November prices remain high, but cheese prices are dropping

The November Class and Component Prices were announced on December 5.   The Class III milk price of $20.83/cwt was down by only 1% from the October price of $21.02.  While both butter and cheese prices fell, protein remained high at $3.72/lb.  Because butter prices fell more than cheese prices, milk protein prices remained almost unchanged, down only .3%.  See the August 8, 2010 post for an explanation of this relationship.

The long term component price trends are shown below.  Milk protein continues to be valued well above the trend line at a value that represents historical highs, excluding the period in 2007/08 when protein was briefly priced above $4/lb.

Butter prices did fall about 4%, but this has very little impact on the Class III milk price.   The Class III milk price is dominated by the cheese prices as explained in the April 23, 2009  post to this blog.  

"Other solids" have not had much impact on Class III milk prices in the past, but the high price of dry whey is making the value of “other solids”  a critical part of the Class III milk calculation.  The price of "other solids" is determined by this formula.

Other Solids Price = (Dry whey price – 0.1991) times 1.03

In the month of November, cheese, butter, and dry whey, contributed the amounts shown in the table below to the Class III milk price.  By comparison, the contributions for November, 2009 are also shown. This illustrates the dynamics that are happening in dairy pricing.  The math behind the calculations used in the table below is detailed in the August 8, 2010 post to this blog.  

Over the last three years, the price of dry whey and therefore "other solids" has steadily increased.  While cheese and butter prices have gone up by 33% and 32% respectively, dry whey has gone up 86%.

In November, 2009 "other solids" made up 6% of the Class III price but by November, 2012, “other solids” made up 13% of the Class III price.  Whey is being recognized more as a co-product than a by-product of cheese manufacturing and is establishing its value as a food product, not a by-product..  This is a market dynamic that may be permanently shifting the Class III milk prices.  Assuming that it continues, it could have nearly a $2/cwt positive impact on the Class III milk price.

Protein continues to dominate the Class III milk check and milk protein development remains key to a producer’s revenue.

OTHER SOLIDS

Whey exports remain high helping to keep the "other solids" price high.  Because whey is a by-product (or co-product) of cheese production, the available volume of dry whey is determined by the amount of cheese produced.  The amount of whey produced is nearly equal to the amount of cheese produced on a solids basis.  At the current time, 40,000 metric tons of whey are being exported every month.  By comparison, there is about 20,000 metric tons of cheese exported, which on a dry basis would amount to about 12,000 metric tons of cheese solids.  The disappearance of dry whey is clearly driven by exports.

This has created an increasingly tight supply of dry whey.  As stocks are depleted, the laws of supply and demand result in increased prices.

CHEESE

Cheese prices as reported by NASS are currently high at over $2/lb, but they are falling rapidly.  The cheese price is the most important parameter for Class III milk pricing.  The November NASS price for cheese was $2.01/lb.  By comparison, the December 7 price for barrel cheese on the CME is $1.66/lb and block cheese is $1.76/lb.  This would indicate that NASS prices may fall by 15% in the month of December.  CME cash prices for cheese lead the NASS prices by about two weeks.

The drop in cheese prices is unusual considering the relatively tight inventories reported for October.  Cheese production remains consistent with long term trends, and exports remain well above prior year levels.  Because the reporting of cheese inventories and exports lag, this analysis lacks current data, but as of the most recently reported data, there is nothing that should be driving down cheese prices as much as is currently happening.

The drop in cheese prices currently occurring seems to be inconsistent with other data, so it may be short lived.  However, for now it is real and future Class III milk prices are dropping below $19/cwt reflecting the lower cheese prices.

BUTTER

Butter prices calculated by NASS were $1.84/lb for November.  Current CME cash prices are at $1.61/lb or 13% below the reported NASS prices.  Although butter prices have a lesser impact on Class III milk prices than cheese, this would also suggest that December milk prices will be well below October and November prices.  This price decline is also unusual as butter stocks remains at reasonable levels.

WHERE ARE MILK PRICES GOING?

Class III milk prices are headed for their own fiscal cliff beginning in December.  The futures prices show a continuation of lower Class III milk prices beyond December.  However, because exchange rates remain favorable and inventories for cheese, butter and dry whey are not high, it seems reasonable that the drop in future Class III milk prices that exist at the present time may moderate or at least not deteriorate further.

Protein up 13% - Class III over $21

October Class and Components Milk Prices were announced on November 1st.  The increases met all expectations with significant increases in all parameters, especially the most important one, protein.  Milk protein increased $.48/lb as cheese prices increased 10% and butter prices increased a smaller 5%.  See the August 8, 2010 post to this blog for an explanation of this formula driven relationship.

Chart 2 illustrates the magnitude of the protein increase.  Milk protein reached exceptional highs in 2008, driven by unusually huge exports.  Exchange rates are again impacting exports and keeping demand high.   Currently there is a big difference because, in addition to favorable exchange rates, export programs that will have a long term impact are also driving higher exports.

Milk protein made up 53% of the milk check in October (Chart 3).  Clearly, a producer trying to maximize revenue must do everything he can to maximize protein volume from his cows.  An increase of .1 lbs of milk protein per cow per day will increase revenue by $.37 per cow per day.  For a producer with 1000 lactating cows, this represents additional revenue of $135,000 per year.

Although milk protein and cheese are the big news, in the sections below, "Other Solids" will be analyzed first.  Other Solids prices are based on the dry whey price.  While inventories are low, causing the higher prices for dry whey, the production of dry whey cannot react to this shortage because the availability of dry whey is totally dependent on cheese demand.  Dry whey is the by-product or maybe the co-product of cheese manufacturing, but no one makes cheese just to get the whey.  The demand for cheese drives the availability of whey.

Other Solids

Inventories of dry whey are at six year lows.  Demand is far outstripping supply.  There is very little reason to expect this to change.  Whey as a co-product of cheese manufacturing

is a food grade product with relatively high protein (the non-casein proteins that do not remain in cheese pass on to the whey).  There is a high lactose content that gives whey a very sweet taste.  Typically it is low priced.  All these factors make whey an attractive product for use in human foods and animal feed.

Whey exports (Chart 5) remain at record levels.  These exports have more than doubled over the last 10 years.

Typically, Other Solids have not been much of a factor in the Class III Milk Price, but this may be a long term positive change.  In October, Other Solids made up 12% of the milk check or $2.47 per cwt of milk.

Cheese

Cheese prices are the real story for the month of October.  Inventories of cheese are lower than they have been since 2009 in spite of significant increases in production and demand.

The low inventories are keeping cheese prices near record levels.  Chart 8 shows the NASS prices ending with the October average price.  CME prices are typically about two weeks ahead of the NASS prices and as of early November, the CME prices maintaining prices above $2/lb.

The production of cheese continues its long term trend of increases.  Cheese is continuing to increase its dominance of the U.S. dairy industry.

Butter

Butter inventories remain tight, but not as tight as in 2010 and 2011.

Butter production continues it growth which started in 2006.

This growth in demand is really fueled by exports (Chart 12) which remain robust, but do not show much current growth.  Exports represent about 7% of butter production.

Butter markets are reaching an equilibrium, which will probably result in a softening of butter prices.  Fortunately, the price of butter does not have a large impact on the Class III Milk Price.  The math behind this is explained in the April 23, 2009 post to this blog.

Where is it all going?

The rest of 2012 looks very good.  The increased price of cheese to over $2/lb appears to be holding and can be expected to maintain the Class III Milk Price above $20/cwt for the remainder of 2012.  Although the futures market is not expecting the price to stay above $20/cwt in 2013, there is good reason to expect the above $20/cwt prices to continue into 2013.

Milk Prices hit $19

On October 3, September Class and Component Milk Prices were announced.  Class III prices were exactly $19/cwt up $1.27 from the prior month.  During the last month, prices for cheese, butter, and dry whey have moved up rapidly, positively impacting all the dairy financial statistics concerning milk revenue.

The increases are positive for improved dairy cash flow, but high dairy milk prices can also have a long term negative impact on consumption.  The first section below analyzes the impact of high milk prices on retail cheese prices which in turn negatively influence consumption.

The 8% increase in butter prices vs. the 5% increase in cheese prices held protein to only a 4% gain.  This relationship can be reviewed in the August  8, 2010 post to this blog..

All three component prices are running above their historic levels.  As Chart 2 shows, the value of other solids is becoming a factor.  The other solids value is calculated based on dry whey prices and is therefore linked to cheese production and whey demand.

Payment for protein remains the dominant part of the milk check.  This relationship has been consistent for a long time and reinforces the growing importance of cheese as well as the need for higher levels of milk protein.  The producers' best strategy is to do everything possible to increase protein production.

Why is $20/cwt milk not good for the dairy industry?

In 2007, when milk prices reached $20/cwt, producers received a nice bump in their revenue line.  As we know, this was quickly followed by a severe drop in milk prices.  Part of this was the sudden changes in exchange rates which negatively impacted the U.S. export competitiveness, but there was also a negative impact on domestic consumption which decreased demand for cheese.

As can be seen in Chart 4, the high milk prices forced cheese makers to increase their prices which of course led to an increase in the retail price of cheese.  That increase resulted in a drop of 2%  in per capita consumption which has never recovered. 

Following the 2008 drop in consumption, the long term trend of increasing cheese consumption continued but at a slower rate as illustrated in Chart 5.  There have been additional price increases in 2010 and 2011.  The drop in consumption and the slower growth rate now account for a 5% decrease in domestic consumption as compared to where consumption would be if the growth trend prior to 2007 had continued.

The conclusion is obvious.  High prices for milk will dampen demand in the long term and therefore hurt long term demand for dairy products.  This leads to increased volatility in milk prices. 

Because the price of Class III milk is linked closely to the price of cheese (see blog post for April 23, 2009), everything that influences the price of cheese directly influences the price of milk.

The remainder of this post covers movements in the parameters that determine the price of milk (August 8, 2010 post).  The most impactful is cheese, followed by butter, and dry whey.  They will be reviewed in that order.

Cheese

The NASS cheese price for September was $1.86/lb, an increase of $.10 from the prior month.  That is certainly not a high, but the early October prices on the CME are approaching record highs, with cheese blocks reaching $2.09/lb.  The NASS prices typically follow the CME prices with about a two week lag.  This relationship was covered in the October 2, 2011  post to this blog in the cheese section.  Based on current CME prices, it is likely that October will see another significant increase in cheese prices.

Inventories of cheese fell at the end of September.  Charts 7 & 8 show this inventory drop graphically. The tighter inventories will also be contributing to increased prices in October. 

Unfortunately export data for August and September is not yet available.  The export data through July shows record levels of exports.  With a weakening of the USD in August and September,   exports should be even higher than in the last reporting month of July.

The near term future for cheese prices is very positive.  However, higher retail cheese prices are a concern because they will cause a future drop in demand.

Butter

Butter prices for September were $1.83/lb, an increase of $.13 over the prior month.  October prices on the CME are currently $1.91/.lb, so barring underlying changes, the butter price for October will probably show another increase.

Butter inventories are continuing to tighten as shown in Chart 11.  

And butter production keeps increasing but can't seem to keep up with demand.

Exports are the drivers of increasing demand.  The very high levels of exports in 2008, caused inventories to be low and prices shot up as a result. Inventories are again increasingly tight and spikes in exports may again deplete stocks.

Other Solids

The price for other solids increased more than any other milk component.  The 15% increase was driven by the price for dry whey which was up 9%.  Whey exports remain high as shown in Chart 13.

Whey inventories have been declining for 5 years putting upward pressure on the price of dry whey.  

As a result, the value of other solids has increased to a respectable $.40/lb.

The Future

Exchange rates are favorable for exports, inventories of cheese, butter, and dry whey are low and the CME prices for all dairy products are increasing.  It certainly looks like milk component prices will show additional increases in October. 

The current high feed prices will probably keep producer margins positive but not excessive.  When prices reached $20/cwt previously, there was a significant increase in the number of cows which contributed to oversupply and very low prices the next year.  While high feed prices are not positive for the producer, they should have the impact of keeping cow numbers within reason.

August Milk Prices Show Significant Increases

August Class and Component milk prices were announced on August 29.  The Class III milk price increased to $17.73/cwt from $16.68 in July, a 6% increase.  The increase was driven by 5% increase in cheese and a 10% increase in butter.  The size of the increase in butter was unexpected.

Chart 1

These changes have slightly altered the make-up of the Class III milk price shown in Chart 2.  In July, protein made up 54% of the milk payment and in August, it made up 53%.  While the milk protein price was up just 3% and butterfat was up 11%, it is important to note that the factors influencing the payment chart were only slightly affected.  By far, the most important component for the dairy producer is still milk protein.  The most important goal of the dairy producer who wants to increase revenue is to find ways to increase milk protein pounds.  This typically involves an increase in milk production and an increase in milk protein percent.

Chart 2

The long term trends remain very positive.  Butter increased to the level of its recent trend line as shown in Chart 3 and milk protein continued to increase above its long term trend.  As will be discussed below, there is reason to believe that in the short term butterfat will continue to increase in price faster than milk protein.  However, in the long term, milk protein prices will increase more than butterfat as both consumer consumption and exports drive higher demand for cheese.

Chart 3

CHEESE

Demand for cheese continues to grow and production also continues to grow to meet that demand.  Over te last twelve years, cheese production has increased nearly 40%.  There is no reason to expect this trend to change.  Per capita consumption in the U.S. has not reached European levels and has shown steady growth over time.

Chart 4

Exports of cheese remain very healthy (chart 4) with a record June export level (Chart 5).

Chart 5

Since 2006, cheese exports have seen a very steady and healthy increase.  Currently industry assistance programs are well positioned to support U.S. exports of dairy products and cheese appears to be the strongest segment of this growth.  Chart 6 shows a 500% increase in the volume of cheese exports during the last 12 years.

Chart 6

Cheese inventories are remaining in balance between production and demand.   Charts 7 and 8 illustrate that there are no significant bubbles or severe shortages in cheese inventories which could disturb pricing.

Chart 7

Chart 8

BUTTER

Growth in demand for butter has been very different for cheese.  Per capita consumption has been stable with slight growth in the last eight years.  Demand has developed based on population growth, a slight increase in per capita consumption, and exports.  Butter production has grown more than 45% over the last 12 years.  Comparatively, butter production has grown faster than cheese production.

Chart 9

The growth is driven primarily by exports.  Note the higher export levels shown in Chart 10 in 2008 required increased production as shown in Chart 9 for 2008 and 2009.

Chart 10

Butter exports created an inventory shortage in 2008 which was recovered in 2009 with lower exports and continued high butter production.

Chart 11

Butter has reached equilibrium in 2012.  Good production and exports well below the 2008 record year let inventories return to normal levels.  Recently butter inventories show a little shortage developing which is starting to have an impact on pricing.

OTHER SOLIDS

Other solids pricing is driven by whey prices.  The USDA formula is;

Other Solids Price = (Dry whey price – 0.1991) times 1.03.

Dry whey is a major export item which has seen growth of nearly 250% over the last 12 years.

Chart 12

Whey inventories shown in chart 12 have been decreasing as demand has increased.

Chart 13

Whey is a by-product of cheese manufacturing.  It consists primarily of lactose and non-casein  proteins.  Whey is finding higher value uses and is becoming more in demand, but production is limited by the amount of cheese produced.  As can be seen in Chart 3, "Other Solids" has attained a higher value in the last two years and may stay or even increase further in value as demand outstrips supply.

LOOKING AHEAD

NASS cheese prices for August were $1.77/lb and butter prices were $1.69/lb.   As has been demonstrated in other posts to this blog, the NASS cheese prices lag the CME by about two weeks and butter prices track very closely.  Chart 14 shows the tight correlation between CME and NASS butter prices.

Chart 14

At the end of August, CME prices for cheese blocks were $1.82/lb and cheese barrels were $1.78/lb.  Both were very close to the August NASS prices of $1.77/lb which is used in the milk protein pricing calculation.  However, butter prices on the CME on the last day of August were $1.84.lb, well above the average NASS prices for August of $1.69.

Table 1

In the immediate future, it seems fairly certain that butter (and therefore butterfat) will increase faster than cheese (and therefore milk protein).  Remember that as butter increases in value, it has a positive impact on butterfat prices and a negative impact on the value of milk protein.  As of the date of this post, Class II milk futures for November and December 2012 are at $19.97/cwt.