Is Inflation Hitting Dairy Prices?

The news is full of inflation concerns.  This post will deal with inflation in the dairy industry, specifically fluid milk. This data used in this post is from the beginning of 2018 through May 2021.  Milk prices are compared based on per gallon prices of whole milk and two percent milk, which make up most of the fluid milk sales.  Producer milk prices are converted from hundred-weight to gallons based on 8.6 pounds per gallon.  Prices are based on 12 month moving averages to eliminate seasonal trends and short-term fluctuations.

Chart I below compares the producer milk prices with U.S. retail milk prices.  The producer prices are based on Class I prices for the Northeast Federal Order which has the largest amount of Class I milk of any Federal Order.  As can be seen in the chart, retail prices are growing while producer prices are stable. In the last 18 months, retail prices have increased by over eight percent and producer prices have declined by one percent. 

Chart I - Retail and Producer Milk Prices

The spread between the retail price for milk and the price paid to producers for Class I milk includes the cost and margins to process milk, deliver milk, and sell the milk in grocery stores and other outlets.

Chart II below charts the "spread" between retail prices and producer prices on a per gallon basis.  Over the last 18 months. the spread between producer prices and retail prices has increased by $.29 per gallon.  This is where the inflation in retail milk prices is coming from.

Chart II - Expenses and Margins to Process, Deliver,
and Sell Fluid Milk.

Below are three tables.  One is based on the U.S. retail milk price, one is based on producer prices for the NE Federal Order, and one is based on the spread between them.

The retail prices are based on the retail (grocery) prices as collected from the checkout scans of the UPC codes.  As shown in Table I, the retail price fell in 2018 as compared to 2017.  However, since 2018, the prices have been escalating.  In 2020, retail milk prices increased by over 6.2 percent compared to 2019.  There is price elasticity of demand for milk, so these increased retail prices may accelerate the decrease in sales of fluid milk.  In the time span used in this analysis, 2018 through May of 2021, the retail price of milk has increased by nine percent with the bulk of this occurring in the last year and a half.  

Table I - Retail Price of Milk

Producer Class I milk prices are calculated based on the prices of skim Class III and skim Class IV milk and butterfat.  Class III skim prices are based on the price of cheese, butter, and dry whey with cheese prices having the most impact.  Class IV skim prices are based on Nonfat Dry Milk (NDM).  See the prior post for an update of how these commodity prices are moving.  

There is no USDA link between milk retail prices and producer prices.

Table II - Producer Price of Milk for the NE FMMO

Table III has the most revealing data on where milk inflation is building. In the last18 months, processing, distribution and selling have increased their share of the retail price by 17 percent. Are the elements in this piece of the pie really incurring higher expenses that they are passing on to customers, or is the general expectation of inflation allowing some retail price increases which are improving margins for this part of the pie?  Labor costs and energy costs are increasing.  However, because many of the costs in processing delivery and selling are fixed, like depreciation, the variable costs of wages and energy would have to raise more the overall percentages in Table III.  This is unlikely.

Table III - Spread Between the Retail Milk Price and
Producer Milk Price

IS THERE REALLY INFLATION IN DAIRY?

There is clearly no inflation in the value of raw milk.  Producer prices for Class I milk are stable, not rising.  The Class I skim base price is based primarily on the price of cheese and NDM.  It bears no relationship to fluid milk pricing.

Is the inflation in retail milk prices coming from processing, delivery, and selling?  The answer is yes.  With the annual increases shown in Table III the increases appear to be more than just increases forced by rising labor and fuel prices.  There appears to be a significant increase in margins.  

Fluid milk is a commodity.  Retail prices are subject to competition.  The news has created an expectation for consumers that prices are rising.  For the dairy segment of consumer prices analyzed in this post, most of the increases have to do with growing margins.  Over time, competition will re-tighten these margins. 

As the U.S. and the world exit the COVID period with a return to "normal" many of the inflationary prices that are concerning today will lessen and will return to more normal levels.  As an example, lumber prices were strongly inflated a few weeks ago, but are already returning to lower levels of inflation.  Fluid milk prices will likely follow a similar pattern