Understanding Supply and Demand: Dairy

As with all goods and services, the prices of dairy products are determined by the dynamics of supply and demand, which in turn are affected by a variety of factors. Dairy markets are unique in that they have the potential to react dramatically to relatively small changes in supply and demand.

This module will review the primary elements that impact supply and demand for dairy products. Whether you are a hedger or a speculator, an awareness of these supply and demand elements will results in a better understanding of these vital markets.

Milk production and supply in the U.S. has been steadily increasing over the years, which can be attributed to better herd management, coupled with technological and genetic advancements that help produce more milk, from fewer cows. In 2016, the U.S. produced 212 billion pounds of milk from a herd of 9.3 million dairy cows.

Milk production takes place in every state; the top five dairy producing states are California, Wisconsin, New York, Idaho and Michigan.

One key distinction of the dairy markets, compared to other agricultural commodities, is that raw milk is produced 365 days a year. Production ebbs and flows throughout the year with the springtime, known as the milk flush, producing the greatest volume of milk. After spring, production begins to taper off as the year progresses.

Weather has always factored into milk production. Summer’s higher temperatures tend to inflict heat stress on cows, which has a negative impact on milk production. Advancements in cow comfort management has helped dairies to recuperate some of that lost production through new cooling and ventilation techniques. These techniques reduce the stress on the cows and keeps milk production stable during the summer months.

Due to its perishability, milk is not storable. Milk that is produced, but not processed into drinking milk, is either converted into cheese, butter, nonfat dry milk or dry whey. Turning milk into these storable products provides a cushion to meet demand when milk output fluctuates throughout the year.

The demand for milk and dairy products is influenced by several factors, including domestic and international economic conditions and competing dairy alternatives. In addition, the dairy industry has received some welcome reports relating to the health benefits of consuming dairy products. This has helped generate more demand for dairy products, ranging from butter to protein enriched drinks.

Domestic demand is driven at the retail and food service level. The U.S. market can consume all the dairy products it produces, leaving very little to export. This has historically been the case; however, conditions began to change in the early 2000s. While there is still only a small percentage of U.S. dairy products going to the export market, it continues to grow and develop.

The driving forces on the export side have been income growth, the demand for low-cost protein and production economics from other countries which have impacted their ability to meet global dairy demand.

The primary export markets for U.S. dairy products are Mexico, Canada, China, Southeast Asia, North Africa and the Middle East. Protein-dense nonfat dry milk and dry whey are the most demanded products. Cheese and butter are also exported in smaller quantities, but only when other areas of the world are running a deficit.

These are just some of the key factors affecting dairy supply and demand. There are many other factors that play a role in supply and demand, such as energy, interest rates and currency risk.

At every stage of the dairy market chain, from production to processing and exporting, market participants face volatility and the risk of adverse price movements caused by the idiosyncrasies of supply and demand. Dairy futures and options provide a means to manage this risk as well as to take advantage of potential profit opportunities.