Commodity Inventories Determine Prices. Where do Commodity Inventories Stand?

Producer milk prices are determined by formula from the prices of four dairy commodities: cheese, butter, Nonfat Dry Milk (NDM), and dry whey.  The prior two posts (January 10 & December 20) covered where these commodity prices were in 2020 and where the futures prices of these commodities are going.  The four commodity prices are largely determined by available inventories.  When there is a lot available, prices will be lower than when commodities are scarce.  

This post will examine the inventory levels and prices of cheese and butter over the last three years and where they currently stand.  Because NDM and dry whey prices are determined by global inventories they will not be covered in this post.  Cheese and butter prices are the main determinants of butterfat, milk protein, and Class III milk prices.  NDM which is not covered in this post has a strong influence on the Producer Price Differential.  Dry whey prices are used to set the price of Other Solids in milk and has a small influence on producer milk prices.

Monthly changes can be very volatile and therefore can be misleading and difficult to follow.  The data in this post is based exclusively on twelve-month moving averages.  Twelve-month averages decrease the volatility of seasonal and monthly swings and allow better visibility of where the market is and where it may be going. 

In some of the charts below, there are "blips" in around March and April 2020.  That is when the impact of COVID and the drastic shifts in consumer demand started.  The changes were drastic, and it took a while for the production and supply chains to manage the changes.  That time has passed, and those changes should be considered as a one-time event that has passed.

Data for 2020 is available through November 2020.

BUTTER

The price of butter determines the price that all Federal Milk Marketing Order producers get for butterfat.  Therefore, the price of butter is very important.  There is a inverse correlation between butter inventories and butter prices.  In the last few years butter prices increased to record levels as inventories were tight.  During 2020 the inventories levels increased, and butter prices dropped to more typical levels.

Chart I below provides a very clear view of the correlation between butter inventories and butter prices.  During 2018 and 2019, inventories were very low and prices were high.  In 2020, the inventories increased, and prices tumbled.  The inverse relationship here is very clear.

Chart I - Butter Inventories and Prices

In turn, this begs the question as to why the inventories were low and what changed to increase the wholesale availability of butter.  The answer to this is somewhat complex with multiple variables contributing to these inventory swings.

The first thing to be covered will be butter production (churning).  Chart II illustrates the increase in butter production.  Since the start of 2018 to the end of 2020, U.S. butter production has increased by 13 percent.  This is well above the increases in domestic demand.  Therefore, it resulted in an increase in inventories.  Milk production of butterfat has continued to reach new record highs and new capacity for churning has also contributed to the increase in butter production.

Chart II - Butter Production

Chart III below repeats the above chart with domestic production of butter and adds a comparison to butter domestic disappearance from cold storage.  Toward the end of 2020, the area in the circle on Chart III, shows the increasing spread of higher domestic production and a static level of domestic disappearance.  Obviously, this will contribute to larger inventories.  But this chart also shows that in 2018, production was well above disappearance.  During that time, butter prices were still high, and inventories were low (Chart I).  The answer to that is exports and imports that will be covered next.

Chart III - Butter Production and Butter Disappearance

Butter exports and imports have made some significant changes in 2018 through 2020.  Butter exports (Chart IV) were high in 2018 and early 2019.  This contributed to the low butter inventories and high prices in 2018 and early 2019.

Chart IV - Butter Exports

Butter imports in Chart V are the exact opposite of the export chart above.  Imports were low in 2018 also contributing to the low butter inventory levels.  In 2019 significantly more butter was imported to meet demand.  Additionally, imports of Irish butter branded as "Kerrygold" continued to grow significantly.  In 2020 as U.S. butter inventories grew, less butter was imported.  Also noteworthy in Chart V is the March "blip" in imports.  This can be attributed to the drastic changes in dining caused by COVID and can be considered as a one-time event.

Chart V - Butter Imports

Taken together the exports minus imports are shown in Chart VI as "Net Exports."  Note that the "Net Exports" are all negative numbers, meaning that the U.S. is consistently importing more butter than the U.S. is exporting.  Chart IV on exports had a swing of two million pounds with reduced exports.  Chart V on imports had a swing of three million pounds with increasing exports.  Together, this results in the chart below on "Net Export" which has a four-million-pound reduced swing.  

Chart VI - Butter Net Exports

With "Net Exports" negative, the inventory of butter has remained low through the late 2019.  As butter production started increasing in 2020 butter inventories grew to a higher-level reducing butter prices. The futures market as covered in the prior post showed an increase in butter prices in 2021.  However, based on the current inventory levels and the current trends, there is little reason to expect higher butter prices.

CHEESE

Cheese inventory levels are always more difficult to analyze as the basis for the Agricultural Marketing Service (AMS) survey of cheese prices is based strictly on "young" cheddar cheese and the inventory of "young" cheddar cheese is not public.  The data below is based on the inventories of American cheese which is composed of around 70 percent cheddar and the remainder is a mix of other cheeses.

Chart VII below shows the relationship between American Cheese inventories and the AMS price of cheese.  While the inverse relationship is similar to the one for butter (Chart I), in 2020, the relationship does not consistently show the inverse relationship.  The rapidly changing cheese prices in March 2020 set off a rollercoaster of cheese pricing.  It appears that the relationship is only beginning to normalize currently.  As will be shown below, the cheese production and inventory levels do not support the 2020 pricing, because confusion and early buy-ins upset the normal pricing process. 

Chart VII - American Cheese Inventory and Pricing

Production of Cheddar cheese was pretty normal in 2020.  From the beginning of 2018 to the end of 2020, production of Cheddar cheese grew by six percent.  Variances from the trend line never exceeded 2 percent.  Currently production is above the trend line.  

Chart VIII - Production of Cheddar Cheese

Imports of American cheese do not vary much and amount to only about one-half of a percent of production, so they have very little impact on inventories.  American Cheese "Exports" and "Net Exports" are shown in Charts IX and X. They are down in 2020.  COVID has reduced travel to Mexico and upset the Mexican economy.  Mexico is the largest importer of U.S. cheese. 

Chart IX - Exports of American Cheese

Chart X - Net Exports of American Cheese

Domestic disappearance is shown in Chart XI.  While domestic disappearance did have a blip in the month of April 2020, it has recovered and appears normal.

Chart XI - American Cheese Domestic Disappearance

Overall cheese inventories seem to be in line with strong production and normal disappearance levels.  The price of cheese as determined by AMS seems to be high (Chart VII) and the cheese futures for 2021 covered in the prior post are expected to drop a little in 2021. This seems reasonable.  The big factors influencing cheese inventories is higher production and reduced exports. 

SUMMARY

The summation of the above is pretty clear.  Butter inventories will not shrink in 2021 and therefore prices of butter will remain at normal long-term levels.

Cheese inventories are reasonable.  Production of Cheddar is reaching record highs.  The increases in production outweigh the disappearance.   Exports to Mexico, the U.S. largest customer will probably remain depressed in 2021.  This could lead to some slippage in price.  That is the same forecast as in the prior post where futures prices were reviewed.

What Does 2021 Look Like?

The prior post reviewed how the year 2020 compared to 2018 and 2019.  This post will review how the year 2021 may look based on current futures prices compared to 2018, 2019, and 2020.  Futures prices can change quickly, but this post will review how the current futures for 2021 compare to the three prior years.  All Federal Milk Marking Order (FMMO) pricing data used in this post is now complete for 2020.

The futures information below will cover the same areas as in the prior post, covering the four commodities used to price producer milk, cheese, butter, Nonfat Dry Milk (NDM), and dry whey.  It will also examine 2021 futures pricing for Class III and Class IV milk.

One of the big issues in 2020 was the huge spread between Class III and Class IV milk prices.  The new pricing formulas for Class I skim milk have made the price of Class IV skim milk extremely important because the price of Class IV milk is now always in the Class I milk price formula.  It was previously in the Class I formula only when the Class IV skim milk price was higher than the Class III skim milk price. The spread between Class III and Class IV milk prices in 2019 was one of the five factors discussed in November 22, 2020 post to this blog for causing negative PPDs.

The four commodities used to price producer milk will be reviewed first.

Chart I below shows the futures prices for cheese in 2021. While January's price is low, overall, the 2021 pricing is positive.  On the average, the cheese price is $1.85 per pound, slightly below 2020 but higher than 2018 and 2019.  This will make the Class III milk price and the price of milk protein relatively high.  For details on the relationship between the cheese price and the Class III milk/milk protein prices, see this post.

Chart I - Futures Cheese Prices

Chart II shows the futures prices of butter in 2021.  Prices for butter were extremely high in 2018 and 2019.  In 2020, with higher butter inventories, the price dropped significantly.  In 2021, some price improvement is expected and will bring the average price slightly above 2020, but still well below the 2018 and 2019 prices.  The price of butter is the basis for pricing butterfat for the Federal Orders.

Chart II - Futures Butter Prices

NDM is primarily an export product and is subject to international supply and demand, currency exchange rates, and other international events.  The 2021 price of NDM is expected to be well above the prices in the prior three years (Chart III below). 

NDM is the basis for pricing Class IV skim milk. The Class IV skim price is in turn used for pricing Class I and Class II skim milk and the combination of the three Classes, I, II, and IV, has a significant impact on the average or Uniform price of producer milk.  Because both domestic and international factors influence the price of NDM, there will be changes and volatility, but for now the increases in the NDM price is very good news for producer milk prices.

Chart III - Futures NDM Prices

Chart IV shows the futures prices for dry whey.  The price of dry whey is also very dependent on international forces and can change quickly and can be volatile.  Dry whey prices are the basis for pricing "Other Solids" in the Class and Component pricing formulas.   The 2021 monthly pricing of dry whey varies within a very tight range between $.43 and $.44 per pound.

Chart IV - Futures Dry Whey Prices

Overall, the futures prices of the above four commodities are positive.  In the charts below, the impact of these commodity prices is shown for Class III and Class IV milk.  The prices of Class III and Class IV milk are also the basis for pricing Class I and Class II milk.  

Because the Class III milk price is primarily dependent on the price of cheese, the Chart I cheese prices above and the Chart V Class III prices below show a very similar pattern.  See this prior post to review the relationship between the cheese price and the Class III price.  The 2021 futures market is showing an average price of $17.94 per cwt. for Class III milk. This is a good price, higher than 2018 and 2019 and only slightly lower than the 2020 price for Class III milk.

Chart V - Futures Class III Milk Prices

Chart VI shows the futures prices of Class IV milk.  Because the Class IV skim milk price is based entirely on the price of NDM, Charts II above and Chart VI below have a very similar pattern.  The average 2021 price of $15.64 per cwt. of Class IV milk is well above the 2020 price.  The 2020 price of $13.49 per cwt. is well below the futures prices for 2021.  The low 2020 price had a severe financial impact of producer milk prices.  The reason for this severe financial impact will be covered in Chart VII and VIII below.

Chart VI - Futures Class IV Milk Prices

Chart VII shows the comparative 2021 prices of Class III and Class IV milk prices.  When the new Class I formula was developed, it changed Class I pricing from being based on the higher of Class III or IV milk to being based on the average price of Class III and IV milk plus $.74 per cwt.  During 2020, when Class III prices were high and Class IV prices were low, this caused an unusually negative impact on the Producer Price Differential (PPD) and kept producer milk prices lower than before the change in the Class I formula.

Chart VII - Futures Class III and Class IV Milk Prices

When the spread between the Class III and Class IV milk prices is greater than $1.48 per cwt, the impact of the new formula will price Class I milk lower than the previous Class I formula.  See this prior post for an analysis of the Class I formula change. This situation will continue to have a negative impact on the PPD through July 2021 and will only have a positive impact on the Class I price beginning in August 2021.

Chart VIII - Spread Between Class III and Class IV Milk Prices

What does all this mean for producer milk prices in 2021?

Based on the current futures prices, 2021 should be a good year for producer milk prices and will have an increasing positive impact as the year progresses. The price for milk protein will be consistently good and butterfat prices will be increasingly good.  A producer that concentrates on component levels in his milk will have a very good year financially.

During 2020, the low price of NDM and Class IV skim milk contributed to large and consistent negative PPDs.  If prices remain as they are currently traded on the futures market, the slight decreases in the Class III price and the significant increases in the Class IV milk will lessen the negative PPDs and help create positive PPDs toward the end of 2021.

The futures prices above were based on data from early 2021.  Futures prices can change rapidly and NDM and dry whey prices can change very quickly based on both domestic and international events.