Game Changer

Fundamental changes in what drives U.S. dairy industry prices are happening quickly.  The changes from fluid milk to processed products like cheese and yogurt have been going on for decades.  The change from a domestic market to global market is newer, and more complex.

The focus of this post will be Nonfat Dry Milk (NDM)/Skim Milk Powder (SMP).   The amount of NDM/SMP produced is growing as fast or faster than yogurt or cheese.  The big difference is that the majority (52% YTD) is exported.  That means that the price is not determined domestically, but internationally.

In 2013, the U.S. became the world's leading exporter of NDM/SMP.   In the first four months of 2014, exports continue to be very strong reaching a monthly record export level of 60,358 metric tons in May.  For the first five months of 2014, exports have averaged 48,011 metric tons per month, 10% above 2013 levels.  It appears that the U.S. NDM/SMP exports will maintain a leadership position in 2014.

The majority is being exported to Asian countries, half way around the globe.  The big competitors to supply this market are Europe and New Zealand.  Obviously, New Zealand has a freight advantage when exporting to the Asian markets and Europe had the advantage of being the leading exporter in the market for the last three years.  In spite of these advantages for New Zealand and Europe, the U.S. significantly expanded exports of NDM/SMP to the Asian markets in 2013 and became the leading global supplier.

Country by country exports for 2013 can be seen below.  The top three are the strong contenders for this market.  Australia is a smaller player and India's participation in this market has been sporadic.

The total export market for NDM/SMP has increased steadily, growing by 50% over the last five years.  There is a significantly growing global market and the U.S. has become the leader.  Can it continue?

The U.S. has a very diversified list of customers.  The sales to Mexico, the Caribbean, and South and Central America represent long-term customers who are not easily served by the EU or New Zealand.  However, the majority of exports go to the other side of the world where there can be significant competition from the EU and New Zealand.

Prices for NDM/SMP are determined globally, not domestically.  The chart below shows the comparative prices for U.S. west coast (where NDM/SMP is exported to Asian countries) vs. Oceania.  This essentially compares U.S. West coast export prices to New Zealand's prices.  Both prices are FOB the export location.  This data shows that prices are falling and that the U.S. prices may be overpriced currently.    It also shows that the U.S. West coast pricing is tied to the global markets.

WHAT DOES THIS MEAN TO U.S. MILK PRICES?

The NASS prices are used in many of the U.S. formulas for milk pricing.  The chart below shows the NASS price vs. the West Coast prices for NDM/SMP.  They are virtually identical.  This is the next step in the logic of tying U.S. prices to the global market.

The price of NDM/SMP is the basis of Class IV skim milk pricing.

Class IV Skim Milk Price = (NFDM Price−0.1678) x 8.91

Class II skim milk is priced as follows:

Class II Skim Milk Price = Advanced Class IV Skim Milk Pricing Factor + 0.70 

The Advanced Class IV price is calculated like the component Class IV price with slightly different timing in the determination of the NASS NDM price.

Class I skim milk is based on the higher of the Class III or IV advanced pricing.  As reported in the prior post, Class IV skim milk price is running above the Class III skim price most of the time.

This means that producers paid on the advanced system are receiving a higher price for their milk because of the global NDM/SMP prices.  That means that producers paid on the component system receive a higher producer price differential because of global NDM/SMP prices.  The majority of California producers are partially paid based on the higher price of NDM/SMP on the global market.  See the February 15, 2014 post to this blog for more details.

NDM/SMP has clearly entered the global market.  How long will it be before cheese and butter are based on global conditions?  To some extent they are now, just not to the extent of NDM/SMP.

This is a game changer for U.S. dairy producers.  It does increase volatility in U.S. milk pricing.  It does increase the importance of dairy components, especially protein.  What is the key to success in this environment?  Being the low cost producer globally is the next challenge for the U.S. dairy industry.

Class III still above $20 / Class IV Near a Record High

On July 2, the June Class and Component  Prices were announced.  Cheese and milk protein prices were down, but butter and butterfat were up significantly.  The Class III price was $21.36/cwt., down $1.21/cwt. from the prior month.  The comparison to the prior month is shown below.

To put this in perspective, the June 2014 prices are also compared to the June 2013 prices in the chart below.  As can be seen in this chart, the June 2014 prices are quite positive vs. one year ago.  While the June compared to May chart shown above presents a negative picture, it is only negative because of the exceptional prices seen in the earlier month of 2014.

The chart below shows the long term trends in component pricing.  Butterfat is at record price levels and other solids remain near record highs.   Butterfat, which is currently worth $2.45/lb. is at a price level that has only been exceeded once before, ten years ago in April 2004.   The price of butterfat is mathematically linked to the price of butter.

The price of milk protein has dropped to  $1.37/lb. in the last two months.  This represents a 29% drop.  The reason for the drop has mostly to do with the dramatic price increase in the wholesale price of butter.  Milk protein's value is based on two factors, the wholesale price of cheese and the increased value of butterfat when it is used in cheese rather than butter.  Of the $1.37/lb. drop in the value of milk protein, $.93/lb. is caused by the increased value of butterfat. Only $.44/lb. has resulted from a decrease in the value of cheese.  For a more detailed analysis of the math behind these calculations, see the August 8, 2010 post to this blog.

The other important development in June, was the very strong Class IV price.  Currently the Class IV price is $1.77/cwt. higher than the Class III price.  When the Class IV skim price is above the Class III skim price, it becomes the basis for Class I pricing.   The Class IV skim price is also used to calculate the Class II skim price.  This has a positive impact on the producer price differential for those paid on the Federal Milk Marketing Order Component system, and also has a positive impact on the Class I skim milk price for those paid on the Federal Milk Marketing Order Advanced system.  For a full review of the importance of Class IV pricing, see the February 25, 2014 post to this blog.

The Class III/Class IV price differential as expressed in the CME futures market indicates a continuance of Class IV prices above Class III pricing for the next three months.  While both prices are expected to see some decline, the higher price for Class IV is expected to continue.

Rabobank has recently released their Q3 global dairy market analysis.  As usual, it is very informative.  The U.S. dairy industry has become increasingly involved and increasing dependent on exports to the global dairy market.  This puts U.S. dairy industry pricing very much dependent on international developments.  The Rabobank report sites very strong milk production increases in the EU and New Zealand, the two largest global exporters of dairy products.  They also expect significantly reduced imports from China.  Because U.S. dairy prices have not YTD significantly declined, they are projecting H2 price declines for the U.S. due to increased global supplies.

New Zealand is the main supplier to China, so if China reduced purchases, New Zealand would have to look to new International markets to find a home for their huge export business.  This would increase international competition and could significantly reduce international dairy prices resulting in lower prices and reduced volumes of U.S. dairy exports.

On the other hand, the U.S. Dairy Export Council recently released a paper on China's growing imports of dairy products.  This paper may have a longer term viewpoint, but the two recent releases from reliable sources seem to be at odds.

Adding to the complexity of the analysis is the make-up of the export items.  China imports primarily whole milk powder and the majority comes from New Zealand.  Whole milk powder is a market that the U.S. does not significantly participate in.  The U.S. is the world leader in nonfat dry milk/skim milk powder exports but China imports only about 10% of the U.S. nonfat dry milk/skim milk powder exported.  These facts would suggest a limited impact on U.S. exports.

The first half of 2014 is finished.  Additional H1 data for analysis will soon be available and additional analysis of this data will be posted to this blog later this month.