At this time of year, milk production is seasonally increasing in the northern hemisphere (US and Europe) while heading towards the winter/dry season in the Southern Hemisphere (Oceania and South America). Compared to the start of the year, the milk production prospects have brightened for Europe and New Zealand, while the US continues to post impressive growth.
In the US, milk production grew 2.3% vs. year ago in February (leap year adjusted), making it the sixth consecutive month of gains over 2%. Cow numbers increased another 4,000 head during the month and stand at a 20-year high, thereby providing plenty of firepower for additional milk growth this year. Weakness in California and the Pacific Northwest was more than offset by growth in the South Central Plains, Upper Midwest, and Northeast. Milk processing capacity limits have already been exceeded in the Northeast and the upcoming spring flush will create additional headaches handling milk.
Oceania production remains below year ago as slight growth in New Zealand is offset by continued weakness in Australia. In February, Australian milk output was 6.8% below prior year with all states producing less milk than February 2016. However, New Zealand milk output was up 0.6% from the prior year while milk solids were up 3.3%. The additional solids will likely increase product availability in the second half of their production season.
The European Commission recently forecasted a 0.6% increase in milk production for 2017 in Europe. While the number of dairy cows is expected to decline by 1.6%, increased efficiency in milk output per cow of 2.0% pushes the total production higher. The shrinkage in the herd is partly due to a loss of 380K cows from the Netherland’s Phosphate Reduction Plan. Milk production is expected to be about flat vs. year ago in Q2 with modest gains in the second half of the year. Milk prices have recovered to the low to mid-30’s, enough to stimulate production. Ireland is off to a slow start given poor winter weather, but other countries such as France as seeing milk output near year ago levels.
In the US, growth in milk production has found its way to increased cheese production. In February, total cheese output was up 2.1% vs. year ago with American cheese up 5.4%, but Mozzarella was down 1.7%. Cheese exports were up 8% in February, but with weak domestic demand to start the year, stocks grew at triple the average pace during the month. Milk production will hit seasonal highs in Q2, which will translate into more cheese production.
Unlike cheese, butter production has been lagging year ago levels in recent months. Exports have been higher than last year, but represent a small portion of production. Similar to cheese, domestic butter demand has weakened, partly due to restocking to start the year along with a later Easter. As a result, butter stocks grew at the double the average rate in February and stood at the highest level for the date since 1993. However, this has not yet translated to lower prices due to tightness in the global market.
Milk powder production is higher in the US given stronger milk output and surplus milk in parts of the country. Despite a solid export pace, stocks in February grew to 20% above last year’s level.
The outlook for the dairy market has weakened from the start of the year as supply fundamentals have proven to be not as bad as expected and demand growth has been modest at best. After falling in February and early March, the GDT price index has posted two small increases over the last month, largely on the back of stronger WMP prices. The outlook for the 2nd quarter is for prices to remain range bound with potential weakness in SMP given the intervention stocks situation in Europe. Just three months ago, the EU Commission was starting to offer SMP for sale out of intervention with expectations for a slow draw-down in stocks as the year progressed. Now, rather than an outflow, new production will soon enter the intervention program. As a result, the mountain of milk powder that has limited any price recovery in SMP will grow larger, further pushing any recovery out into 2018.
In January, I included a graph with US all milk prices over the last 20 years and pointed out the occurrence of roughly 3-year cycles. For subscribers to that theory, 2017 is the next cycle high. However, at this point, prices are not shaping up to approach the levels seen in 2014 or 2011. So, is this really a cycle “high” year? Or have we seen a structural change with the removal of quotas in the EU? The truth could be somewhere in the middle. The GDT price index is over 40% higher than last summer’s lows. US milk prices are also above the last 2 years. In that respect, we may be seeing a cyclical high, but one that is weighed down by excessive SMP stocks (global) and a much lower cost of production (US). Another factor is the lack of commodity inflation witnessed by oil prices around $50/barrel. The price of crude oil has moved in a similar direction as dairy prices since early 2014. With a less than robust global economy, the outlook for oil prices, and commodity prices in general, is mostly sideways in a narrow range.
My outlook for cheese prices has been lowered from last quarter as the stocks build and production outlook weighs on prices. The brief journey into the $1.30’s likely spurred demand and prices rebounded above $1.50, only to roll back into the $1.40’s last week. Global prices are roughly the same as current CME spot prices, although CME futures prices are premium to both EU and NZ prices. Milk and cheese production are strong in the US – the flush will see cheese plants running full around the country. Exports are expected to be ok, but not great. As a result, domestic demand will need to keep up with supply growth. That is my assumption in the price forecast with cheese prices averaging in the $1.50’s in Q2 with a range plus/minus 10 cents. A bullish scenario is hard to dream up right now as the more likely scenario is for softer domestic demand and lower cheese prices. The second half is expected to see a recovery along the lines of last year. Much higher cheese prices will be predicated on a drop in production, something that is not anticipated at this point.
Butter continues to be the strongest performer in the dairy complex. A tight global fat market has pushed EU and NZ prices up to the US level, which should provide a floor for US prices. The supply fundamentals in the US are heavy – weak cream multiples, abundant milk supplies, and rapidly growing stocks. But that hasn’t seemed to matter as butter prices continue to trade in the $2.10 area. There is the possibility for a pullback in prices following the Easter demand period and before ice cream demand picks up in earnest later this spring. My forecast is for a continuation of the recent price trend with prices remaining in the $2.10-2.20 range for Q2 and even through the rest of the year. Deferred demand for second half coverage has supported cash prices so far this year in the face of bearish fundamentals. If the end-user bid dries up, butter prices could decline, likely below $2.00. But that could attract buyers from the export market and push prices back up. In short, while US fundamentals point to lower prices, the global market is supportive to US prices near current levels.
From the strongest (butter) to the weakest (milk powder), the burdensome stocks situation has weighed on NFDM/SMP prices so far this year and appear to be a drag on any price recovery. The positive news for SMP is that the GDT price has stabilized after dropping sharply and prices in the 3 main regions (EU, NZ, and US) are mostly aligned. In the US, large volumes of powder have traded over the last few weeks as reported by CDFA and the CME spot price has found support at $0.80. Export data for February show another strong month of US shipments with exports up 31% vs. last year and 21% higher than January. On a daily basis, February exports were the highest in nearly 2 years. Shipments to Mexico were up sharply from last year (+38%) in the face of growing concern over trade with America’s largest dairy customer. But while that all sounds positive, it likely is not enough to overcome the growing mountain of milk powder stocks in Europe and the US. As noted earlier, the SMP intervention stockpile is expected to grow and milk powder plants in the US will be full through spring flush. I have lowered my forecast since Q1 with prices expected to remain in the $0.80’s until late summer and slowly move higher to close out the year. I do not rule out the possibility of another blow-out on the downside to $0.70 if supplies overwhelm demand. The bearish scenario is at some point, everyone could have enough powder and there won’t be any buyers left. It is more difficult to come up with a bullish scenario as long as the stocks remain burdensome.
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.
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.