, much of the Class III milk was de-pooled.

Tracking de-pooled milk accurately is impossible but by most estimates, significant de-pooling occurred in December 2019.  As some milk de-pools from a Federal Order with a higher price, there is less money available for others who remain in the pool.