Improved margins will encourage production

Improved margins will encourage production

by Mark Stephenson
The author is director of Dairy Policy Analysis, University of Wisconsin-Madison.

Throughout the year, I keep track of the changing dairy scene and make changes to my nearby forecasts on a regular basis. Those changes are usually minor adjustments based on current events. I always take extra time once a year to stop and put the pieces together in a more systematic way and look at the bigger picture for the year ahead. Right now, I’m curious about the foundation laid down in 2013 which provides the structure upon which we build markets over the next 12 months.

Milk production will grow
Strong profits are the market’s way of telling producers that the market wants more product. There are many ways to measure profit, but one proxy for our industry is the milk-feed margin. Those margins have been below average for most of 2012 and 2013. However, as we enter 2014, the margins have improved nicely to well-above average. My forecast moving forward . . . margins will be even better than the current values. Those improved margins provide the signal or the incentive for producers to make more milk.

Recent high feed costs have kept gains in milk per cow at historically modest growth. Farms have simply not pushed cows to reach their full potential. But, with a better corn and soybean harvest, coarse grain prices have moderated significantly and feed will be priced in a range to pursue higher milk yields.

Additionally, with beef animals in short supply, some dairy replacements were diverted from milk production. However, there are still plenty of heifers in the pipeline, and I expect that the better margins will encourage expansion of the national herd. More cows and more milk per cow is a one-two punch for expanded milk production.

Domestic consumption data
Fluid milk sales have taken a dramatic turn south. Despite medical evidence citing the crucial need for milk consumption to promote bone density in the pre- and early-teen years, per capita consumption of milk continues its downward spiral. Some of this may be a category shift as consumers grab more yogurt for breakfast and move away from cold cereal with milk. Nevertheless, these high-valued sales are lagging.

The good news on the consumption side is that milk equivalent sales of all dairy products, on a per capita basis, are still growing. We continue to eat more cheese and who hasn’t read about Greek-style yogurt sales. Domestic sales of dairy products have been good and producing those products will require steady to moderate growth in milk flow.

Export buoy prices
Domestic sales are fine, but they wouldn’t support the kind of growth that we’ve seen in milk production over the last decade. Trade in dairy products has been favorable for both imports and exports. Imports have declined as a percent of milk production, in part because we are producing excellent cheeses domestically and in part because the U.S. dollar has remained historically weak compared to the Euro.

Export opportunities have been truly extraordinary. The graphic above shows the growing export sales of U.S. milk production as a percent of milk solids. Last year, New Zealand finished its production season in extreme drought. What looked like a very promising beginning to its season ended very poorly with total milk down 1.3 percent (June 2012 through May 2013).

In contrast, the European Union experienced excessive rain in the latter half of its season (April 2012 through March 2013) which also resulted in diminished milk production and exports from Europe. The U.S. was well-positioned to take advantage of those market opportunities.

The U.S. is still a relatively new player in the world market but we are already the third-largest exporter behind New Zealand and the European Union. It takes a while to cultivate new markets and learn your customers’ preferences.

For example:

  • We consider yellow Cheddar cheese, sold by the pound, as a standard product, while the currency of world trade is Gouda cheese sold by the kilogram.
  • We make 80 percent butterfat butter and the world wants an 82 percent product.
  • We produce nonfat dry milk when the world expects skim milk powder.

These are small, but important, differences in greater market opportunities.

We are beginning to make significant inroads into more consistent sales. Milk drying plants are adding capacity to make whole milk powder — a product of great demand in world markets. Companies are exploring new opportunities to sell unrefrigerated UHT (ultra high temperature) milk into Asian markets. Export sales growth will help to sustain our expanded milk production in the long run.

 U.S. trade in dairy products

Putting the puzzle together
Last year we crossed the milestone of producing more than 200 billion pounds of milk in this country. That is enough milk to fill more than 300,000 Olympic-sized swimming pools. I think that the U.S. will produce even more milk in 2014.

The third quarter economic growth rate in the U.S. was much better than analysts had expected (2.8 percent) and may be an indication that we are breaking out of our slow recovery from the recession. This would be good news for domestic dairy product consumption.

We can’t count on adverse weather in Oceania or the European Union in the year ahead. But even with a return to more normal production growth in those countries, demand growth from Asia is forecast to be even larger. There should be ample opportunities for U.S. companies to expand foreign sales of dairy products in 2014.

Taken together, I expect milk production to overrun domestic and export demand just slightly and milk prices to decline modestly —about 70 cents per hundredweight, on average, when compared to 2013. I also forecast prices remaining fairly flat throughout the year. This shouldn’t be viewed as bad news for producers as feed prices will be well below 2013 levels and margins will be much improved. This should be a year when many producers get a chance to restore some of the balance sheet lost in 2009 and 2012.

This article appears on page 783 of the December 2013 issue of Hoard's Dairyman.

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