Dr. Cameron S. Thraen, Associate Professor and OSUE State Dairy Markets and Policy Specialist, Department of Agricultural, Environmental and Development Economics, The Ohio State University
- What is ahead for the markets?
- How much safety in the Margin Protection Program (MPP) safety net?
- MPP margin forecast for 2015-2016
As I write this, the market focus in squarely on the international markets. Right at this moment, the turmoil in the U.S. equity market driven by concerns over the economic prospects for China is paramount. Economic growth rate for China has slowed from double digits to around 7%. While the rest of the developed countries would love a 7% growth rate, this is a much reduced level for China which needs a rate of economic growth in the range of 10 to 12% to manage its huge economy. The equity market in China has declined by 35%. Troubles with the China economy are certainly causing troubles for the rest of the world economies and only time will tell how this will all play out for the rest of us.
To the U.S. dairy industry, China’s economic impact on world markets is well understood. Just a year ago, we all were jubilant as aggressive commodity buying by China in world dairy markets, particularly for whole and skim milk powders, was driving milk prices to record levels. In the U.S., dairy production was a bit slow to take off, but as usual, it did expand, reaching full potential just as the international market made a sudden shift. First, Russia, as a retaliatory political move, imposed a near 100% ban on imports of key dairy products from the European Union countries, Oceana, and the U.S. Unable to sell cheese and butter to Russia, the European Union and Oceana moved aggressively into the milk powder market. This was the dropping of shoe number one.
The other shoe dropped when China began to pull back dramatically on import purchases in the milk powder markets. After importing a vast inventory of whole and skim milk powder in 2013 and 2014, China buying slowed considerably. With a glut of milk on the market, dairy product prices had nowhere to go but down, and down, and down. After peaking in the first quarter of 2014, nonfat and skim milk powders, whey, cheese, and butter prices on the international markets have fallen to levels not reached since 2009 to 2010. So how have U.S. dairy product prices faired during this period?
First off, nonfat and skim milk, and whey prices have followed international prices right on down. After peaking near $2.10/lb in the first quarter of 2014, nonfat and skim prices have fallen to $0.80/lb. Whey price hit its high at the end of the second quarter of 2014 near $0.70/lb and has declined to near $0.35/lb.
However, two key U.S. dairy commodity prices are showing signs of domestic strength driven by a strong U.S. retail economy and the assistance of the Cooperatives Working Together (CWT) export assistance program. The CWT program has provided export assistance for an equivalent 1.294 billion pounds of milk in the form of cheese (45.3 million lb, butter 28 million lb, and whole milk powder 33.4 million lb). As a result the U.S. cheese price, while trending down with world markets, appears to have found a floor near the $1.70/lb. The U.S. butter price appears to be a market disconnected from the international scene. While butter prices in Europe and Oceana have tumbled to the $1.10 to $1.30/lb range, the U.S. butter price has gone up from its recent 2015 low of $1.50/lb to the level of $1.90/lb now.
So how does all of this translate into farm level prices in the U.S. versus the EU and Oceana? In the August 2015 podcast by dairy economists Mark Stephenson and Bob Cropp, they show a slide depicting equivalent farm level prices (go to this site to listen to the podcast: http://dairymarkets.org/PubPod/Podcast/Outlook/). The current U.S. milk price, at $18.38/cwt compares to an EU price of $13.61/cwt and a Oceana (NZ) price of $10.61/cwt. Clearly, the economic impact is being felt much more strongly by dairy farmers in the EU and Oceana. How quickly the excess supply adjusts to the relative level of demand will depend for the most part on rapid the adjustment in milk production coming from the EU and Oceana rather than the U.S. From my reading of the international news, their economic pain is significant and the draw back could be rather swift. Some good news is that latest Global Dairy Trade Index, a composite price index of the eight traded dairy commodities, trading on September 1, is up 10.1% and this follows a 15% increase from the August 18th trading event. Perhaps a bottom to the international market has arrived.
The value of the U.S. dollar remains historically high. This makes it much more difficult for export products from the U.S. to be price competitive in international markets. The current turmoil across the international economic landscape will only serve to add strength to the U.S. dollar in coming months. The strong U.S. dollar also has a positive side in that it limits international demand for U.S. grain exports and helps keep the prices of feed lower. Prices in the key grain and feed commodity markets are at five year lows. Cash corn remains below $4/bu, with the futures market forecasting this level well into 2016. Soybeans are under $10/bu and soybean meal, while strengthening a bit, remains under $375/ton. Alfalfa hay is under $180/ton.
A natural question to ask is: “How long will the down turn in market prices last and when will prices reach bottom and turn upward? “ I do not know. A couple of dairy economists who have put their collective efforts to understanding the milk price cycle have an informative paper on the topic available on the Dairy Markets and Policy website. To read the information paper, go to Stephenson and Nicholson at: http://dairy.wisc.edu/PubPod/Pubs/IL15-03.pdf. As their conclusion, these two dairy economists state “Forecasts for the margins during the current cycle through 2017 vary from quite optimistic--‐--‐a short cycle with a limited number of months with an MPP margin below $8.00/cwt (the statistical forecast) — to a cycle close to the average length of 40 months, with a prolonged period of where the MPP margin is below $8.00/cwt (the simulation model). Futures market forecasts are similar to the statistical forecasts through early next year, then shows more moderated increases.” This puts the bottom of the price cycle sometime between January 2016 (statistical and futures market models) and January 2017 (dynamic simulation model).
Using the current (6/02/2015) futures market price data on milk and feed input prices, the USDA Farm Services Agency (FSA) Decision tool for MPP (http://dairymarkets.org/MPP/Tool/) shows an anticipated July-August margin of $7.71/cwt. Anticipated margins for the remaining two calculation periods are: September - October ($8.67/cwt) and November – December ($8.88/cwt). Looking out into 2016, the USDA/FSA tool shows anticipated margins staying above $8/cwt for the first half of 2016 and then increasing to the upper $9.00/cwt level in the last quarter of 2016. With the 2016 sign up period for MPP ending on September 30, 2015, now is the time to pay close attention to the market forecasts. Use the Decision Tool to work out your best option if you intend to purchase up from the $4/cwt level. Remember, the MPP is not a price or margin risk management program, rather it is a catastrophic loss safety-net program, operating much like a way out-of-the-money PUT option with premiums that do not adjust to market conditions. As a national program, there is neither consideration for management style, scale of dairy, nor geographic location. While the national average price for milk has fallen from the peak, so have feed prices, and by the logic of MPP, this does not qualify as a ‘catastrophic loss event’. If you are looking to manage price risk volatility, you should look to the Livestock Gross Margin-(LGM) Dairy program and the futures and options markets. If you have already signed-on to the MPP, then LGM-Dairy is off the table and then the futures and options markets remain as a viable price risk management tool that can be used along with MPP.
So what is the ‘glass half full’ take on all of this? If the U.S. economy can shake off the China troubles, gasoline prices fall as forecasted to the $2/gal mark, and U.S. retail demand remains strong for cheese and butter, then the U.S. milk price will remain substantially above that of our competitors out in the international markets. Significant production pull back will come not from the U.S. but from the EU and Oceana. And the ‘glass is half empty’ view? We become infected by the China contagion, the U.S. equity market turns to a bearish market, and retail demand weakens as U.S. consumers pull back. Cheese and butter prices move down by $0.50/lb or more, and with these, the farm price for milk declines by another $2/cwt.
For up-to-date market and policy information on the Ohio dairy industry, as well as informative charts, research papers on many industry issues, and for useful links to other sites, please visit and bookmark the Dairy Markets and Policy website: http://dairymarkets.org/ to which I contribute.