Fourth Quarter Dairy Market Outlook

Milk Production

Summary: US milk production continues to post solid growth near 2% while Europe shows more signs of recovery. A watch-out is the wet spring weather in New Zealand and potential negative impact on milk output. Overall, milk supplies in key exporting countries/regions are growing. 

Milk production in Europe has turned the corner and all major countries are growing. The latest official data for EU-27 milk output is for July and shows a 2.2% gain vs. prior year – the strongest growth rate since March 2016. Unofficial data for September point to solid gains in France (+2.8%), Germany (+2.7%), and the UK (+2.2%). Combine those results with likely gains in other countries and the EU growth rate could easily top 3-4%. The majority of this additional milk will end up in cheese (and whey) or butter-powder, and will push prices lower without a corresponding increase in demand. With milk prices in Europe moving up in the last 2 months, there is additional incentive for farmers to produce more milk and growth is expected to continue in 2018.

US milk production posted 2% growth again in August, continuing a string of 44 consecutive months of year-over-year gains in milk output. Of the top 23 states, only 4 saw declines vs. last August – California, Oregon, Washington, and Idaho. Continued strong growth in the Southwest and Upper Midwest, along with a recovery in the Northeast, more than offset that weakness in the West. The nation’s dairy herd remains at 9.405 million, the highest level since December 1995. While cull rates have increased over the summer, an ample supply of heifers entering the herd has kept overall cow numbers basically flat. September milk production could see a drop-off as hot weather hit several major production areas, but the outlook is for continued milk production growth through mid-2018. If margins shrink as expected, the culling rate could pick up and tighten milk supplies in the 2nd half of next year. 

New Zealand is the main watch-out for milk production given unfavorable spring weather (cold, wet). Heavy rains have limited the ability to turn cows onto pastures. As a result, milk production fell 1.2% vs. year ago in August with more weakness reported in September. Weather conditions will improve as summer approaches, but it is not yet known how much production was impacted by the slow start to the season. While NZ is an important exporter, the milk output of Europe is 7 times larger and the US is 4.5 times larger. A 1% increase in European milk output can offset a 7% drop in NZ. Some press reports have pointed to higher prices in 2018 due to lower NZ milk output, but they don’t seem to have factored in the impact of more milk from Europe.  

Demand

Summary: US dairy product demand is mixed with fluid milk sales continuing to slide while cheese and butter experience modest growth. US exports have been a bright spot in the first half of the year, but the pace slowed for most products in July. Chinese demand is a key factor going forward. If they maintain their recent pace, China would help absorb the expected growth in milk output in Europe and Oceania.

US domestic sales of cheese and butter were both up only 10 million lbs year-to-date through July. Higher exports of most products have helped offset the weaker domestic usage. Through July, butter exports are 10 million lbs. higher than the same period in 2016 while cheese exports are 80 million lbs. higher. Look for the trends of modest domestic growth and better export sales to continue for the balance of 2017. Retail cheese sales remain sluggish – down 2% vs. year ago in the most recent Nielsen data. Some question the accuracy of traditional scanner data as more food is sold online and through non-measured channels. In any event, it is widely known that retail food sales are suffering this year and dairy is not immune to those trends.

China continues to be a dominant buyer of dairy products. In August, their purchases of WMP were up 91% from last year and were the 2nd highest August on record behind 2012. Nearly all (95%) of the WMP came from New Zealand. For SMP, imports were 64% higher than last year and a new record for the month. Given burdensome stocks, European companies were more aggressive with sales and picked up market share. While smaller volumes, both cheese and butter imports saw strong growth in August with butter more than double last year and cheese up 41%. On the negative side, whey imports fell vs. prior month (-8%) and prior year (-3%), which helps to explain recent weakness in whey prices. 

Dairy Market Outlook

Summary: Increasing milk supplies are somewhat balanced out by strong Chinese demand. Butter prices are forecasted to fall from 2017 levels while cheese and NFDM/SMP see modest downward pressure. The whey complex is mixed with higher protein products appearing to stabilize while prices for dry whey, lactose, and whey permeate have more room to move lower from here.   

A decidedly bearish tone has overtaken the dairy markets over the last month, more so for milk powders and whey products than cheese or butter. At conferences in Europe and US over the last few weeks, conversations about the 2018 outlook have been quite pessimistic. Milk supplies are increasing and stocks are expected to build, in some cases to more burdensome levels than today. But not all the news is bearish. Very strong demand by China is a key factor for dairy markets in 2018 as noted above. Simply put, if China continues to buy large amounts of milk and whey powders, cheese, and butter, prices could stabilize near current levels. If not, the outlook becomes more bearish. The trend in GDT prices over the last few months reflects a more balanced outlook between supply and demand. The major driver of the GDT price index is whole milk powder (WMP) and the price outlook is mostly stable at this point. This could limit any downside in the overall index even if prices for other products decline.    

Cheese

Summary: My outlook for US cheese prices is unchanged from last month with prices expected to remain range bound between $1.50 and $1.75 through the end of 2017. With additional capacity coming online in 2018, prices could be lower than currently forecasted.

CME cheese prices have continued the familiar pattern of rebounding from the $1.50’s back into the $1.70’s. Seasonal increases in demand along with occasional tightness in cheese supplies due to less milk available have pushed both block and barrel prices to the top end of the range seen this year. Cheese prices in Europe have been declining at the same time US prices have increased, while NZ prices have held fairly steady. US export prospects are less favorable given today’s gap and recent US dollar strength. Stocks will move lower through the fall, but remain above last year’s levels. There is always the chance of a brief run to the upside if fresh cheese supplies tighten, but the fundamentals don’t support any sustained rally in cheese prices. My outlook for next year hasn’t changed and is very similar to this year on average. On the bearish side, expected declines in European cheese prices could pressure US prices lower. However, global cheese demand seems pretty healthy, which should moderate any price declines. Like other products, upside scenarios are less likely given what we know today. 

Butter

Summary: Butter prices in the US have fallen over the last month while the rally in Europe appears to be nearing an end. Prices should be supported by holiday demand before moving lower.

After hitting $2.75 in early August, many thought it was only a matter of time until prices hit $3.00. Instead, prices gradually fell, briefly dropping below $2.30. Despite much higher prices in Europe, stocks of butter in the US are adequate and demand has softened. The nervousness from end-users in the US has decreased, but not disappeared yet. My forecast is for a slight firming of prices back into the $2.40’s in October and November during peak holiday demand. Butter has the ability to surprise, so higher prices cannot be ruled out. Prices are expected to decline post-holiday buy-in, but are likely to remain well supported by end-users locking in prices near or below budget for 2018. In Europe, December future prices have fallen just below €6,000/MT ($3.20/lb) while Q2 2018 is near €4,800 ($2.50-2.60). If these prices materialize, it takes some pressure off the US market, but is still supportive to $2.00+ prices.

NFDM/SMP

Summary: NFDM/SMP prices have limited upside given large stockpiles in Europe and the US. Low prices will help encourage demand, which could limit downside.  

At recent conferences, the gloomiest outlooks were for skim milk powder (SMP)/NFDM prices. Instead of shrinking, EU intervention stocks increased in recent months. Combine that with record high US private stocks and additional SMP exports from Canada and the mountain of supply is daunting. However, the age of most of the EU intervention stocks is well over a year with some approaching 2 years. So, the impact on the SMP market is likely less than first thought. A rumor has come out of Europe during the week of October 9 regarding significant changes to the Intervention program for next year and was immediately interpreted as bearish.

In Europe, prices for SMP have fallen to €1,550/MT with talk of €1,200-1,300/MT possible. At €1,550, that puts it near current US NFDM prices and slightly below NZ GDT prices. My forecast for NFDM is for lower prices into the $0.70’s through Q1 2018. By next spring, some modest improvement is expected with prices recovering to $0.90-1.00/lb by Q4. Like other products, additional downside seems more likely than any upside price movement at this point. However, low prices should attract demand, some from more price-sensitive customers and regions (e.g. Mexico). So, while most fundamentals appear bearish, it’s important to remember the old adage “low prices cure low prices.”   

Whey Products

Summary: Prices in the whey complex have turned lower with heavy supplies and increased competition from SMP/NFDM weighing on the market.

Dry whey prices continue to move lower with European prices showing the most weakness while US NDPSR prices lag the market. As Chinese demand has eased lower, whey prices have quickly come under pressure. Production was up 20-25% in July and August, and with faltering demand, stocks have ballooned to nearly 70% above last August. The price trend is lower in the whey complex.      


 

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.