Dairy Market Outlook

Milk Production

The story remains mostly the same for milk production to start the year – growth in the US, but weaker in other major exporting regions (EU and Oceania). These trends are expected to continue in the first half of the year with gains in the US more than offset by weakness in the other regions. As the global market rebalances, milk prices are moving higher, which will eventually incent farms to expand production, but not until later this year.

In the US, November milk production was up 2.4% vs. year ago – the third straight month of growth over 2%. Eighteen of the top 23 states grew in milk output with the biggest gainers being KS (+11.6%), TX (+11.4%), CO (+5.9%), MI (+5.3%), and SD (+5.0%). ID, NY, and WI also posted solid gains. Cow numbers continue to move higher, providing a solid base for additional growth this year. My outlook remains the same with 2% growth forecasted for 2017.

The positive outlook in the US stands in contrast to the other major exporting regions. New Zealand is seeing the impact from several years of low milk prices combined with unfavorable weather to start this season. October milk output was down 5.5% from prior year while November was down 4.5%. Given the highly seasonal nature of NZ production, output will likely remain below year ago for the balance of the season. In Europe, the voluntary cutback in milk production has resulted in a more substantial drop in milk production in Q4. October was down 3.5% with anecdotal reports from November showing even sharper declines in a few key countries. Milk prices in both Oceania and Europe have improved and stand at or above break-even for most farms. As a result, milk production could post year-over-year growth by mid-year in Europe, but any growth will likely be modest. One watch-out is the potential for the Dutch dairy herd to be cut by 100,000+ cows due to new phosphate rules in 2018. This would be negative for milk production, but details on implementation are still being worked out.  

Dairy Products & Stocks

In the US, more milk means for dairy products, particularly cheese. Total cheese production in November was up 2.7% vs. prior year with strong gains in Cheddar (+5.9%). Milk powder production was also higher, increasing 1.2% from last year. However, butter production dropped nearly 6% below year ago levels as cream was pulled away from butter churns to holiday items. With good prospects for additional milk production growth in 2017, the production of the major dairy products (cheese, butter, milk powder) should continue to grow.  

While dairy product production is solid in the US, so is demand, particularly domestic sales of cheese and butter. Cheese stocks have declined seasonally, yet remain above year ago levels. Domestic demand for cheese has been solid, both retail and foodservice. Butter stocks have been the main story with a sharp drawdown in inventories last fall. In fact, the drop during November was the largest since 1989. Butter, and dairy fat in general, has benefitted from more positive views as the “healthy” fat. This shift in demand has pushed prices to a higher level than historically seen and is expected to continue in 2017. In addition, a strengthening economy and moderate gas prices should support continued demand growth for dairy products this year. 

In the US, milk powder is impacted more by global events than cheese or butter. The global milk powder market has rebounded from multi-year lows, largely driven by lower milk production in Europe and New Zealand. Fears of future supply problems have put a bullish tone into the market in recent months. However, milk powder stocks will act as a drag on any price recovery in 2017. In Europe, the EU Commission has over 700 million lbs in government “intervention” stocks in addition to private stocks. Combined with US stocks of over 200 million lbs, the two regions have well over 1 billion lbs of milk powder, more than enough to buffer milk supply shortages for a while. 

DAIRY MARKET OUTLOOK

For those relatively new to dairy markets, the graph below shows the cyclicality of dairy prices. Following the pattern displayed on a regular basis over the last 20 years, 2017 is expected to be at or near the next cycle high, albeit at a lower price than the past few cycles. One explanation is a lower feed cost and overall lower commodity cost environment this year when compared to 2014, 2011, and 2007-08. In the “up” phase of the dairy cycle, the tendency is for higher prices rather than lower prices. So as 2017 progresses, any bullish news could have an outsized impact on dairy markets as prices can overreact to fears of lower supplies.  

The trend for dairy commodity prices globally has been higher over the last 6 months, but with occasional pullbacks. In the two most recent GDT Events, the price index has moved lower, mainly due to lower WMP prices. With weak milk output expected to continue in NZ, GDT prices will likely see additional upside movement as buyers become more aggressive to secure product. However, the pace of future price increases is expected to slow. 

Cheese

Cheese prices in the US have settled back into the $1.60’s following a short-term rally to the $1.80’s and $1.90’s. Global prices are in the same general area, which is supportive to higher exports for the US this year. In addition, the flow of imported cheese is expected to drop as global prices have increased in recent months. New barrel cheese capacity in Texas has helped push barrel prices lower during a seasonally weak demand time. However, this new capacity will be needed this year as no other meaningful capacity is anticipated and the trade flow will result in less cheese in the US. If domestic demand continues as expected, cheese prices will trade at a higher level than last year. Price forecasts have moved higher with analysts now expecting prices to average in the mid-$1.70’s for the year. While the fundamentals remain fairly balanced, the tone has changed to be more bullish than last month. As with other dairy commodities, the expectation of less supply or fear of shortage is an important factor in pricing this year. Futures prices have moved higher over the last month as market psychology can push prices higher than current fundamentals would indicate. If anything, I can see prices moving above $2.00 in the second half if an actual shortage does occur. At this point, it is not expected, but there is relatively more risk in the second half in my opinion. 

Butter

Only a few months ago, butter prices had sunk to $1.75 with buyers breathing a sigh of relief looking ahead to 2017. In retrospect, $1.75 butter likely spurred more retail featuring during the holidays in the US, and also made US butter competitive in the export market. Numerous anecdotal reports have noted strong demand for both butter and cream exports to Canada and Mexico in recent months. The combination of strong domestic demand and higher exports led to a sharp drawdown in butter stocks last fall. Butter stocks declined by 68 MM lbs from October to November, the biggest drawdown between those two months since 1989. I was expecting a low in butter stocks of around 200 MM lbs. Instead, stocks have sunk to near 150 MM lbs. While stocks were above prior year on November 30, the reaction to the drop in stocks has been decidedly bullish. In the last few weeks of December, butter prices rallied to the mid-$2.30’s, defying seasonal trends. Prices have eased back into the $2.20’s, but a general sense of nervousness prevails. As with cheese, my price forecast has been increased to reflect the more bullish market tone. A $1.90-2.00 range in the first half is less likely than previously imagined, so the new forecast is for prices to remain above $2.00 as end-user buying is expected to be strong enough to support deferred futures and therefore cash prices near last year’s levels. With a lot of companies budgeted at or near $2.00, the past 6 weeks has probably created some anxiety around protecting their budgets. So the relief felt by buyers in October has been replaced by the more common emotion in the butter market – fear. Higher global pricing is also supportive to US prices as the narrower price differential will favor exports and discourage imports. As usual, butter remains the most difficult dairy product to forecast as “unknown unknowns” continue to impact prices, mostly to the upside. 

NFDM/SMP

The milk powder market was mixed over the last month with WMP prices pulling back and SMP/NFDM prices continuing to slowly move higher. Global prices for SMP/NFDM are usually fairly close together given the ability to switch from one region to another. However, NZ/GDT prices currently carry a premium to both US and EU prices - $1.21/lb ($2,660/MT) in NZ vs. $1.02-1.03 ($2,250-2,270/MT) in the US and EU. This gap reflects tighter supply conditions in NZ and the sizeable mountain of SMP intervention stocks in the EU. The first tender of EU intervention stocks in mid-December yielded very little in terms of actual sales, but they will conduct bi-weekly tenders to work down the pile this year. At over 700 million lbs, this will take time and provide a drag on any price recovery. However, the largest milk powder state, California, is not expected to see much growth in milk output this year. As a result, powder plants will run at less than capacity. Other regions of the country will see surplus milk head to dryers, but probably not enough to offset the loss from California. In addition, the higher NZ prices are supportive to US prices.


 

Disclaimer: Information contained within is not guaranteed, is the opinion of the mccully group, llc, and is intended for informational purposes only. Commodities trading involves risk and is not suitable for everyone. Nothing contained within constitutes a solicitation to buy or sell derivative contracts. Trading futures/options contracts should be done with licensed professional brokers. The mccully group, llc is not a licensed commodity broker nor trades in commodity futures markets.

About the Author

Mike McCully is the owner of The McCully Group LLC, which provides management consulting for dairy and food companies. For more than 15 years, Mike worked in dairy, meat, and grain management roles at Kraft Foods where he was responsible for the commodity risk management for dairy and meat, dairy policy, sourcing of dairy commodities, and corn purchasing.