In the US, projected dairy farm margins continue to edge lower to near or below break-even for most farms. While feed prices dropped slightly, milk futures prices fell more over the last month. As a result, the average MPP margin for the year is around $7.75/cwt – a level that would result in payments for the top tier of MPP coverage. Using USDA net milk income data, a $2/cwt drop puts most dairy farms into negative margin territory. US dairy farmers are starting to see lower prices in milk checks, which is expected to lead to slower growth in milk production this year. However, dairy farmers in Europe and Oceania are still enjoying relatively high milk prices, so the signal to slow output has not reached them yet.
US milk production growth has slowed to 1% vs. year ago for 2 of the last 3 months – the smallest increases since Q2 2016. Cow numbers have declined slightly, albeit only 7,000 head from the peak, and weekly dairy cow slaughter data shows only a small increase vs. year ago in December. Therefore, a noticeable increase in culling of the nation’s dairy herd has not yet started and likely won’t for several months. As noted above, farm margins are expected to be negative at least into the spring. Conventional wisdom would say that will result in increased cow culling and farm sell-outs. However, the growth of large farms could offset losses from smaller farms. I’m still forecasting milk production to increase around 1% for the year – less than the long-term growth rate of 1.5%. A recovery in dairy prices by mid-year is dependent on a slow-down in global milk supplies with the US being the first to hit the brakes.
The main story for global dairy markets continues to be the strong recovery in European milk production. While comparisons to Q4 2016 are easy due to the voluntary production cut-backs, a 6.1% gain in November is still robust – the equivalent of the US growing 9%. Nearly every country in the EU-28 posted solid gains in November with the largest volume increases coming from Germany, France, UK, and Italy. Dairy farms have not yet received a signal to slow output, but should soon. European dairy farms have been quicker to adjust milk production when prices dictate. If that holds true this year, European milk production would slow by mid-year. But if it doesn’t, dairy product prices will continue to be weighed down by too much supply. In addition, any attempt by the government to help dairy farmers could mute the signal to slow output and only prolong the price slump.
New Zealand’s weather is negatively impacting milk production with December output falling 6% vs. last year. The cold, wet spring set cows and pastures back to start the season, and after a brief period of favorable weather, the summer has turned hot and dry. Due to the weather challenges, Fonterra recently reduced their forecast for milk collections this year and are now expecting 4% less milk than last year. Given their importance to global trade, the supply reduction from NZ is supportive to prices.
The January 16 Global Dairy Trade (GDT) auction saw a rally in prices, the largest percentage gain since November 2016, reflecting lower volumes offered and heightened concern over weather conditions in New Zealand. Whole milk powder prices are forecasted to remain within a narrow range around $3,000/MT. While global dairy demand is growing, it is not enough to offset the supply growth in the major export regions. Until supplies start to head lower, prices have more downside than upside potential.
With the holidays over, the US cheese market starts the year with more than ample stocks. After a slow Q1 in 2017, domestic demand saw relatively good growth while exports were strong all year. With global cheese prices converging, the US has lost the edge it had in summer and fall 2017. As a result, export sales will probably be harder to secure as Europe and New Zealand are more competitive. My forecast is for the NDPSR price to dip into the mid-$1.40’s in Q1. I think CME barrel prices will spend some time in the $1.20-1.30’s while blocks trade nearly a dime higher in the $1.40’s. The wide block-barrel spreads seen last year are expected to occur again this year given the surplus milk situation in the Midwest and additional barrel capacity. I see minimal upside risk in the first half of the year, but if supplies start to contract by mid-year, there is more potential for higher prices later in the year.
In the US, butter stocks will finish 2017 near year ago levels and then start the seasonal build into the spring. US butter prices have been relatively stable around $2.20 for several months and that is expected to continue as solid end-user buying interest supports both cash and futures prices. I forecast a small drop in prices by spring and then a rebound back to the $2.20-2.25 area. One unknown is the impact from new churn capacity this summer. As of now, I see it mitigating price spikes in the fall and keeping prices in the $2.20’s. However, there is potential for lower prices given the additional supply.
In Europe, the origins of last year’s butter price spike can be traced to the fall of 2016 when production fell short of prior year. That trend continued through the first half of 2017, but showed signs of recovery in September and October as some of the additional milk found its way to butter churns. More milk into 2018 should result in more butter and therefore a recovery in stocks to above prior year levels. If that occurs, the panic that consumed the European butter market in 2017 should not reappear this year. However, the market will remain nervous until stocks build to a comfortable level.
Global butter prices are converging. NZ butter futures are trading in the $2.00-2.20 range while European futures are near the upper end of that range. Butter prices are not the model of stability, so it’s easy to think this period of relative calm won’t last for long. But it appears the supply situation is improving, which should keep prices near current levels.
The milk powder market continues to have the most bearish outlook of any dairy product given the burdensome stocks in Europe and the US. USDA showed production of combined NFDM and SMP up 3.9% vs. year ago in November. The 10% increase in NFDM offset a 12% drop in SMP, which points to weaker export demand. After revised data showed stocks moving lower in October, stocks edged higher during November and were 40% above prior year levels (or 86 million lbs). That gap will have to close before prices can move higher.
The EU intervention stocks continue to provide a bearish backdrop for the global milk powder market. Despite opposition from several countries, the EU Commission is moving to a tender offer system with variable prices for the intervention program this year. This means less certainty for manufacturers looking at the intervention program as a way to move product. It is important to keep in mind the intervention program is designed to support milk prices and not product prices. With high milk prices currently, the Commission likely has more latitude to make changes to the program. The watch-out will be what, if anything, politicians do to help dairy markets if/when milk prices fall and farmers start to complain. Given the impact Europe has on the global dairy market, any policy could have an impact across the world.
Prices across the whey complex have fallen sharply since peaking in Q2 2017. Like other dairy products, global dry whey prices have converged near $0.30. The latest Dairy Products report showed a rebound in US dry whey production in November (+12% vs. year ago) after dropping 4% in October when several plants shifted production to higher protein products. The shift to dry whey in November pushed stocks back up, 66% or 40 million lbs more than last year. One can argue this news is reflective of market conditions late last year, but it’s definitely not bullish. My forecast is for lower US prices into the spring as the market deals with burdensome stocks.
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.