Why was Q2 Milk Pricing so Volatile? What will Happen in Q3?

UPDATED FOR ALL FOUR WEEKS OF AUGUST NASS PRICING

Cheese pricing data for the second quarter of 2020 is now complete.  Some data is available for July.  The charts in this post give us a good picture of why there were huge swings in dairy prices in the second quarter.  Data for the third quarter of 2020 is showing major changes from the second quarter.  This post will focus on Cheddar cheese as it is the primary commodity used to calculate producer milk prices.

In late April and early May cheese prices took a huge drop as COVID 19 uncertainty prevailed and domestic disappearance fell.  Many buyers took advantage of this "buy on the cheap."  In June and July cheese prices escalated to record prices.  August prices are now "falling like a rock."

Cheddar cheese prices are the main parameter for producer milk prices.  As shown in Chart I, production of Cheddar in the second quarter of 2020 was relatively robust compared to average production of the last three years.  Compared to the second quarter of 2019, production of Cheddar is up 2.6 percent.  Cheddar is not a growth product, so the increase is above norms.  The record high cheese prices in June and continuing in July cannot be blamed on low Cheddar production.

Chart I - Production of Cheddar Cheese

Withdrawal from cold storage of American cheese for domestic use is shown in Chart III and net exports of American Cheese are shown in Chart IV.    Both charts show a significant increase in June.  Domestic disappearance of American cheese was up eight percent in June compared to the June level of the three prior years.  Deliveries of American cheese for the Coronavirus Food Assistance Program (CFAP) contributed to the spike in June withdrawals from cold storage.

Chart II - Domestic Disappearance of Cheddar from Cold Storage

Cheese net exports were very low at the beginning of 2020 due to exchange rates.  June net exports of cheese were up 75 percent from January of 2020 (Chart III).  The June spike in exports is for deliveries of cheese purchased at low prices in April and May as reported by the U.S. Dairy Export Council. 

Chart III - Net Exports of American Cheese

Comparing Charts II and III, the changes in domestic disappearance are far greater than changes in net exports of American cheese.

Strong production and strong withdrawals from cold storage, netted to a reduction in inventories of American Cheese (primarily Cheddar) in the second quarter.  However, inventories are still at or above averages in the second quarter.  In total there was no shortage of available American Cheese (Chart II below).  Chart II below includes data for July as well as June.  June and July inventories took a plunge from May but are still not showing an inventory shortage from norms.  The inventories may not be exactly what is needed with the change from food service to retail demand, but overall, inventories of American cheese are not low.

Chart IV - Inventory of American Cheese

WHERE DO PRICES GO FROM HERE?

August is a four-week month for Federal Order Milk Pricing. The charts below have been updated to include all four weeks.  There are three parameters for pricing Class III and another for pricing Class IV.  Class IV milk prices have become more important with the change in pricing formulas implemented in May of 2019

All three of the parameters for Class III pricing are down.  Cheese is by far the most important parameter and the price has taken a nosedive in the last three weeks.  In four weeks' time it has fallen from $2.63 per pound to $1.71 per pound, a 35 percent drop.  If the nosedive continues, it could drastically impact August producer prices.

Chart VI- NASS Survey of Cheese Prices

The second most important parameter is butter pricing (Chart VI). It has also taken a dive in the last two weeks.   Butter has dropped by 14 percent in week three but leveled out in the fourth week..

Chart VI - NASS Survey of Butter Prices

Dry whey pricing, (Chart VII) which is used to price Other Solids, has also decreased.  It has dropped from $.35 per pound to $.32 per pound, an eight percent drop.

Chart VII - NASS Survey of Dry Whey Prices

The combined impact of these three commodities has reduced the Class III price to $19.77 per cwt for August. 

Nonfat Dry Milk (NDM) pricing shown in Chart VIII is used to calculate the skim milk price of Class IV milk.  NDM has been steady at its low price of around $.95 to $.98 per pound.  Therefore, the Class IV price will remain low and because the Class IV skim price is now used consistently in the Class I price calculation, the Class I price will remain low.  Because the NDM price now determines not only the Class IV skim price but also consistently influences the Class I price, it will keep the Uniform (average) price low and increase the possibility of a negative Producer Price Differential.

Chart VIII - NASS Survey of NDM Prices

With the Class III prices falling, the PPD will not be as negative as it was in June and July.  When week four NASS prices are updated and the August Class III prices are released, this post will be updated with the final numbers.  Check back in a few days for these updates.

July Prices Showed Improvements Over June. What will August bring?

In the July post, the June analytics of high cheese and Class III milk prices combined with a large negative Producer Price Differentials (PPD) and massive de-pooling was reviewed.  July analytics followed some of the same patterns, but with improvements and a few negatives.  This post will provide insights into what happened in July and where the market seems to be going in August.

The highlights of this post will cover the following:

• The July PPD was again negative for all Federal Orders paid on the component system.  On the average, the negative PPD was 16 percent greater in July than June.

• The Uniform (average) price for all classes of milk increased in all Federal Orders.  On the average, the Uniform price was 16% higher in July than June.  That is very good news for those who remain in the FMMO pools.

• Massive de-pooling continued in July.  De-pooling of Class III milk in the Upper Midwest increased further in July.  California continued to de-pool almost 100 percent of their Class III milk.

• The July price of milk protein increased to $5.63 per pound, a record high and 24 percent higher than June.  This very good news for producers focusing on milk protein production.

• The July Class III milk price was $24.53 per cwt., a 17 percent increase from the prior month.

• Cheese exports did spike in June with a 29 percent increase.  However, year-to-date, cheese exports are still showing no growth over the prior year.  The spike in June was primarily forward purchases from Mexico at low April and May prices.  It is a one time event, not a change in ongoing exports.

• Cheddar cheese production has remained robust and published inventories have remained within normal ranges.  However, the combination of increased exports executed in late April and May at low prices and delivered in June, CFAP purchases put out for bids in May for delivery in June and July, and other forward buying of Cheddar when prices were low have put stress on Cheddar resulting in higher prices.  The change from food service to retail purchases. have also created havoc in Cheddar production, processing, and purchasing.  Read this article from the New York Times for details.

• The record high cheese prices are starting to decline in the weekly NASS surveys.  Will the August price signal a return to normal?

Table I below shows the Uniform Price and PPD for each of the Federal orders paid on components.  July Uniform milk prices were higher than May or June prices.  That is very good news for those that stayed in the Federal Order pools.

The PPD reached a more negative level in July.  This was caused by the very high Class III milk price compared to the Uniform price.   The low Nonfat Dry Milk (NDM) price held down both the Class I and Class IV prices.

With Class III at $24.53 per cwt. and an average negative PPD of $7.51 per cwt., the combination of the Class III less the PPD adds to $17.02, very close to the Uniform price of $17.00 per cwt. shown in Table I.  While there are multiple adjustments in Federal Order PPD calculations, the essence of the PPD concept and calculation is to produce an even pay for those in the pool. The data in Table I clearly shows this relationship.

Table I - The Uniform Price and PPD

With a large July negative PPD, de-pooling was again very aggressive.  Below are Charts I and II showing the Class III pooled volumes of two of the largest Federal Orders, the Upper Midwest and California.  When milk is de-pooled, Federal Order pricing does not apply.  Typically, the producer is able to maintain near Class III prices when de-pooling, but the price can be lower.

In July the Upper Midwest the pooled Class III milk dropped to 446 million pounds.  That is about 15 percent of the milk that was being pooled in the first half of 2019.

Chart I - Class III Milk Volume in the Upper Midwest

California Class III milk pooled was at 1,411 million pounds shortly after becoming a Federal Order.  In 2020, that has fallen to a very low level and in July reached a new low of just 11 million pounds.  Practically all of the California Class III milk is not pooled.

Chart II - Class III Milk Volume in California

Charts III and IV show the estimated de-pooling in the Upper Midwest and California.  In the Upper Midwest de-pooled milk is reaching record levels. 

Chart III - Estimated Upper Midwest de-pooled Milk

De-pooling in California went down slightly only because less Class IV was de-pooled.  As long as the Class III milk price is high, it will remain out of the pool.

Chart IV - Estimated California de-pooled Milk

With the high cheese prices and lower butter prices, milk protein, as covered in the prior post reached an extraordinarily high value of $5.63 per pound in July.  Producers spiking diets for protein development are getting high returns.

Chart V - Milk Protein Prices

WHERE IS AUGUST PRICING GOING?

In the July 31 post to this blog  an analysis of the August Class I price was detailed.  It was based on high cheese prices, but the new Class I formula brought the base skim milk price down to $13.34 per cwt.  The September Class I skim price was just announced at $13.02 per cwt.

The Class III skim price is primarily based on the NASS price of cheese.  As shown in Chart VI, the price of Cheddar cheese is falling in the NASS surveys, but at $2.21 per pound it is still high.  Based on the first two weeks of data, the August Class III Skim price would be $17.08 per cwt.  With the Class I skim price still well below the Class III skim price, a strong negative PPD can again be expected in August.

Chart VI - Weekly NASS Survey of Cheese Prices

With cheese prices declining, historically, the Class III price for the month would have been lower than the Class I and the PPD for August would be positive.  However, with the new formula for Class I, which is based on a combination of the Class III and Class IV prices, the Class I is much lower.  (See the July 31 post to this blog for details on the change in formulas.)

Unfortunately, there seems to be little movement in the Class IV skim price.  The Class IV skim milk price is based on the NASS value of NDM.  As shown in Chart VII, the price of NDM is low and steady.  Based on the first two weeks of data, the Class IV skim price would be $7.14, very close to the July price of $7.16 per cwt.  This will keep the PPD well into negative territory in August.

Chart VII - NASS Survey of NDM Prices

If cheese prices continue to fall, the August Class III price will be lower than the price mentioned above which is based on the first two weeks of the four-week month.  Regardless, the August PPD will be negative.

Updates will be covered in this blog as additional data becomes available.

Dairy Outliers

What are "Outliers?"  "Outliers" is a word made popular by Malcolm Gladwell.  It refers to data that does not fit the norm.  The Coronavirus has created significant "Outliers" in dairy data.  The data simply does not fit any past data.  These dairy outliers happened so fast and are so extreme that they are difficult to understand, and accurate forecasts are impossible.  This post will focus on dairy outliers.  The "Outliers" have created significant surprises in dairy pricing, some good and some not so good.  It is also difficult to forecast when the "Outliers" will disappear and when there will be a return to normal.

The price of cheese in July 2020 reached a record at $2.59 per pound (Chart I). That price was 10 percent higher than any other prior NASS cheese price.  It is also double the price of cheese only two months ago.  The cheese price is really the driver behind most of the outliers in current dairy data.

Chart I - NASS Cheese Price for the Last 20 Years.

The price of cheese has increased the value of milk protein to new record high of $5.63 per pound in July (Chart II).  That is 20 percent higher than the previous record high achieved in 2008.  It is also 170 percent higher than the price of cheese just two months ago.

This is an especially important factor for producers because the amount of milk protein can be increased through feed additives that at the current protein price provide a huge ROI.  Increased protein levels are always worth the cost of feed additives, but at $5.63 per pound, the financial returns are a great opportunity,

Chart II - Milk Protein Prices for the lat 20 Years

The Class III price (Chart III) did not reach a record high in July at $24.54 per cwt.  However, it was within four cents of being a record high.  The prior high occurred six years ago.   The Class III price increased over 100 percent in just two months.

Chart III - Class III Milk Price for the Last 20 Years

The spread between Class III and Class IV milk prices reached $8.14 per cwt.  The July spread was 34 percent higher than the prior record high which occurred in 2004.  The financial impact of this spread was covered in the prior post.  The change in the formula for Class I milk has made the spread as shown in Chart IV a major factor in driving the Producer Price Differential (PPD) negative.

Chart IV - The Spread Between the Class III and Class IV Milk Prices
for the Last 20 Years

Chart V illustrates the PPD for the Northeast Federal Order.  The PPD differs for each Federal Order and the Northeast Federal Order was chosen for this chart because it is a large Federal Order and because it has a balance of milk usage covering all four milk Classes.  The chart covers the PPD for all months starting in 2000 through June 2020.  The negative PPD in June is 126 percent greater than the previous low PPD which occurred in 2004.  In just one month it has dropped by $6.71 per cwt.

A negative PPD leads to de-pooling which leads to an even higher negative PPD.  What causes the negative PPD?  Escalating cheese prices have traditionally caused negative PPDs, and now with the new Class I formula, a large spread between the Class III and Class IV price as illustrated in Chart IV (see Chart II in the prior post) can also cause a negative PPD.

Chart V - FMMO #1 PPD for Last 20 Years

What do all these "Outliers" mean?  The first notable fact is that dairy "Outliers" like this have no precedent.  There is no history to follow.  "Outliers" usually disappear quickly, however, the current pandemic is far from over.  People are still primarily eating at home and buying their groceries at retailers.  Food service is still in a major slump. The Coronavirus Food Assistance Program (CFAP) is also far from over.

Prices as followed on the CME show significantly declining future cheese prices.  It seems reasonable that they are going down after reaching record highs.

There are currently no answers or basis for when the "Outliers will be replaced by more normal analytics, but the data will continue to be followed in future posts to this blog.