Cheese Drives the Class III price. Where are Cheese Prices Going?

Monthly, the USDA issues a report on cheese production, cheese imports and exports. cheese disappearance, and the month end inventory of cheese in cold storage.  Because the Class III price is very tightly tied to cheese prices, which in turn is tied to cheese inventories, this data can provide a very helpful analysis of the evolving health of the Class III price.

The data below will cover the following:

• Cheese Production, which is down

• Cheese Exports and Imports expressed as Net Exports

• Cheese Disappearance from cold storage, which is down

• Cheese Prices, which were up, but are starting to trend down

• Cheese Inventories, which are again growing

Most of the data reviewed will be based on 12 month moving averages.  This eliminates seasonal variations and short-term fluctuations.

CHEESE PRODUCTION

Cheese production has significantly slowed.  When there is too much milk available it is typically used for cheese production because cheese has a longer shelf life than most other dairy products.  During 2017 and early 2018, there was excess milk that was channeled to cheese.  The annual growth of cheese production reached four percent.  The 12-month moving average of cheese production is now down to an annual growth of just .6 percent (Chart I).

Chart I - Percent Growth of 12 Month Average Cheese Production

CHEESE NET EXPORTS

Cheese exports and imports were covered in detail in a recent post.  While cheese net exports were up slightly in 2019 over 2018, the growth rate was way down from prior years (Chart II).  Much of this had to do with trade agreement negotiations, primarily with Mexico, Canada, and China.

The current rates of growth mean that there is no significant relief from cold storage inventories via net exports.

Chart II - Percent Growth of 12 Month Average Net Exports

CHEESE DISAPPEARANCE

The cheese disappearance is based on reductions from cold storage.  Chart III shows the rate of decline in cheese disappearance.  This is not consumption, but withdrawals of cheese from the cheese makers cold storage.  Lower withdrawals cause a growth in cheese inventories, which in turn reduces the wholesale price of cheese. 

Chart III - Percent Growth of Cheese Disappearance

IMPACT OF WHOLESALE CHEESE PRICES ON INVENTORIES

Chart IV below shows the relationship between the price of cheese and the domestic cheese disappearance shown in Chart III above.  Clearly the cheese price, shown in red, has an inverse relationship with the domestic cheese disappearance shown in blue.  The price elasticity of demand is very clear, as the price goes up, the disappearance goes down.  The most recent cheese prices indicate a decrease in the price of cheese beginning at the end of 2019 and continuing for the first two months of 2020.

Chart IV is based on available data for the full year of 2019.  The price of cheese reached a high of $2.17/lb. in November 2019.  Since then the price of cheese has dropped every month and as of February 2020 was down to $1.79/lb., an 18 percent drop.

Chart IV - Percent Growth of Cheese Disappearance vs. Cheese Price

DAYS INVENTORY OF CHEESE

The important point of all this is that with a higher cheese price, which causes lower disappearance, cheese inventories are growing.   With decreased disappearance, inventories of cheese in cold storage are again starting to grow.  In December 2019, the inventory of cheese had grown to 36 days as shown in Chart V below.

Chart V - Inventory of Cheese

WHAT DOES ALL THIS MEAN?

The cycles of supply and demand are again working to level the needed supply to meet the demand.  In economic terms, this is known as the price elasticity of demand.  When supplies are low, prices rise and when supplies are high, prices fall.  The days of inventory reached a low in October 2019 and started growing in November 2019.  With that growth, cheese prices have dropped and so has the Class III price.  The decline in the Class III price started in November 2019 and has continued to drop every month through February 2020, the most recent month of Class III milk prices.

With the rise in cheese inventories, Class III milk prices will continue to fall.  These trends will continue to be followed in the blog.

What happened to the FMMOs in 2019?

This post provides additional detail to the recent "Progressive Dairy" article published by this author.  The year 2019 was the first year that California was included as a Federal Milk Marketing Order (FMMO).  It was also a year that saw extreme amounts of de-pooling.  When milk is de-pooled, it is not reported in the FMMO numbers although the producers are still a member.  This significantly clouds the real numbers on production and usage of milk in the FMMOs.

The article in "Progressive Dairy" provides a summary of the FMMOs.  The charts and data in this post provide details for the individual orders.  The information reported in the article and in this post includes estimates for the amount of milk that was de-pooled in 2019.  The data specifically reported in the FMMO publications does not include the de-pooled milk and as a result the reported data varies significantly from month-to-month and does not report the total milk production by the FMMO members.  Because Class I cannot be de-pooled, the de-pooling primarily reduces the amounts of Class III and IV milk.  The estimates used for de-pooled milk are based on historical information and seasonal trends.

SUMMARY OF THE FEDERAL ORDERS

In total, the profile of the Federal Orders is shown in Chart I below.  The volume of Class III milk for cheese now makes up near half of the total milk supply.  Class I milk for drinking is down to less than one quarter of the milk supply and falling.  As Class I milk continues to fall, the “Uniform” price will fall, and more de-pooling will result.

Chart I - Profile of All Federal Orders

THE UPPER MIDWEST FEDERAL ORDER

The Upper Midwest Order is the largest Federal Order and the milk from this order is used primarily for Cheese (Chart II).  In 2019, 88 percent of the milk in the Upper Midwest was used for cheese production.  About 25 percent of that Class III milk was de-pooled in 2019.

Chart II - Profile of Midwest Federal Order

Because Cheese dominates the Upper Midwest Order, the difference between the Class III price and the Uniform price is minimal.   The Uniform price is the average of the four Classes.

However, the Producer Price Differential (PPD) can become negative when cheese prices are rising.  That event involves the timing of the pricing of each Class of Milk.  If the price of cheese is rising, the Class I skim price may then be lower than the final “Component” priced Class III skim milk, creating a lower “Uniform” price and a negative PPD.  The producer would then owe money to the pool of the four Classes of milk.  To avoid this, producers (typically through their cooperative) will elect to de-pool to avoid “owing” this money.  When this happens, much of the Class III milk is de-pooled and not reported to the FMMO. 

Additionally, as of May 1, 2019, the base Class I milk price is now based equally on the skim price of the Class III and Class IV milk plus 74 cents and is calculated before the month starts via the “Advanced” pricing system. This can also reduce the Class I price causing a negative PPD, resulting in additional de-pooling.  See the January 12 post to this blog for additional detail on the change in Class I pricing. 

Also, when the Class IV price is above the Class III price, some of the Class IV milk may be de-pooled for the same reasons stated above.

THE CALIFORNIA FEDERAL ORDER

When California became an FMMO, one of the big changes was the ability to de-pool milk from all but the Class I milk for beverages. Under the previous California payment system, de-pooling was not allowed for any milk. The huge portion of California milk used in Class III and Class IV provides a large volume of milk that can be de-pooled.

As shown in Chart III, 37 percent of the milk delivered in California is used as Class IV milk for nonfat dry milk and butter.  California uses roughly 13 billion pounds of milk in Class IV production.  Other Orders use far less of their milk for Class IV.  An extreme example is the Upper Midwest which uses only 3 percent of its milk for Class IV.

When the Class IV price is higher than the Class III price it may be advantageous to de-pool as much Class IV milk as possible to avoid losing the higher price of Class IV and likely incurring a negative PPD. 

Chart III - Profile of California Federal Order

The California Order started de-pooling from its first month as a Federal Order.  It would appear that much of the motivation for becoming a Federal Order was the ability to de-pool. 

Additionally, California under their prior state-run pricing system had a mechanism for providing a premium for milk that was paid under the “quota” program.  This was maintained after California became a Federal Order and the payment system for “quota” milk was managed by the state of California.  The milk that is not covered by “quota” is accessed a fee which is used to pay the premium for the milk that is included in “quota.”  The “quota” payment factor as well as de-pooling makes the California milk that is not covered by quota and is not de-pooled, some of the lowest paid milk in the U.S.

THE NORTHEAST FEDERAL ORDER

The third largest Order is the Northeast Order (Chart IV).  The Northeast Order has a nicely balanced portfolio of milk usage.  Class I milk, typically the highest priced milk, is the largest use of milk in the Northeast Order.  Class II milk is also high priced and with 24 percent of the Northeast Order milk used in Class II production, the PPD has been consistently positive.  For that reason, de-pooling has been essentially nonexistent.

However, due to the formula revisions made May 1 of 2019 reviewed above, the Northeast did exhibit an unusual negative PPD at the end of 2019.  That may lead to increased de-pooling for the Northeast Order in the future.

Chart IV - Profile of Northeast Federal Order

THE MIDEAST FEDERAL ORDER

The Mideast Federal Order (Chart V) is about half the size of the Upper Midwest Order.  Of the Federal Orders paid by the “Component” formulas, the Mideast has the largest percent of Class I milk.  There is also a large percentage of Class III milk.  There was significant de-pooling as cheese prices rapidly increased in the last part of 2019.

Chart V - Profile of Mideast Federal Order

THE CENTRAL FEDERAL ORDER

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The Central Federal Order (Chart VI) is about the same size of the Mideast Order, but with a larger amount of Class III milk.  With 26 percent Class I milk and 49 percent Class III milk, the rapidly increasing cheese prices lead to a significant amount of de-pooled milk in final months of 2019.

Chart VI - Profile of Central Federal Order

THE SOUTHWEST FEDERAL ORDER

The Southwest Federal Order also has almost half of its milk in Class III (Chart VII.). Because of the large amount of Class III milk, there was also a significant amount of de-pooled milk in the final months of 2019 as cheese prices were increasing.

Chart VII - Profile of Southwest Federal Order

THE PACIFIC NORTHWEST FEDERAL ORDER

The smallest of the Federal Orders paid by the “Component” formulas is the Pacific Northwest Order (Chart VIII.). The milk in this Order is heavily weighted by Class III and Class IV milk.  The Class IV milk shares the same West coast export advantage as the new California Order.  The largest category of milk usage is Class III with an estimated 42 percent of the total including de-pooled milk.

Chart VIII - Profile of Northwest Federal Order

THE FEDERAL ORDERS PAID BY THE “ADVANCED” FORMULAS

The Federal Orders paid on the “Advanced” system are characterized very differently.  Together, the FMMOs paid by the “Advanced” formulas make up less than 10 percent of the milk delivered by all FMMOs.

There are four Federal Orders that are paid by the “Advanced” formulas and three of these are located in the Southeast United States.  They all share the characteristics of being small and primarily fluid milk. The profile of these three orders is shown in Chart IX.

Chart IX - Profile of the Three Orders in the Southeast U.S.

The fourth Federal Order paid by the “Advanced” formulas is Arizona.  Chart X shows the profile of the Arizona Order which is very different from the other three Orders paid by the "Advanced” formulas.  Because of its West coast location, a significant amount of the milk is used in Class IV.

Chart X - Profile of Arizona Federal Order

For additional details on the FMMOs in 2019, see the recent "Progressive Dairy" article by this author.