Where did the Current Dairy Problem Come From?

In some of the previous posts to this blog, we have established that cheese pricing, as influenced by supply and demand, has led to the current economic woes of the U.S. Dairy Industry. More milk goes to cheese than any other category and the Federal Milk Marketing Order payment system is based primarily on cheese prices. How did we get too much cheese, who did it, and when will it be corrected?

In this post, we will examine what led to the current dilemma and what it will take to return to high milk component pricing.

In the July 26 post, we showed how the growth of cheese consumption in the U.S. has been extremely steady. In this post, the other side of the supply/demand equation will be studied. In other words, cheese production will be studied independent of cheese consumption.


A number of countries have been reporting accurate cheese production numbers for nearly 40 years. This includes the following list of countries:

• Argentina


• Australia


• Brazil


• Canada


• New Mexico


• New Zealand


• USA

With the exception of the European Union (EU), the list includes all the major cheese producing countries.

The chart below shows the growth in cheese production year by year for all these countries combined. Starting in 2006, world cheese production started to exceed the normal growth illustrated by the straight line on this chart. By 2008, cheese production was above the straight line growth by a greater amount than ever seen in this nearly 40 year history. There was just too much cheese in the world.

Throughout most of 2008, the U.S. cheese markets were protected by an unusually weak USD which made U.S. cheese cheap on the global market. Dairy producers responded by increasing herd sizes and, thereby, increasing milk production.


The next chart (below) breaks the overall chart (above) for cheese production into its U.S component and the non-U.S component. Both were above the "normal" growth line, but the non-U.S. production was significantly higher (above the long term growth line) than the U.S. cheese production.

So what countries were responsible for this spurt in the growth of cheese production? The U.S. neighbors, Mexico and Canada, have steadily increased production but in an orderly manner, staying close to the long term growth line.

Australia has been erratic, but was below the long term growth line for 2007 and 2008.

The EU27 do not have 40 years of accurate data, but when the 10 years of available data is reviewed, the problems do not seem to be in the EU.

So what countries does that leave? Argentina, Brazil, and New Zealand are significant contributors to the oversupply of cheese.

What does all this mean?

Given that cheese is a global commodity with standards and interchangeability, the conclusions can only be analyzed in the global market.

The U.S. is cutting back milk production primarily by reducing cow numbers. By sometime in early 2010, cow numbers in the U.S. will probably be back to the early 2007 levels. Will this solve the problem?

As long as there is global excess, the problem will not be solved. There will continue to be too great a supply for the global demand. Prices may improve, although not drastically, until the global equation of supply and demand comes into balance. A return of the weak dollar could temporarily help the U.S., but would probably be temporary.

The only way to win is for the U.S. to become the most efficient cheese making force on the face of the earth. Capitalist ways will bring this about, but it will be painful for the dairy industry. Milk producers must learn how to produce milk protein at the lowest possible cost and cheese making and cheese logistics must become extremely efficient. Genetics, feed, and geography are a few of the key variables.

The U.S. has not consistently won the global price wars. Steel, automobiles, clothing, and information technology are just a few of the industries that have lost to global competitors.

So who is coordinating the efficiency effort for the U.S. dairy industry?

Indicators Show Improvement Ahead

The leading and underlying dairy industry indicators are starting to show improvement. Exchange rates, import statistics, export statistics, and cheese pricing are all trending in a favorable way for the U.S. dairy industry.

The key exchange rate for the New Zealand Dollar vs. the U.S. Dollar is trending to more normal levels. There is, however, still a good way to go if it is to reach the 2008 levels.


As a result, cheese imports from New Zealand appear to be coming off their highs which were reached from the end of 2008 through the first quarter of 2009.


Cheese exports, although not at 2008 levels, are improving and are at levels that were only exceeded in 2008. Will they continue to rise? It all depends on the global price of U.S. Cheese which is largely determined by exchange rates.

The increased levels of support prices has had a dramatic impact on cheese prices on the Chicago Mercantile Exchange (CME). Little of this, however, will influence August Class III prices due to the lag in National Agricultural Statistical Services (NASS) cheese pricing.

There is one statistic that is not positive - cheese inventories are at historical highs. These inventories will have to be worked down before real price increases in cheese can develop through supply and demand.

The USDA released their monthly Livestock, Dairy and Poultry update on August 19. These forecasts do not attempt to make adjustments caused by exchange rate fluctuations. They predict increases to $11.53/cwt for Class III Milk in the fourth quarter of 2009.

To see a significant change in milk prices, the many domestic actions to reduce cow numbers will have to be accompanied by favorable exchange rates so that U.S. Cheese is financially attractive on the world market. The U.S. buys it's cheese on the world market.

Make Allowance Changes hurt Class III Prices

The Federal Milk Marketing Order (FMMO) pricing model uses formulas to determine the prices paid to the milk producer. These prices are based on a system which takes the prices of the end products like cheese, butter and dry whey and subtracts the cost of making these products to arrive at the value of the raw materials (the milk and milk components). The higher the cost to make the product, the less the raw material is worth.


In most competitive manufacturing environments, the cost to make the product typically drops from year to year as improved production techniques and automation improve the efficiency of the operation. It appears that manufacturing efficiencies are not being realized in the dairy industry.

Between the beginning of 2007 and the end of 2008, the make allowances in the formulas increased dramatically.



The cost to product cheese went from $.165 to $.2003, a 21% increase

The cost to product butter went from $$.115 to $.1715, a 49% increase

The cost to product dry whey went from $.159 to $1991, a 25% increase

While international events have put great financial pressures on the cheese markets, the Cheese processors are getting a bigger allowance.

What does this mean for the milk producer?

Regardless of where the cheese and butter prices are, it takes $.8149/cwt out of every milk check.


Protein is worth $.11/lb less!

Butterfat is worth $.07/lb less!

Other Solids are worth $.04/lb less!

Class III Skim Milk is worth $.60/cwt less!

Class III milk is worth $.81/cwt less!

It is obvious that these make allowances were increased when milk prices were high, and there was money to spread around. However, now that the dairy markets have collapsed there is no downward change to the make allowance.

To have a successful national dairy industry all parts of the production and distribution chain must become brutally cost effective. It seems like the milk producer is the one feeling all of the pressure and all the pain.

Cheese Production, Imports, and Exports - Doing the Cow Math

Publication of U.S. and global dairy numbers usually have cheese production in kilo metric tons (kt) and cheese import and export numbers from different countries also expressed in kt. It is hard to relate these numbers to the U.S. dairy industry and even more difficult to judge how their changes can impact supply and demand for cheese and therefore for milk and milk prices.

In this post, everything will be expressed in U.S. type cows numbers - something everyone in the dairy industry can relate to.

All calculations are based on numbers which are based on assumptions. For this quantification, the "assumptions" are based on 20,443 lbs of milk per cow per year (USDA 2008 average) and 9.8 lbs of milk to make a lb of cheese (International Dairy Foods Association conversion factor). In reality, processed "American Cheese" requires less milk because other ingredients are added to real cheese.

NEW ZEALAND CHEESE EXPORTS

In 2009, New Zealand is expected to produce 395 kt of cheese and consume 28 kt of cheese. The remaining 367 kt are exported.

The 367 kt is equal to 390,000 U.S. cows.

(It takes nearly twice as many New Zealand cows to make the equivalent amount of cheese.)

CHANGE IN U.S. CHEESE EXPORTS

In the first 5 months of 2009, the U.S. exported 42 kt of cheese. In the same 5 month of 2008, the U.S. exported 60 kt of cheese.

The decrease of 18 kt over 5 months is equivalent to 46,000 U.S. cows.

At May export rates, this would equate to 53,000 fewer cows needed than in 2008.

U.S. IMPORTS OF CHEESE FROM NEW ZEALAND

In the first 5 months of 2009, the U.S. imported 15 kt of cheese from New Zealand.

This 15 kt is equivalent to 38,000 U.S. cows.

This was 6.9 kt greater than in 2008.

INCREASE IN NEW ZEALAND PRODUCTION OF CHEESE

From 2006 to 2008, New Zealand increased annual cheese production by 80 kt.

This increase of 80 kt is equivalent to 85, 000 U.S. cows.

INCREASE IN U.S. PRODUCTION OF CHEESE

From 2006 to 2008, the U.S. increased annual production of cheese by 196 kt.

This is equivalent to 208,000 U.S. cows!

FUTURE INCREASES OF CHEESE IN NEW ZEALAND

In the next 5 years, New Zealand is expected to increase cheese production by 66 kt annually.

This increase of 66 kt is equivalent to 70,000 U.S. cows.

The comparisons could go on and on, but maybe this helps relate what has happened to cheese and cheese prices and therefore milk prices. However, it certainly leaves a number of questions.

• What will happen to the additional 66 kt of cheese that New Zealand will be making?
• Will New Zealand cheese be cheaper than U.S. cheese on the global market? In the U.S? Will the U.S. dollar get weaker and lower the price of U.S. cheese on the global market?
• How far will U.S. cow numbers have to be reduced to bring the global demand for cheese in line with production? Will other countries reduce their herd sizes?
• How can U.S. cheese making become more efficient? For years, the "make allowance" had increased and increased indicating that making cheese is becoming more costly.

A few of these questions will be analyzed in future posts to this blog.

Your comments please!