Milk Production

Milk production in the US continues to grow around 2% vs. prior year and is expected to remain near that level barring any unforeseen weather issues. Over the last month, lower milk futures prices and higher grain/feed costs have reduced the projected dairy farm margins for the 2nd half of the year. However, margins remain profitable, cow numbers are at a 21-year high, and milk production is expected to continue to grow 1.5-2.0% through 2017. There are important regional differences however. California output continues to decline with 1.1% losses in April and May. In Wisconsin, recent moves to rbST-free milk by major processors were likely the main reason May production dropped below year ago (-0.7%) for the first time since April 2014. These 2 states produce roughly half the butter in the US, so it is not surprising then to see the lower US butter production figures. Milk is growing in the Southwest (TX, NM, CO) to fill new plant capacity while milk growth in MI, NY, and PA is straining plant capacity in that region. Through May, nearly 109 million lbs of milk was dumped in the Northeast order (up 32 million lbs or 41% vs. 2016) while 47 million lbs of milk was dumped in the Mideast order (up 6 million lbs or 16% vs. 2016).      

After almost a year of declines, made worse by voluntary cutbacks in Q4, milk production in Europe showed signs of growth in March and April, albeit modest. In May, several countries posted solid growth – Ireland +7%, Poland +3%, and UK +1%. However, the Netherlands are starting to see the impact of the cow herd reductions with a 1% drop year-over-year. Both Germany and France remained below year ago in April and May output in France remained weak, down 3% vs. last year. With a profitable milk price, milk output is expected to continue to slowly expand in the 2nd half of the year and into 2018.   

For the Southern hemisphere, the outlook for Oceania and South America has improved from the last 1-2 seasons. Fonterra is projecting an opening price of $6.50/kg milk solids for the 2017-18 season – up from $6.15 in 2016-17. They are forecasting 2-3% growth in milk supplies for next season. Milk output in Australia should also recover, but at a slower rate than NZ given the challenges within the domestic industry. Finally, key producers in South America, Brazil, Uruguay, and Chile, are experiencing year-over-year growth, while Argentina is getting back to flat.     

Overall, milk production in the main exporting regions – EU, US, and Oceania – is transitioning from a period of contraction into growth mode. Growing supplies of milk and dairy products in the 2nd half of this year and into 2018 are expected to moderate price increases, particularly for butter.  

Speaking of butter, to meet growing demand for butter, dairy farmers in five eastern Canadian provinces recently approved a 5% dairy quota increase, effective July 1. This is the largest one-time quota increase since the system was implemented nearly two decades ago. According to AgCanada.com, the quota policy covering Prince Edward Island, New Brunswick, Nova Scotia, Quebec and Ontario – collectively called P5 – previously implemented incremental quota increases totaling 7% between August-December 2016. This action has 2 potential impacts on dairy markets. For butter, the increased production would lessen Canada’s needs for imports, particularly from the US. However, the resultant skim milk could end up in products destined for export and possibly depress prices. Anecdotal reports say this is already happening. As a result, various countries are actively exploring potential responses including a WTO appeal. 

Dairy Market Outlook

After a spring mini-rally, the GDT price index has levelled off and fallen slightly in the last 2 Events. While the world seems to be short of butter/butterfat, it has ample supplies of milk powders and whey products. With milk production trending higher in key exporting regions in the 2nd half of the year, dairy product supplies should also increase into 2018. Without a corresponding increase in demand, the additional supply could likely put downward pressure on prices, especially milk powders. Not to be overlooked, recent weakness in whey and lactose prices could be an early sign of a broader dairy market downturn.      

Cheese

US cheese prices started to diverge from global prices last month and the gap has opened wider in recent weeks. Heavy domestic supplies, particularly barrel cheese, have pressured prices lower. Retail demand remains sluggish with total cheese sales down 2% vs. year ago through mid-June. With prices in Europe and NZ in the $1.80’s and 1.90’s, US cheese exports are competitive. May exports were 48% above last year and the highest volume since March 2014. It is expected the strong export pace will continue, which should provide some support to prices. I continue to believe US cheese prices will post seasonal increases by Q4 and range from the $1.50’s to the $1.70’s, but with a wide block-barrel spread of 10-20 cents. 

Butter

If you regularly track butter prices, you likely find yourself extending the scales of the price graphs each week. Butter prices in Europe continue to set new record highs climbing to over $3.15 this week. However, prices in New Zealand and the US have levelled off in the last few weeks. As noted earlier, US butter production has suffered due to lower milk output in California and Wisconsin. US butter stocks saw an average increase during May with May 31 stocks at 314 million lbs, which were 3.5% lower than last year. In isolation, the US fundamentals point to prices in the $2.00-2.25 area. However, the global fat deficit, particularly in Europe, has driven US prices to the $2.60’s. With lower milk and butter production during the summer and fall months, along with the threat of hot weather (and higher ice cream demand), butter prices could increase into the $2.70’s and 2.80’s in Q3. Given the interest in end-user coverage, it seems unlikely there is much downside at this point. An improvement in milk/fat production will help rebuild butter stocks, but the timing is likely more 1st half 2018 than 2nd half 2017. Butter prices are expected to remain high and volatile until late in the year.   

NFDM/SMP

In contrast to butter prices, NFDM/SMP prices have moved lower over the last month. While the large mountain of SMP stocks remains in the EU intervention program, tender offers were accepted by the European Commission in recent weeks in the mid-$0.90’s. This will likely have the effect of establishing a soft cap on prices for at least a few months, if not longer. After seeing signs of a recovery in the spring, forecasts were raised with prospects of prices over $1.00 by fall. However, reality has set in once again, and the price outlook is lowered to the $0.80’s and $0.90’s through the end of the year. With buyer demand slowing, the upper end of that range could even prove to be difficult to achieve given upcoming gains in milk production in Europe and Oceania. A telling sign of slowing US demand is the increase in stocks in May despite near flat production and strong exports, implying weak domestic demand. In addition, the push to get more butter also results in more NFDM/SMP, so that could also depress prices. 

Whey Products

The rally in whey prices that started last fall is over and prices are now moving lower. The US NDPSR price has sunk to the mid-$0.40’s as stocks are building. The USDA Dairy Market News prices are more reflective of current conditions with both Central and West prices in the low to mid-$0.40’s. However, there are also reports of offers in the $0.38-0.40 range. Prices in New Zealand and Europe are also both moving lower. Reports out of China note soybean stocks are at a 5-year high and the government has directed end users to utilize more soybeans, so whey usage could fall. I expect prices to continue to decline in the 2nd half as Chinese demand has slowed and production has increased. 

While I thought lactose prices would slowly move higher through the balance of the year, they have reversed directions in recent weeks. The European price on GDT fell to $0.38/lb ($839/MT) on July 4 – down about 14% in a month. Like dry whey, lactose stocks have also been increasing with a large jump during May. Despite the recent weakness, my forecast is for prices to stabilize and remain steady for the second half of the year in the upper $0.30’s ($850-875/MT). However, any additional weakness in whey would likely push lactose prices down as well. Demand for SMP standardization is reportedly solid, but the shift into higher protein whey production is generating additional lactose. 


 

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.