The Impact of COVID-19 on Dairy Pricing. - A look in the Rear-View Mirror

COVID-19 has changed most every aspect of life around the globe.  This post will examine the impact on the U.S. dairy industry.  The analysis below reflects primarily the impact on producer pricing of milk.

The first item to be reviewed will be the deaths in the U.S. that are related to COVID-19.  Chart I below shows a 7 day rolling average of COVID-19 deaths starting in March 2020 through the most current available data.  As reported by the CDC, the majority of these deaths result from underlying health conditions complicated by COVID-19.  The largest spike was in April with another increase in August.  Since the beginning of August to the present there is a downward trend in deaths.

Chart I - U.S. COVID-19 Related Deaths

Much of the disruption in daily life has resulted from measures such as quarantines and closing of restaurants, intended to reduce the number of deaths involving COVID-19.  Demand for dairy products changed with the closing of restaurants, schools, and other places normally frequented by people.  This led to a massive change from reduced food service demand to increased retail demand.   For instance, retail cheese sold in grocery stores is usually branded and in small packages bearing brand names such as Kraft, Borden, etc.  Cheese for food service is packaged by non-retail companies and is typically packed in large containers without consumer branding.  Because of the overnight change in demand, there were brief shortages and excesses causing significant pricing changes. The structure for providing the appropriate product for each channel is significantly different and the rapid change caused major disruption in supply and demand and thereby it caused extreme volatility in commodity dairy product prices. 

As a result, the wholesale price of commodities which are used to price producer milk changed quickly and drastically.   What is amazing is that the dairy industry changed in a matter of months to service the new high demand channels.  There are four commodities that are used to price producer milk in most of the U.S.  They are cheese, butter, Nonfat Dry Milk (NDM), and dry whey.  Cheese and butter are primarily consumed domestically while NDM and dry whey are primarily export products. 

In this post, cheese and butter parameters will be covered first as they are the most significant commodities used to price Class III milk, milk protein, and butterfat.  Some of the charts below use moving averages as they level some of the seasonal changes and month-to-month "blips."

During this time NASS prices for cheese and butter followed a similar pattern.  In April, as COVID-19 deaths spiked and quarantining was implemented, the prices of both cheese and butter first took a major drop and then increased to higher prices than before the drop. The cheese prices that followed were record setting highs for cheese.  Chart II shows the progression of cheese prices from a low of $1.12 per pound to $2.63 per pound within a few weeks.  The low prices brought some major buys at bargain prices which then resulted in shortages in some channels leading to the record setting prices.   

Chart II - NASS Cheese Prices

The butter price shown in Chart III follows a similar pattern but without record setting high prices.  The reason for this will be coved later in this post.

Chart III - NASS Butter Prices

The prices of NDM and dry whey follow different patterns from cheese and butter.  Chart IV shows a major drop in NDM prices in May with a fairly steady increase to its current price.  These prices result from international supply and demand and are only slightly impacted by domestic supply and demand.  NDM prices are used to price Class IV skim milk.

Chart IV - NASS NDM Prices

The prices of dry whey took an entirely different pattern with highs during the first four months of COVID-19 in the U.S.,  but then prices fell by nearly 20 percent. Dry whey prices are used to set the value of "Other Solids" in the Class III milk price.

Chart V - NASS Dry Whey prices

What did not change?  

The product used to represent the NASS cheese is Cheddar cheese.  USDA data separates cheese into two categories, American Cheese and "Other" cheese.  Cheddar cheese is considered an American cheese.  Chart VI shows the production of Cheddar cheese and other American cheeses.  Unlike many of the above charts, this chart shows no variation during the time of COVID-19 lifestyle changes.

Chart VI - Production of American Cheeses

Production of Butter is shown in Chart VII.  This is shown as a 12-month moving average as there are annual cycles of butter production that make trends more difficult to follow.  Butter production has been increasing in 2019 and 2020, after years of minimal changes in butter churning.  In 2020, the increases have been very significant, and with little impact from COVID-19.  

Chart VII - Production of Butter

The "bottom line is that the COVID-19 pandemic had little impact on the production of cheese and butter.

Inventories and prices of cheese and butter have made some major increases and decreases during the COVID-19 pandemic.  The changes for cheese are shown in Chart VIII.  As shown in Chart VI above, production of American Cheese has not changed much in the last three years.  In early 2019, American cheese inventories were high and cheese prices were low.  In late 2019, American cheese inventories fell, and prices increased.  In 2020, American cheese inventories found a bottom and have increased during the COVID-19 restrictions.  The current prices are likely to continue as long as American cheese inventories do not significantly increase in the near future.

Chart VIII - Inventories and NASS price of Cheese

Butter inventories and prices have taken a different path. As shown in Chart VII, butter churning has increased.  Butter disappearance from cold storage has been steady through the COVID-19 pandemic and the increased churning has therefore increased cold storage supplies.  With increased inventories, lower prices have prevailed and will probably continue for some time.

Chart IX - Inventories and NASS price of Butter

In conclusion, the "crisis" of COVID-19 has had a very significant impact especially on cheese prices.  Cheese prices are the most influential variable in producer milk prices.  While the COVID-19 pandemic continues to be a threat to the U.S. lifestyle, it appears that the worst of deaths and price volatility is behind us.  American cheese inventories are at a 50 to 55 days' supply which is "normal."  

The CFAP program has delivered some nice cash support for the dairy industry.  Now the problem that may arise will likely be the familiar one of too much milk.

This blog will continue to monitor the changes as we begin to exit the COVID-19 pandemic in 2021.

The Pricing of NDM and Class I & IV Milk

In May of 2019, the formula for Class I was changed.  The change was covered in the January 2020 and July 2020 posts to this blog.  The change in formula was intended to make hedging by processors more accurate by improving the accuracy of hedging the Class I skim8price.  The prior formula left uncertainty in hedging as it chooses the higher of Class III or Class IV skim prices as the basis of Class I skim pricing.  

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

The Class III skim price is driven by the price of cheese and the Class IV skim price is driven by the price of Nonfat Dry Milk (NDM).  Because the cheese price is driven by domestic supply and demand, it is not subject to international competition and currency rate changes.  NDM is primarily an export product and is subject to international competition, currency exchange rates, and international supply and demand.  Prior to May 2019, the volatility in NDM prices had a minimal impact on the Uniform milk price as the Class IV category is the second smallest Class of milk and the Class IV skim milk price was typically the lower than the Class III skim milk price.  With its inclusion in determining the Class I skim price on a regular basis, NDM has become a more important commodity in dairy pricing.

Because the Class IV skim price has been lower than the Class III skim price most of the time there is a $.74 adjustment in the new formula shown above.  The new formula does diminish highs in producer milk prices caused by high Class III skim milk prices because it is now always diluted by the Class IV skim price.

During 2020, the volatility caused by Covid-19 combined with the new formula changes sent producer prices in a spin.  Chart I is updated from prior posts and illustrates the variations in the price of Class I skim caused by the new formula.  During the first 13 months of the new formula, the variation was "as expected."  In July, August, and September of 2020, the impact was huge and disastrous to Class I pricing, the "Uniform" price, and the Producer Price Differential.  Because the new formula averages the Class III and Class IV prices, the impact on the Class I price did not take advantage of the high Class III prices during this time period.  

Chart I - Impact of the Class I Formula Change

This post will focus on the Class IV skim milk price which is based on the NASS NDM price.  Some of the data will include Skimmed Milk Powder (SMP) which is similar to NDM but with some differences in specifications..  NDM is a U.S. term defined by the FDA in the Federal Code of Regulations.  SMP is a World Trade Organization term defined in the Codex Alimentarius.

In 2019, 65 percent of the U.S. production of U.S. NDM/SMP was exported.  Therefore, the pricing is primarily determined by global pricing.  Chart II below shows the export price of NDM compared to the NASS price for NDM.  The two lines on the Chart II are nearly identical.  This confirms that the NASS price is really determined by global events as mentioned above.

Chart II - NDM export prices vs. NASS prices for NDM

NDM and SMP are so similar that the prices for the two products are very close.  Unfortunately, the international price of NDM is typically a little lower than the international value of SMP.  Chart III plots the global prices of SMP from Europe and New Zealand.  The "European" prices are based on export prices from Germany and the "Oceania" prices are based on exports from New Zealand.  As shown in this chart, NDM commands a lower price than SMP, however the prices do have a tight correlation.  When one goes up, the other goes up and vice versa.  All data in Chart III is based on the price at the point of origin.

Chart III - Global prices for SMP and NDM

Charts IV and V illustrate the comparison of production of SMP/NDM and production of just SMP by the three leading exporters.  Chart IV shows that the U.S. is second to the E.U. in total production of SMP/NDM.  New Zealand is a much smaller producer.

Chart IV - Production of NDM/SMP

However, as shown in Chart V, the U.S. is a small player compared to the E.U. and New Zealand in the global market for SMP specifically.

Chart V - Production of SMP

Chart VI illustrates the growth of U.S. production of NDM and SMP.  During the last five years, the U.S. has grown the production of SMP by 8 percent annually while the U.S. production of NDM has increased by only .5 percent annually.  When combined, the annual increase in SMP/NDM is two percent.

Chart VI - U.S. Growth of SMP/NDM Production

How has this impacted U.S. pricing of NDM and the Class I and Class IV milk prices?

Chart VII shows the NASS price of NDM for the last 20 years.  It has hit highs of over $2 per pound in 2007 and 2014, but these are outliers.  Over the last 20 years, the NDM price has averaged $1.10 per pound.  The current price of $.97 per pound is below the average and some improvement can be expected.  However, the increase will be limited as the U.S. has excess NDM to "dump" on international markets.  That will in turn adversely impact the Class I milk price, the Class IV milk price, the "Uniform" milk price, and the Producer Price Differential.   

Chart VII - Long-Term NDM Prices

When the NDM price is at the long-term average of $1.10 per pound, the Class IV skim price would be $9.90 per cwt. and the Class IV price at current butterfat prices would be $14.81 per cwt.  For the long term, that would be as good as it gets.

There is debate as to whether the new formula for Class I pricing should be reversed back to the old formula.  Perhaps a better alternative for producers and processors would be to use only the cheese price as Class III milk now amounts to half of total milk usage.  Processors would be able to hedge the Class I skim price and producers would not have to suffer the volatility of international prices.